Assess the risks associated with investments for their implications on expected returns

Prompt

For this assignment, you will assume the role of a financial advisor responsible for developing investment portfolios for two clients. In developing each portfolio, you will interpret client financial information and craft sound and informed portfolios that are personalized to the unique needs of your clients. You will also select five stocks from a provided list and produce valuations by selecting the most appropriate valuation model. These valuations may also be used within the portfolios you are developing for your clients.

Specifically, the following critical elements must be addressed:

I. Client Analysis: In this section, you will analyze your clients' financial documentation and determine their risk tolerance and objectives. To effectively address the critical elements in this section, you must analyze the information for both client one and client two.

A. Analyze each client's financial documentation in order to perform the following evaluative activities. Be sure to support your analysis with relevant client information.

1. Explain the clients' risk tolerances.

2. Explain the clients' return objectives.

3. Explain the clients' liquidity objectives.

B. Using the three objectives above, give a brief investment statement classifying the clients into one of the following categories: growth, income, or capital preservation. Justify your response with specific client information.

II. Stock Analysis: In this section, you will select five stocks from the provided list and determine their values by applying an appropriate valuation model from the following options: price to multiple model (earning or sales), dividend valuation model, or free cash flow model.

A. Determine the value of each stock by using an appropriate model based on the characteristics provided for each stock; use each model at least once.

B. Provide a rationale for the stock valuation method you chose for each stock. Cite specific information to support your decisions.

C. Using the calculated valuation, the current market price, and historical performance, determine the expected return for each stock.

III. Portfolio Development: In this section, you will develop a portfolio for both clients based on their risk tolerance, return objectives, and liquidity objectives. You will select appropriate assets from the provided list.

A. For each client, develop a portfolio from the list of assets provided that is informed by your analysis of each client's objectives and (if applicable) the stock valuation you determined.

B. For each portfolio, calculate the expected portfolio return using the CAPM (beta) model.

C. For each portfolio, calculate the expected portfolio standard deviation.

IV. Portfolio Performances

A. Provide a rationale to present to each client for each of the portfolios you have developed. For each rationale, include specific examples to support your recommendations, and be sure to address the following:

1. Explain how your recommendations align with the clients' risk tolerance.

2. Explain how your recommendations align with the clients' return objectives.

B. Using the provided ex-post portfolio return statistics, evaluate each portfolio's performance and compare it to its appropriate benchmark. In your evaluation, be sure to address the following:

1. Calculate portfolio returns.

2. Calculate the Sharpe ratio for both portfolios and benchmarks.

3. Calculate the Treynor's measure for the portfolios only.

4. Calculate Jensen's measure for the period for the portfolios only.

FIN 340: Final Project Scenarios & Tables

Overview: These scenarios and tables will be necessary to complete the final project.

Client 1:

Ezra, aged 26, is single.However, he is dating and is preparing to get engaged.He will need roughly $5,000 for an engagement ring almost immediately, and expects he will need $10-15,000 for the wedding in the next 12-24 months.He is currently employed and earns about $70,000 per year in salary.This salary is enough to cover all his taxes and normal living expenses of approximately $4,800.This leaves him with about $1,000 in savings each month ($350 to 401K, $650 to savings).He has been able to save roughly $15,000 to date in a 401K plan from work and about $20,000 in cash savings.His 401K plan has been invested in 100% in the stock market, including some sector specific funds.His other savings have been in interest bearing savings and cash substitutes such as money market funds.He recently received a windfall $60,000 and this prompted him to come to you for some advice.The following are few of Ezra's comments to help guide your thoughts:

1. "I understand I am young, so I need to take on as much risk as I can."
3. "I am willing to lose 30-40% on my invested capital if the return is commensurate."
5. "I do like to have a decent sized cushion in the "bank" in case something happens at my job."
7. "I don't foresee my risk tolerance changing after I get married."
9. "Do you have any good stock tips?"

Client 2:

Jacob and Rachel, 53 and 52 respectively, are married with 4 children.Two of the children are currently in college and two in high school.They expect the other 2 children to attend college.The couple has done relatively well for themselves and earn roughly $275,000 before tax between the two of them, which equates to $190,000 after taxes.They live well below their means and this should allow them to cover all of their children's college expense out of pocket, but won't leave much for them to save over the next 6-8 years.Through savings and portfolio growth, they have managed to accumulate $900,000.To this point, they have been moderately aggressive (70 - 75% equities) with their portfolio, but feel they need to begin preparing the portfolio for partial retirement in 8 years and full retirement in 13 years.

1. "I know we still need to be somewhat aggressive, we could live until we're 90, so we need to plan for some growth even in retirement."
3. "We definitely can't afford to take a big hit in our portfolio.We don't have enough time to recover."
5. "Our jobs allow us to work part-time in retirement and we will probably do so as long as we are able."
7. "What do bond yields look like today?"
9. "I think we'll need to draw from 3-5% of our portfolio in retirement.We'd like to earn enough income from the portfolio to cover that."

CAPM Inputs (Element III & IV):Use the values as appropriate for the CAPM formula and the Portfolio Measures.

Market Return9%

Risk-free Rate0.75%

Stock Analysis Table (Element II & III):Use the information in this table to help determine the value of 5 of these stocks using the stock valuation models in Chapter 8 of the textbook (pgs. 308-324)

Symbol

Estimated Beta

Dividends per Share

Earnings per Share

Sales per Share

Free Cash Flow per Share

5 Year Dividend Growth

Average Industry P/E Ratio

Average Industry P/S Ratio

Free Cash Flow Growth

IBM

0.86

Use Last Year

Use Last Year

Use Last Year

Use Last Year

4.6%

23.7

1.12

2.60%

KO

0.66

Use Last Year

Use Last Year

Use Last Year

Use Last Year

3.2%

22.6

2.2

3.50%

BMY

0.78

Use Last Year

Use Last Year

Use Last Year

Use Last Year

0%

24.4

3.37

N/A

ORCL

1.1

Use Last Year

Use Last Year

Use Last Year

Use Last Year

21.1%

20.5

4.45

10%

MMM

0.98

Use Last Year

Use Last Year

Use Last Year

Use Last Year

7.0%

23.8

2.59

7%

BAX

0.75

Use Last Year

Use Last Year

Use Last Year

Use Last Year

-16.9%

36.09

3.68

N/A

BIG

1.04

Use Last Year

Use Last Year

Use Last Year

Use Last Year

N/A

23

1.12

N/A

NFLX

1.57

None

Use Last Year

Use Last Year

Use Last Year

N/A

52.5

6

N/A

AKAM

1.34

None

Use Last Year

Use Last Year

Use Last Year

N/A

41.8

3.58

17%

GE

1.12

Use Last Year

Use Last Year

Use Last Year

Use Last Year

6.3%

23.8

2.59

N/A

Portfolio Development (Element III) - Available Assets Table:Use the Stocks listed in Analysis Table along with these additional ETFs to build a portfolio that will meet the risk, return and liquidity objectives of the clients.

Symbol

Estimated Beta

Standard Deviation

SPY

1

13%

IWM

1.15

16.50%

EFA

1.03

15%

EEM

1.09

20%

SHY

0

1%

IEF

-0.2

6%

TLT

-0.48

13%

LQD

-0.02

5.25%

HYG

0.38

7.50%

Ex-post Returns (Element IV):Imagine that One year has passed since you developed the client portfolios in Element III.Now you will use the following table which provides the actual returns of each individual asset over the past year.Use these to calculate the Portfolio Return for both clients.

Symbol

Return

Standard Deviation

Benchmarks

Return

Standard Deviation

IBM

8%

20.00%

Growth

9.6%

13.1%

KO

6%

13.00%

Income

8.1%

10.2%

BMY

13%

28.00%

Capital Preservation

5.8%

7.2%

ORCL

2%

16.00%

MMM

6%

14.00%

BAX

-6%

16.00%

BIG

13%

32.00%

NFLX

18%

45.00%

AKAM

21%

37.00%

GE

10%

16.00%

SPY

9%

11.00%

IWM

14%

18.00%

EFA

9%

15.00%

EEM

-1%

19.00%

SHY

1%

1.00%

IEF

4%

6.00%

TLT

4%

13.50%

LQD

7%

6.00%

HYG

8%

8.00%