FRANKLIN UNIVERSITY MBA737 EQUITY ANALYST PROJECT.
Franklin University MBA737 Equity Analyst Project
Franklin University
MBA 737
Equity Analyst Project
The Equity Analyst Project involves a total of three assignments:
1. Individual Asset Allocation Exercise
2. Team Analysis of Select Industry Groups
Team Analysis of Companies within an Industry Group
The intent of the project is to simulate a top-down, three-stage approach to security analysis that proceeds with, first, an analysis of general economic factors, then industry comparisons, and finally the analysis of individual companies within a particular industry. Here is justification for this approach:
The results of several academic studies have supported this technique. First, studies indicated that most changes in an individual firm’s earnings could be attributed to changes in aggregate corporate earnings and changes in the firm’s industry, with the aggregate earnings changes being more important…
Second, studies…[have] found a relationship between aggregate stock prices and various economic series, such as employment, income, or production…
Third, an analysis of the relationship between rates of return for the aggregate stock market, alternative industries, and individual stocks showed that most of the changes in rates of return for individual stocks could be explained by changes in the rates of return for the aggregate stock market and the stock’s industry.[1]
The following is provided as a guide to your analysis in these three assignments:
Individual Asset Allocation Exercise
This exercise involves an analysis of general economic conditions or systematic risk, i.e., the risk that affects all industries and companies, in the U.S. economy. You are asked to determine in percentage terms an optimal allocation of $1,000,000 among the following three asset classes: U.S. equities, U.S. Treasury bonds, and cash. The goal is to maximize your expected return over the next 12 months. You are asked to write a 1-2 page paper providing your analysis of the asset classes’ return prospects and your justification of your allocation of monies among them.
First, consider historical returns on various asset classes in the U.S. Look at Figure 10.4 on p. 305 of your textbook. Also, in Table 10.2 on p. 312 you can see that historically equities outperform bonds in terms of average return but they also carry more risk as defined by their standard deviations. These historical results show that on average the return on equities is highest but in some specific years this may not be true. For example, look at Table 10.1 on pp.308-309 and you can see that in three out of the five years from 2000 to 2004 the annual return on large-company stocks (defined in the text as the S&P 500)[2] was negative.
In this exercise your investment horizon is one year. In considering your allocation among U.S. equities, long-term Treasury bonds, and cash to maximize your prospective return over the next twelve months, we might next more precisely define these asset classes. We can define U.S. equities as the Standard and Poor’s (S&P) composite index [“At present…includes 500 of the largest (in terms of market value) stocks in the United States.” (p.304)]. More detailed information is available directly from Standard & Poor’s:http://www2.standardandpoors.com/portal/site/sp/en/us/page.topic/indices_500/2,3,2,2,0,0,0,0,0,0,0,0,0,0,0,0.html
Excel spreadsheets of Index returns dating from 2009 back to the late 1980’s are available at
http://www2.standardandpoors.com/spf/xls/index/MONTHLY.xls.
Web-based finance sites also customarily carry data on the S&P 500. For example, –at Yahoo! Finance:http://finance.yahoo.com/q?s=%5EGSPC
–at CNNMoney.com:http://money.cnn.com/data/markets/sandp/?
–At MSN: http://moneycentral.msn.com/detail/stock_quote?Symbol=$INX
We can define long-term Treasury bonds as 30-year U.S. government bonds. Historical data on yields on debt claims are available from the Federal Reserve at http://www.federalreserve.gov/releases/h15/data.htm. For historical on the 30-year T-bond, defined as “Market yield on U.S. Treasury securities at 30-year constant maturity, quoted on investment basis” go to
http://www.federalreserve.gov/datadownload/Output.aspx?rel=H15&series=b56abb6d9cc35f28ccf86b8a0188e948&lastObs=&from=&to=&filetype=csv&label=include&layout=seriescolumn
Long-bond Treasury rates are also available from the following sites:
— http://www.ustreas.gov/offices/domestic-finance/debt-management/interest-rate/yield.shtml
— http://www.bloomberg.com/markets/rates/index.html
The third alternative is cash. Assume no return on that share of your monies held in cash.
This analysis necessarily involves your assessment of systematic risk, i.e., the risk that affects all industries and companies, in the U.S. economy over the next twelve months. Let’s more fully define systematic risk. According to the textbook, systematic risk “…influences a large number of assets, each to a greater or lesser extent…[and is] sometimes called market risk…Uncertainties about general economic conditions, such as GDP, interest rates, or inflation, are examples of systematic risks. These conditions affect nearly all companies to some degree” (p. 343). Your task is to consider your investment alternatives in light of systematic risk expected over the coming year.
Your considerations about investing in U.S. equities will thus involve your determination of the near-term prospects for the U.S. economy and the implications of these prospects for U.S. equities.
A useful site for recent and upcoming U.S. macroeconomic data releases is http://www.bloomberg.com/markets/economic-calendar/. Click on the highlighted report or “Consensus” next to any particular report to get data (either recently reported or the near-term consensus, respectively), the schedule of future data releases, a definition, and, importantly for our purposes, a section entitled “Why Do Investors Care?” More generally, many other sites provide information on macroeconomic data, such as:
–http://info.wsj.com/classroom/Indicators/guide.html
–http://www.bea.gov/
— http://www.gpoaccess.gov/indicators/index.html
–http://research.stlouisfed.org/fred2/
Finally, the decision to invest in 30-year U.S. T-bonds importantly involves expectations about future inflation and the term structure of interest rates, i.e., “the relationship between short- and long-term interest rates” (p. 162). On p. 161 of the textbook the distinction is made between “real” interest rates and “nominal” interest rates. “Nominal” interest rates are the rates that are quoted in the financial press; they are the rates at which we borrow and lend. Per the approximated Fisher equation (Eq. 5.4 on p. 162), the nominal rate includes the so-called inflation premium, h, so that the higher the expected inflation, h, the higher the nominal rate, all else equal. In considering longer-term T-bonds one must also be aware that, in addition to expected long-term inflation, there is greater interest rate risk: “…longer term bonds have much greater risk of loss resulting from changes in interest rates than do shorter-term bonds” (p. 164). Specifically, should interest rates increase, the market value of 30-year bonds will fall and the fall will be more dramatic for a 30-year T-bond than for a 10-year Treasury bond. Conversely, price gains from any drop in rates will be more dramatic the longer the term to maturity on a bond. One should also keep in mind that while in general longer-term rates are typically higher than short-term rates for the same level of overall risk, there have been occasions when the reverse is true, and the term structure of interest rates is inverted. (Please see Figure 5.5 on p. 163 on the historical relationship between long-term and short-term U.S. interest rates.) Finally, in finance we assume that there is no credit or default risk on Treasury securities. It is assumed that there is no risk that the U.S. government will fail to meet its outstanding debt obligations. This is, of course, not the case for corporate issuers.
Finally, what are the implications of interest rate changes for the equity market? Here is one response to this question: http://www.investopedia.com/articles/06/interestaffectsmarket.asp
Questions for Individual Asset Allocation Exercise:
1. Allocate your fictional $1,000,000 among the following three asset categories:
Asset
U.S. Equities
U.S. 30-Year Treasury Bonds
Cash
Allocation
100%
2. Justify your allocation based on your outlook for systematic risk in the U.S. economy over the next year.
Team Analysis of Select Industry Groups
This analysis is a team assignment that requires your team to analyze a select group of alternative industries to determine which is most likely to perform best in terms of growth and earnings over the next 12 months. Your instructor will create your teams, ideally based on similar views about the near-term prospects for the U.S. economy expressed in the Individual Asset Allocation Exercise.
To guide this second stage analysis, you are asked to rely on theNorth American Industry Groups database available at Yahoo! Finance. The system is comprised of 9 macroeconomic sectors, 31 business segments and 215 industry groups.This database is readily accessible via Yahoo! Finance at
http://biz.yahoo.com/ic/ind_index.html
To simplify the exercise the 215 industry groups within the database have been reduced to a more analytically manageable 24 industry groups (each with public firms listed at Yahoo! Finance totaling no less than 5 and no more than 15 companies) in 7 macroeconomic sectors as follows:
Basic Materials
Aluminum
Major Integrated Oil &Gas
Nonmetallic Mineral Mining
Consumer Goods
Appliances
Confectioners
Office Supplies
Financial
REIT-Healthcare Facilities
REIT-Hotel/Motel
REIT-Industrial
Healthcare
Drugs-Generic
Home Health Care
Hospitals
Industrial Goods
Manufactured Housing
Pollution & Treatment Controls
Services
Advertising Agencies
Air Delivery & Freight Services
Drug Stores
Electronic Stores
Home Improvement Stores
Jewelry Stores
Technology
Computer Based Systems
Long Distance Carriers
Personal Computers
Utilities
Water Utilities
To access more details on these groups go to http://biz.yahoo.com/ic/ind_index.html and click on any of the names of the 24 groups to go to each industry’s “Industry Center” page. Additional useful information is available via the link to “Industry Browser” on the left. Also, on each industry’s summary page click on “Company Index” and then on “Public” on the subsequent page next to “View:” to get the list of public companies in this industry. Our focus is on publicly listed companies in which we might ultimately invest. The list of public companies is provided alphabetically. Following each name is the company’s ticker symbol in brackets. See http://www.investopedia.com/terms/s/stocksymbol.asp or http://www.investorwords.com/4968/ticker_symbol.html for brief definitions of stock/ticker symbols.
Please note that on occasion the ticker symbol may also be followed by other letters, such as PK or OB (see http://www.investopedia.com/ask/answers/04/022004.asp or http://www.investopedia.com/ask/answers/120.asp for explanations). It is recommended that we ignore stocks so designated in these exercises.
The goal of this second stage in our equity analyst project is to select one industry out of this list of 24 whose performance prospects you determine are best over the next year. Here are some factors to consider when comparing industry groups:[3]
Degree of Competition in the Industry
Supply/Demand Dynamics for the Industry’s Products
Industry Cost Structure
Degree of Government Regulation-Favorable or Not
Exposure to the Business Cycle
Relative Financial Norms and Standards
Your team is asked to write a 5-10 page paper providing your analysis of the issues involved in your selection of the industry group that you conclude is most likely to prosper in the coming months and your justification of your choice of that industry.
Assignment:Equity Analyst Project: Individual Asset Allocation Exercise
Purpose
To enable the student to demonstrate proficiency in the first stage of a top-down, three-stage valuation analysis: analysis of investment prospects in the U.S. macroeconomy.
Overview
This individual assignment involves an analysis of general economic conditions or systematic risk, i.e., the risk that affects all industries and companies, in the U.S. macroeconomy. You will be asked to determine in percentage terms an optimal allocation of $1,000,000 among the following three asset classes: U.S. equities, U.S. Treasury bonds, and cash. The goal is to maximize your expected return over the next 12 months. You will be asked to write a 1- to 2-page paper providing your analysis of the asset classes’ prospects and your justification of your allocation among them.
Action Items
1. Read the Equity Analyst Project document that your professor will distribute during Week 1.
2. Conduct any necessary research so that you can make a proper analysis.
3. Write a 1- to 2-page paper that provides your analysis of the three asset classes’ prospects and your justification of your allocation among them. Format your paper according theAcademic Paper Guidelines.
Questions for Individual Asset Allocation Exercise:
1. Allocate your fictional $1,000,000 among the following three asset categories:
Asset
U.S. Equities
U.S. 30-Year Treasury Bonds
Cash
Allocation
100%
2. Justify your allocation based on your outlook for systematic risk in the U.S. economy over the next year.
Individual Asset Allocation Exercise
This exercise involves an analysis of general economic conditions or systematic risk, i.e., the risk that affects all industries and companies, in the U.S. economy. You are asked to determine in percentage terms an optimal allocation of $1,000,000 among the following three asset classes: U.S. equities, U.S. Treasury bonds, and cash. The goal is to maximize your expected return over the next 12 months. You are asked to write a 1-2 page paper providing your analysis of the asset classes’ return prospects and your justification of your allocation of monies among them.
First, consider historical returns on various asset classes in the U.S. Look at Figure 10.4 on p. 305 of your textbook. Also, in Table 10.2 on p. 312 you can see that historically equities outperform bonds in terms of average return but they also carry more risk as defined by their standard deviations. These historical results show that on average the return on equities is highest but in some specific years this may not be true. For example, look at Table 10.1 on pp. 308-309 and you can see that in three out of the five years from 2000 to 2004 the annual return on large-company stocks (defined in the text as the S&P 500)[1] was negative.
In this exercise your investment horizon is one year. In considering your allocation among U.S. equities, long-term Treasury bonds, and cash to maximize your prospective return over the next twelve months, we might next more precisely define these asset classes. We can define U.S. equities as the Standard and Poor’s (S&P) composite index [“At present…includes 500 of the largest (in terms of market value) stocks in the United States.” (p. 304)]. More detailed information is available directly from Standard & Poor’s:http://www2.standardandpoors.com/portal/site/sp/en/us/page.topic/indices_500/2,3,2,2,0,0,0,0,0,0,0,0,0,0,0,0.html
Excel spreadsheets of Index returns dating from 2009 back to the late 1980’s are available at
http://www2.standardandpoors.com/spf/xls/index/MONTHLY.xls.
Web-based finance sites also customarily carry data on the S&P 500. For example, –at Yahoo! Finance:http://finance.yahoo.com/q?s=%5EGSPC
–at CNNMoney.com:http://money.cnn.com/data/markets/sandp/?
–At MSN:http://moneycentral.msn.com/detail/stock_quote?Symbol=$INX
We can define long-term Treasury bonds as 30-year U.S. government bonds. Historical data on yields on debt claims are available from the Federal Reserve athttp://www.federalreserve.gov/releases/h15/data.htm. For historical on the 30-year T-bond, defined as “Market yield on U.S. Treasury securities at 30-year constant maturity, quoted on investment basis” go to
http://www.federalreserve.gov/datadownload/Output.aspx?rel=H15&series=b56abb6d9cc35f28ccf86b8a0188e948&lastObs=&from=&to=&filetype=csv&label=include&layout=seriescolumn
Long-bond Treasury rates are also available from the following sites:
— http://www.ustreas.gov/offices/domestic-finance/debt-management/interest-rate/yield.shtml
–http://www.bloomberg.com/markets/rates/index.html
The third alternative is cash. Assume no return on that share of your monies held in cash.
This analysis necessarily involves your assessment of systematic risk, i.e., the risk that affects all industries and companies, in the U.S. economy over the next twelve months. Let’s more fully define systematic risk. According to the textbook, systematic risk “…influences a large number of assets, each to a greater or lesser extent…[and is] sometimes called market risk…Uncertainties about general economic conditions, such as GDP, interest rates, or inflation, are examples of systematic risks. These conditions affect nearly all companies to some degree” (p. 343). Your task is to consider your investment alternatives in light of systematic risk expected over the coming year.
Your considerations about investing in U.S. equities will thus involve your determination of the near-term prospects for the U.S. economy and the implications of these prospects for U.S. equities.
A useful site for recent and upcoming U.S. macroeconomic data releases is http://www.bloomberg.com/markets/economic-calendar/. Click on the highlighted report or “Consensus” next to any particular report to get data (either recently reported or the near-term consensus, respectively), the schedule of future data releases, a definition, and, importantly for our purposes, a section entitled “Why Do Investors Care?” More generally, many other sites provide information on macroeconomic data, such as:
— http://info.wsj.com/classroom/Indicators/guide.html
— http://www.bea.gov/
–http://www.gpoaccess.gov/indicators/index.html
–http://research.stlouisfed.org/fred2/
Finally, the decision to invest in 30-year U.S. T-bonds importantly involves expectations about future inflation and the term structure of interest rates, i.e., “the relationship between short- and long-term interest rates” (p. 162). On p. 161 of the textbook the distinction is made between “real” interest rates and “nominal” interest rates. “Nominal” interest rates are the rates that are quoted in the financial press; they are the rates at which we borrow and lend. Per the approximated Fisher equation (Eq. 5.4 on p. 162), the nominal rate includes the so-called inflation premium, h, so that the higher the expected inflation, h, the higher the nominal rate, all else equal. In considering longer-term T-bonds one must also be aware that, in addition to expected long-term inflation, there is greater interest rate risk: “…longer term bonds have much greater risk of loss resulting from changes in interest rates than do shorter-term bonds” (p. 164). Specifically, should interest rates increase, the market value of 30-year bonds will fall and the fall will be more dramatic for a 30-year T-bond than for a 10-year Treasury bond. Conversely, price gains from any drop in rates will be more dramatic the longer the term to maturity on a bond. One should also keep in mind that while in general longer-term rates are typically higher than short-term rates for the same level of overall risk, there have been occasions when the reverse is true, and the term structure of interest rates is inverted. (Please see Figure 5.5 on p. 163 on the historical relationship between long-term and short-term U.S. interest rates.) Finally, in finance we assume that there is no credit or default risk on Treasury securities. It is assumed that there is no risk that the U.S. government will fail to meet its outstanding debt obligations. This is, of course, not the case for corporate issuers.
Finally, what are the implications of interest rate changes for the equity market? Here is one response to this question: http://www.investopedia.com/articles/06/interestaffectsmarket.asp
Questions for Individual Asset Allocation Exercise:
3. Allocate your fictional $1,000,000 among the following three asset categories:
Asset
U.S. Equities
U.S. 30-Year Treasury Bonds
Cash
Allocation
100%
4. Justify your allocation based on your outlook for systematic risk in the U.S. economy over the next year.
[1] For a brief history of the S&P 500 see http://www.cftech.com/BrainBank/FINANCE/SandP500Hist.html.
[1] Reilly, Frank K., and Keith C. Brown. (2007). An Introduction to Security Valuation. Equity and Fixed Income CFA® Program Curriculum·•Volume 5(pp. 115-153). (p. 264). Boston: CFA Institute.
[2] For a brief history of the S&P 500 see http://www.cftech.com/BrainBank/FINANCE/SandP500Hist.html.
[3] Source: http://www.markrosa.com/economic_analysis.htm. Please note that this site also contains helpful discussions about all three stages of the top-down approach to security valuation.
Franklin University
MBA 737
Equity Analyst Project
The Equity Analyst Project involves a total of three assignments:
1. Individual Asset Allocation Exercise
2. Team Analysis of Select Industry Groups
Team Analysis of Companies within an Industry Group
The intent of the project is to simulate a top-down, three-stage approach to security analysis that proceeds with, first, an analysis of general economic factors, then industry comparisons, and finally the analysis of individual companies within a particular industry. Here is justification for this approach:
The results of several academic studies have supported this technique. First, studies indicated that most changes in an individual firm’s earnings could be attributed to changes in aggregate corporate earnings and changes in the firm’s industry, with the aggregate earnings changes being more important…
Second, studies…[have] found a relationship between aggregate stock prices and various economic series, such as employment, income, or production…
Third, an analysis of the relationship between rates of return for the aggregate stock market, alternative industries, and individual stocks showed that most of the changes in rates of return for individual stocks could be explained by changes in the rates of return for the aggregate stock market and the stock’s industry.[1]
The following is provided as a guide to your analysis in these three assignments:
Individual Asset Allocation Exercise
This exercise involves an analysis of general economic conditions or systematic risk, i.e., the risk that affects all industries and companies, in the U.S. economy. You are asked to determine in percentage terms an optimal allocation of $1,000,000 among the following three asset classes: U.S. equities, U.S. Treasury bonds, and cash. The goal is to maximize your expected return over the next 12 months. You are asked to write a 1-2 page paper providing your analysis of the asset classes’ return prospects and your justification of your allocation of monies among them.
First, consider historical returns on various asset classes in the U.S. Look at Figure 10.4 on p. 305 of your textbook. Also, in Table 10.2 on p. 312 you can see that historically equities outperform bonds in terms of average return but they also carry more risk as defined by their standard deviations. These historical results show that on average the return on equities is highest but in some specific years this may not be true. For example, look at Table 10.1 on pp.308-309 and you can see that in three out of the five years from 2000 to 2004 the annual return on large-company stocks (defined in the text as the S&P 500)[2] was negative.
In this exercise your investment horizon is one year. In considering your allocation among U.S. equities, long-term Treasury bonds, and cash to maximize your prospective return over the next twelve months, we might next more precisely define these asset classes. We can define U.S. equities as the Standard and Poor’s (S&P) composite index [“At present…includes 500 of the largest (in terms of market value) stocks in the United States.” (p.304)]. More detailed information is available directly from Standard & Poor’s:http://www2.standardandpoors.com/portal/site/sp/en/us/page.topic/indices_500/2,3,2,2,0,0,0,0,0,0,0,0,0,0,0,0.html
Excel spreadsheets of Index returns dating from 2009 back to the late 1980’s are available at
http://www2.standardandpoors.com/spf/xls/index/MONTHLY.xls.
Web-based finance sites also customarily carry data on the S&P 500. For example, –at Yahoo! Finance:http://finance.yahoo.com/q?s=%5EGSPC
–at CNNMoney.com:http://money.cnn.com/data/markets/sandp/?
–At MSN: http://moneycentral.msn.com/detail/stock_quote?Symbol=$INX
We can define long-term Treasury bonds as 30-year U.S. government bonds. Historical data on yields on debt claims are available from the Federal Reserve at http://www.federalreserve.gov/releases/h15/data.htm. For historical on the 30-year T-bond, defined as “Market yield on U.S. Treasury securities at 30-year constant maturity, quoted on investment basis” go to
http://www.federalreserve.gov/datadownload/Output.aspx?rel=H15&series=b56abb6d9cc35f28ccf86b8a0188e948&lastObs=&from=&to=&filetype=csv&label=include&layout=seriescolumn
Long-bond Treasury rates are also available from the following sites:
— http://www.ustreas.gov/offices/domestic-finance/debt-management/interest-rate/yield.shtml
— http://www.bloomberg.com/markets/rates/index.html
The third alternative is cash. Assume no return on that share of your monies held in cash.
This analysis necessarily involves your assessment of systematic risk, i.e., the risk that affects all industries and companies, in the U.S. economy over the next twelve months. Let’s more fully define systematic risk. According to the textbook, systematic risk “…influences a large number of assets, each to a greater or lesser extent…[and is] sometimes called market risk…Uncertainties about general economic conditions, such as GDP, interest rates, or inflation, are examples of systematic risks. These conditions affect nearly all companies to some degree” (p. 343). Your task is to consider your investment alternatives in light of systematic risk expected over the coming year.
Your considerations about investing in U.S. equities will thus involve your determination of the near-term prospects for the U.S. economy and the implications of these prospects for U.S. equities.
A useful site for recent and upcoming U.S. macroeconomic data releases is http://www.bloomberg.com/markets/economic-calendar/. Click on the highlighted report or “Consensus” next to any particular report to get data (either recently reported or the near-term consensus, respectively), the schedule of future data releases, a definition, and, importantly for our purposes, a section entitled “Why Do Investors Care?” More generally, many other sites provide information on macroeconomic data, such as:
–http://info.wsj.com/classroom/Indicators/guide.html
–http://www.bea.gov/
— http://www.gpoaccess.gov/indicators/index.html
–http://research.stlouisfed.org/fred2/
Finally, the decision to invest in 30-year U.S. T-bonds importantly involves expectations about future inflation and the term structure of interest rates, i.e., “the relationship between short- and long-term interest rates” (p. 162). On p. 161 of the textbook the distinction is made between “real” interest rates and “nominal” interest rates. “Nominal” interest rates are the rates that are quoted in the financial press; they are the rates at which we borrow and lend. Per the approximated Fisher equation (Eq. 5.4 on p. 162), the nominal rate includes the so-called inflation premium, h, so that the higher the expected inflation, h, the higher the nominal rate, all else equal. In considering longer-term T-bonds one must also be aware that, in addition to expected long-term inflation, there is greater interest rate risk: “…longer term bonds have much greater risk of loss resulting from changes in interest rates than do shorter-term bonds” (p. 164). Specifically, should interest rates increase, the market value of 30-year bonds will fall and the fall will be more dramatic for a 30-year T-bond than for a 10-year Treasury bond. Conversely, price gains from any drop in rates will be more dramatic the longer the term to maturity on a bond. One should also keep in mind that while in general longer-term rates are typically higher than short-term rates for the same level of overall risk, there have been occasions when the reverse is true, and the term structure of interest rates is inverted. (Please see Figure 5.5 on p. 163 on the historical relationship between long-term and short-term U.S. interest rates.) Finally, in finance we assume that there is no credit or default risk on Treasury securities. It is assumed that there is no risk that the U.S. government will fail to meet its outstanding debt obligations. This is, of course, not the case for corporate issuers.
Finally, what are the implications of interest rate changes for the equity market? Here is one response to this question: http://www.investopedia.com/articles/06/interestaffectsmarket.asp
Questions for Individual Asset Allocation Exercise:
1. Allocate your fictional $1,000,000 among the following three asset categories:
Asset
U.S. Equities
U.S. 30-Year Treasury Bonds
Cash
Allocation
100%
2. Justify your allocation based on your outlook for systematic risk in the U.S. economy over the next year.
Team Analysis of Select Industry Groups
This analysis is a team assignment that requires your team to analyze a select group of alternative industries to determine which is most likely to perform best in terms of growth and earnings over the next 12 months. Your instructor will create your teams, ideally based on similar views about the near-term prospects for the U.S. economy expressed in the Individual Asset Allocation Exercise.
To guide this second stage analysis, you are asked to rely on theNorth American Industry Groups database available at Yahoo! Finance. The system is comprised of 9 macroeconomic sectors, 31 business segments and 215 industry groups.This database is readily accessible via Yahoo! Finance at
http://biz.yahoo.com/ic/ind_index.html
To simplify the exercise the 215 industry groups within the database have been reduced to a more analytically manageable 24 industry groups (each with public firms listed at Yahoo! Finance totaling no less than 5 and no more than 15 companies) in 7 macroeconomic sectors as follows:
Basic Materials
Aluminum
Major Integrated Oil &Gas
Nonmetallic Mineral Mining
Consumer Goods
Appliances
Confectioners
Office Supplies
Financial
REIT-Healthcare Facilities
REIT-Hotel/Motel
REIT-Industrial
Healthcare
Drugs-Generic
Home Health Care
Hospitals
Industrial Goods
Manufactured Housing
Pollution & Treatment Controls
Services
Advertising Agencies
Air Delivery & Freight Services
Drug Stores
Electronic Stores
Home Improvement Stores
Jewelry Stores
Technology
Computer Based Systems
Long Distance Carriers
Personal Computers
Utilities
Water Utilities
To access more details on these groups go to http://biz.yahoo.com/ic/ind_index.html and click on any of the names of the 24 groups to go to each industry’s “Industry Center” page. Additional useful information is available via the link to “Industry Browser” on the left. Also, on each industry’s summary page click on “Company Index” and then on “Public” on the subsequent page next to “View:” to get the list of public companies in this industry. Our focus is on publicly listed companies in which we might ultimately invest. The list of public companies is provided alphabetically. Following each name is the company’s ticker symbol in brackets. See http://www.investopedia.com/terms/s/stocksymbol.asp or http://www.investorwords.com/4968/ticker_symbol.html for brief definitions of stock/ticker symbols.
Please note that on occasion the ticker symbol may also be followed by other letters, such as PK or OB (see http://www.investopedia.com/ask/answers/04/022004.asp or http://www.investopedia.com/ask/answers/120.asp for explanations). It is recommended that we ignore stocks so designated in these exercises.
The goal of this second stage in our equity analyst project is to select one industry out of this list of 24 whose performance prospects you determine are best over the next year. Here are some factors to consider when comparing industry groups:[3]
Degree of Competition in the Industry
Supply/Demand Dynamics for the Industry’s Products
Industry Cost Structure
Degree of Government Regulation-Favorable or Not
Exposure to the Business Cycle
Relative Financial Norms and Standards
Your team is asked to write a 5-10 page paper providing your analysis of the issues involved in your selection of the industry group that you conclude is most likely to prosper in the coming months and your justification of your choice of that industry.
Assignment:Equity Analyst Project: Individual Asset Allocation Exercise
Purpose
To enable the student to demonstrate proficiency in the first stage of a top-down, three-stage valuation analysis: analysis of investment prospects in the U.S. macroeconomy.
Overview
This individual assignment involves an analysis of general economic conditions or systematic risk, i.e., the risk that affects all industries and companies, in the U.S. macroeconomy. You will be asked to determine in percentage terms an optimal allocation of $1,000,000 among the following three asset classes: U.S. equities, U.S. Treasury bonds, and cash. The goal is to maximize your expected return over the next 12 months. You will be asked to write a 1- to 2-page paper providing your analysis of the asset classes’ prospects and your justification of your allocation among them.
Action Items
1. Read the Equity Analyst Project document that your professor will distribute during Week 1.
2. Conduct any necessary research so that you can make a proper analysis.
3. Write a 1- to 2-page paper that provides your analysis of the three asset classes’ prospects and your justification of your allocation among them. Format your paper according theAcademic Paper Guidelines.
Questions for Individual Asset Allocation Exercise:
1. Allocate your fictional $1,000,000 among the following three asset categories:
Asset
U.S. Equities
U.S. 30-Year Treasury Bonds
Cash
Allocation
100%
2. Justify your allocation based on your outlook for systematic risk in the U.S. economy over the next year.
Individual Asset Allocation Exercise
This exercise involves an analysis of general economic conditions or systematic risk, i.e., the risk that affects all industries and companies, in the U.S. economy. You are asked to determine in percentage terms an optimal allocation of $1,000,000 among the following three asset classes: U.S. equities, U.S. Treasury bonds, and cash. The goal is to maximize your expected return over the next 12 months. You are asked to write a 1-2 page paper providing your analysis of the asset classes’ return prospects and your justification of your allocation of monies among them.
First, consider historical returns on various asset classes in the U.S. Look at Figure 10.4 on p. 305 of your textbook. Also, in Table 10.2 on p. 312 you can see that historically equities outperform bonds in terms of average return but they also carry more risk as defined by their standard deviations. These historical results show that on average the return on equities is highest but in some specific years this may not be true. For example, look at Table 10.1 on pp. 308-309 and you can see that in three out of the five years from 2000 to 2004 the annual return on large-company stocks (defined in the text as the S&P 500)[1] was negative.
In this exercise your investment horizon is one year. In considering your allocation among U.S. equities, long-term Treasury bonds, and cash to maximize your prospective return over the next twelve months, we might next more precisely define these asset classes. We can define U.S. equities as the Standard and Poor’s (S&P) composite index [“At present…includes 500 of the largest (in terms of market value) stocks in the United States.” (p. 304)]. More detailed information is available directly from Standard & Poor’s:http://www2.standardandpoors.com/portal/site/sp/en/us/page.topic/indices_500/2,3,2,2,0,0,0,0,0,0,0,0,0,0,0,0.html
Excel spreadsheets of Index returns dating from 2009 back to the late 1980’s are available at
http://www2.standardandpoors.com/spf/xls/index/MONTHLY.xls.
Web-based finance sites also customarily carry data on the S&P 500. For example, –at Yahoo! Finance:http://finance.yahoo.com/q?s=%5EGSPC
–at CNNMoney.com:http://money.cnn.com/data/markets/sandp/?
–At MSN:http://moneycentral.msn.com/detail/stock_quote?Symbol=$INX
We can define long-term Treasury bonds as 30-year U.S. government bonds. Historical data on yields on debt claims are available from the Federal Reserve athttp://www.federalreserve.gov/releases/h15/data.htm. For historical on the 30-year T-bond, defined as “Market yield on U.S. Treasury securities at 30-year constant maturity, quoted on investment basis” go to
http://www.federalreserve.gov/datadownload/Output.aspx?rel=H15&series=b56abb6d9cc35f28ccf86b8a0188e948&lastObs=&from=&to=&filetype=csv&label=include&layout=seriescolumn
Long-bond Treasury rates are also available from the following sites:
— http://www.ustreas.gov/offices/domestic-finance/debt-management/interest-rate/yield.shtml
–http://www.bloomberg.com/markets/rates/index.html
The third alternative is cash. Assume no return on that share of your monies held in cash.
This analysis necessarily involves your assessment of systematic risk, i.e., the risk that affects all industries and companies, in the U.S. economy over the next twelve months. Let’s more fully define systematic risk. According to the textbook, systematic risk “…influences a large number of assets, each to a greater or lesser extent…[and is] sometimes called market risk…Uncertainties about general economic conditions, such as GDP, interest rates, or inflation, are examples of systematic risks. These conditions affect nearly all companies to some degree” (p. 343). Your task is to consider your investment alternatives in light of systematic risk expected over the coming year.
Your considerations about investing in U.S. equities will thus involve your determination of the near-term prospects for the U.S. economy and the implications of these prospects for U.S. equities.
A useful site for recent and upcoming U.S. macroeconomic data releases is http://www.bloomberg.com/markets/economic-calendar/. Click on the highlighted report or “Consensus” next to any particular report to get data (either recently reported or the near-term consensus, respectively), the schedule of future data releases, a definition, and, importantly for our purposes, a section entitled “Why Do Investors Care?” More generally, many other sites provide information on macroeconomic data, such as:
— http://info.wsj.com/classroom/Indicators/guide.html
— http://www.bea.gov/
–http://www.gpoaccess.gov/indicators/index.html
–http://research.stlouisfed.org/fred2/
Finally, the decision to invest in 30-year U.S. T-bonds importantly involves expectations about future inflation and the term structure of interest rates, i.e., “the relationship between short- and long-term interest rates” (p. 162). On p. 161 of the textbook the distinction is made between “real” interest rates and “nominal” interest rates. “Nominal” interest rates are the rates that are quoted in the financial press; they are the rates at which we borrow and lend. Per the approximated Fisher equation (Eq. 5.4 on p. 162), the nominal rate includes the so-called inflation premium, h, so that the higher the expected inflation, h, the higher the nominal rate, all else equal. In considering longer-term T-bonds one must also be aware that, in addition to expected long-term inflation, there is greater interest rate risk: “…longer term bonds have much greater risk of loss resulting from changes in interest rates than do shorter-term bonds” (p. 164). Specifically, should interest rates increase, the market value of 30-year bonds will fall and the fall will be more dramatic for a 30-year T-bond than for a 10-year Treasury bond. Conversely, price gains from any drop in rates will be more dramatic the longer the term to maturity on a bond. One should also keep in mind that while in general longer-term rates are typically higher than short-term rates for the same level of overall risk, there have been occasions when the reverse is true, and the term structure of interest rates is inverted. (Please see Figure 5.5 on p. 163 on the historical relationship between long-term and short-term U.S. interest rates.) Finally, in finance we assume that there is no credit or default risk on Treasury securities. It is assumed that there is no risk that the U.S. government will fail to meet its outstanding debt obligations. This is, of course, not the case for corporate issuers.
Finally, what are the implications of interest rate changes for the equity market? Here is one response to this question: http://www.investopedia.com/articles/06/interestaffectsmarket.asp
Questions for Individual Asset Allocation Exercise:
3. Allocate your fictional $1,000,000 among the following three asset categories:
Asset
U.S. Equities
U.S. 30-Year Treasury Bonds
Cash
Allocation
100%
4. Justify your allocation based on your outlook for systematic risk in the U.S. economy over the next year.
[1] For a brief history of the S&P 500 see http://www.cftech.com/BrainBank/FINANCE/SandP500Hist.html.
[1] Reilly, Frank K., and Keith C. Brown. (2007). An Introduction to Security Valuation. Equity and Fixed Income CFA® Program Curriculum·•Volume 5(pp. 115-153). (p. 264). Boston: CFA Institute.
[2] For a brief history of the S&P 500 see http://www.cftech.com/BrainBank/FINANCE/SandP500Hist.html.
[3] Source: http://www.markrosa.com/economic_analysis.htm. Please note that this site also contains helpful discussions about all three stages of the top-down approach to security valuation.
