Reference no: EM133906027

Case Study:

You are to assess a 2-asset portfolio that consists of Westpac shares and Fortescue shares. You have been given the historical prices of these companies over the past 2 years (this spreadsheet Download this spreadsheet) in order to analyse historical performance. Assume that the risk-free rate is 3.5% per year and the forward-looking market return is expected to be 8.5% per year.

Forecast adjustments:

You note that the data you have used does not include dividend information, which you also want to include in your analysis. For Westpac, the annual dividend rate is 7.42%, and for Fortescue the annual dividend rate is 0.83%

You also note that Westpac has suffered from a large one-off event in the recent past (compliance breaches) and, thus, in your return expectations you will adjust the historical return upwards by 1.5% p.a. Fortescue, on the other hand, has had relative good luck recently and, thus, in your return expectations you will adjust the historical return downwards by 1.5% p.a.

1. Based on the daily closing prices, calculate the daily and annualised returns and standard deviations, as well as the correlations of these two stocks.

2. Using the annualised paramaters (as well as the forecast adjustments) and correlation of these two stocks from Section A, construct an efficient frontier with 21 portfolios (starting at 0% to WBC, and going up by 5% weighting for each portfolio - opposite for FMG [i.e. starting at 0% and going up]).

For all portfolios, you need to tabulate weights in each stock, portfolio's return, standard deviation, and Sharpe ratio. Be as exact as you can. 

3. Discuss the role of the minimum variance portfolio and the tangency portfolio and identify the portfolios from Part B that best represent each of these. Hint: You might use a chart to help visualise the concepts you discuss.