Question 4 (45 marks)

This question relates to material covered in Topics 1-5. This question addresses the 1^st, 2^nd and 3^rd subject learning outcomes.

Westpac Banking Corporation (WBC.AX) and Commonwealth Bank of Australia (CBA.AX) are amongst four big banks in Australia. These two companies are having the highest capitalisation within the Financial Sector.

Find the monthly holding period returns for the 2017/18 financial year for Westpac (WBC), Commonwealth (CBA), and the market (MKT) as proxied by the All Ordinaries index. The monthly holding period return is the return you would receive if you bought an asset on the first day of the month (opening price) and sold it on the last day of the month (closing price). Using Excel, conduct a line graph with all three monthly returns included. The line graph will allow easy comparison of the performance of WBC, CBA and the MKT over the year with percentage (%) return results plotted on the y(vertical) axis and time (month) on the x (horizontal) axis. (Use 'Close' rather than 'Adjusted Close' for the selling price.) Note: Opening price MUST equal previous month closing price (10 marks).

For each of the three investment options calculate the average monthly holding period return (3 marks).

For each of the three investment options calculate the annual holding period return (4.5 marks).

For each of the three investment options calculate the standard deviation of the monthly rates of return (6 marks).

Use the scatter plot Excel graph function to plot your results from (3) and (4) above with risk on the xaxis and return on the y axis for each of three investments (3.5 marks).

If the 10 year government bond rate is 2.78% and the long term return on the market as proxied by the ASX is 5.85%, assuming the beta () for WBC is 1.26 and for CBA is 1.23, use the Capital Asset Pricing Model (CAPM) to find the expected returns for WBC and CBA (4 marks).

Construct and graph the Security Market Line (SML) (use a scatter plot and fit the SML line) showing where WBC, CBA and the MKT should lie (5 marks).

Based on your findings construct a portfolio made up of 40% WBC and 60% CBA. Calculate the estimated return and for this portfolio (4 marks).

Based on your understanding of the CAPM and the SML, which of these asset(s) or portfolio(s) would you invest in and which would you not invest in. Explain your choice (5 marks).