Heating Products

The returns (Stock returns 2007-16) gives monthly returns for securities drawn from the FT ALL Share Index for the period January 2007 and December 2016.

a) Create four equally weighted portfolios of one, five, ten, and fifteen securities. Determine, using the appropriate Excel function (see fx)) the standard deviation and variances of the monthly returns for each of the companies included in the portfolios. (Use the 120 months of returns data in the calculations and use the Excel functions identified as Variance.P and Standard Deviation P.)

Next determine the monthly returns on the four portfolios along with the standard deviation of these returns. The monthly portfolio returns are simply the average of the monthly returns for each security included in the portfolio.

Compare the average value of the standard deviations of the returns on the securities included in each portfolio with the standard deviation of portfolio’s returns. Comment on the difference between the outcomes.

Discuss the consequences of increasing the number of securities in the portfolios. Compare your results to those of the studies of naïve diversification. (8 MARKS)

Determine the variance of each security and the co-variances for each pair of securities in the portfolio of five securities using the relevant Excel function. Employ this information to calculate the standard deviation of the portfolio returns using the equally weighted portfolio risk equation. Compare your results to those obtained for the portfolio in part i above. (4 MARKS)

b) Determine the betas for BP, an oil and gas company, and Ferguson (Formerly Wolseley), a distributor of plumbing and heating products, by regressing the returns for each of the two companies on the returns for the FT ALL Share Index (the first column in the spread-sheet).

i. Explain what the values of the betas (the slope coefficients in the regression) indicate and discuss the factors that might explain the differences in the values of the betas of the two companies.

ii. Comment on the implications of the estimated value of beta for investors and the cost of capital for the two companies (Approximately 500 words) (8 MARKS) (TOTAL 20 MARKS)