You Have $100,000 To Invest In 4 Stocks - Pick Each Stock Ca

You Have 100000 To Invest In 4 Stocks Pick Each Stock From A Differ

You have $100,000 to invest in 4 stocks. Pick each stock from a different sector (for example, technology, energy, consumer products, automotive). Prepare the following using Excel. Make sure that your spreadsheets are well formatted, clear and understandable. Feel free to 1) Identify the expected returns using Yahoo Finance. Look at current stock price, expected stock price in one year and the annual dividend. The expected stock price in one year less the current stock price plus the annual dividend gives you the return on your investment (expected appreciation in stock price plus the annual dividend you received). Divide this by the initial investment to get the return on your investment. 2) Once you have the expected return for each stock, identify the overall expected return. This is the return of all stocks weighted by the portion they constitute of your total investment. See slide 13-12 (from Chapter 13). 3) Develop the expected return for your portfolio of stocks using the Capital Asset Pricing Model. See slide 13-41. Assume the risk free rate is 2.6% (approximate US Treasury 10 yr bill rate). Assume the market risk premium is 6.7% (long term average stock market return, including dividends). Because of this, you do not need to add in the dividend yield of your stocks, unlike what I said in class. Calculate the average return for your portfolio of stocks. Compare the returns for each stock and the overall portfolio to what you calculated in 1) above. 4) Are there any reasons why one set of values may be different from the other? If the expected returns from 1) above are higher than those calculated in 3), it may be due to recent favorable conditions for the stock which are resulting in strong estimates for the stock price one year from now. See if you can find any reasons for possible differences.

Paper For Above instruction

The process of constructing an investment portfolio requires meticulous analysis and understanding of various financial models and market conditions. This paper aims to evaluate investment choices through a systematic approach, considering expected returns derived from market data, and comparing these with theoretical estimates based on the Capital Asset Pricing Model (CAPM). By analyzing four stocks from different sectors, we will ascertain the expected profitability and assess discrepancies between empirical and model-based forecasts.

Selection of Stocks and Market Analysis

The initial step involves selecting four stocks from distinct sectors: technology, energy, consumer products, and automotive. This diversification aims to mitigate sector-specific risks and capture broader market movements. The stocks are identified using Yahoo Finance, where the current stock prices, expected stock prices in one year, and annual dividends are analyzed. This data collection aids in estimating the realized or expected returns from holding these stocks.

Calculating Expected Returns

The expected return for each stock is calculated by adding the anticipated appreciation (the difference between the expected stock price in one year and the current stock price) to the annual dividend, then dividing by the initial investment. Mathematically, this is expressed as:

Expected Return = [(Expected Price in 1 Year - Current Price) + Dividend] / Current Price

This calculation provides a grounded estimate based on recent market data, reflecting the likely gains if the stock performs as expected.

Portfolio Expected Return

Once individual expected returns are determined, the overall expected return of the portfolio is computed by weighting each stock's return according to its proportion of the total investment. Given an equal investment of $25,000 in each stock, the weighted average simplifies to the average of the individual expected returns. This process aligns with principles outlined in typical financial modeling (see Slide 13-12 from Chapter 13). It offers an aggregate measure of prospective portfolio performance based on empirical data.

CAPM-Based Expected Return

The Capital Asset Pricing Model (CAPM) offers a theoretical approach to estimating expected returns considering systematic risk. Using the risk-free rate of 2.6% and a market risk premium of 6.7%, the model posits:

Expected Return = Risk-Free Rate + Beta * Market Risk Premium

Where Beta reflects the sensitivity of each stock to market fluctuations, obtainable from Yahoo Finance or other financial sources. For this analysis, the average return across stocks is calculated using CAPM, assuming a beta of 1 for simplicity unless otherwise specified. This yields an expected return reflecting the compensation investors require for market risk exposure.

Comparison and Analysis of Results

Comparing the empirical expected returns with CAPM estimates often reveals variances. Higher empirical returns may result from recent favorable market conditions, positive news specific to the stocks, or optimistic analyst forecasts. Conversely, CAPM assumptions are grounded in market efficiency and systematic risk, potentially underestimating or overestimating actual returns based on firm-specific factors.

Reasons for Discrepancies

Differences between the observed (empirical) and theoretical (CAPM-based) returns can be explained by several factors. These include temporary market optimism, recent earnings surprises, macroeconomic developments, or sector-specific catalysts. For instance, a technological breakthrough or a surge in energy demand can temporarily inflate expected returns in that sector, leading to higher empirical estimates compared to CAPM's systematic risk compensation. Conversely, underestimated beta values or unforeseen economic downturns can cause CAPM estimates to be conservative.

Conclusion

This comparative analysis underscores the importance of integrating both empirical data and theoretical models in investment decision-making. While market-based estimates capture current sentiments and short-term prospects, CAPM offers a disciplined framework considering risk-return trade-offs. Investors must consider both approaches, alongside qualitative factors, to optimize portfolio performance. Recognizing the reasons for divergences aids in refining investment strategies and understanding market dynamics more comprehensively.

References

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• Investopedia. (2022). Expected Return. Retrieved from https://www.investopedia.com/terms/e/expectedreturn.asp
• Yahoo Finance. (2023). Stock screener and data analysis. Retrieved from https://finance.yahoo.com
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