Assignment: The Point of the Project

You are a portfolio manager, and you are trying to put together a portfolio that is designed to beat the market (represented here by the S&P 500 index). To do this you will first pick ten stocks, and then you will figure out how much of each of them to buy, using monthly data from the last five years to make your decisions. You have 100 million dollars to play with and you will pick stocks before the start of trading on August 8th.

You will decide if you have beaten the S&P 500 by looking at the performance of your portfolio over the period August 8th-November 8th. To do this you will compare the risk-adjusted returns of your portfolio with the risk-adjusted return of the S&P. The project has three parts.

Project Part II

We are now going to find the optimal portfolio of risky stocks using historical information. You need to answer the following questions:

1. How did your stocks perform over the past five years? How volatile were your stocks?

2. How did the market do over the past 5 years? How volatile was the market?

3. Calculate the correlation matrix between all the stocks over the past five-years. Are any of the correlations high (above .6) or low (below 0.1)? What does this tell you?

4. Find your optimal portfolio using five years of historical information. What are the optimal portfolio weights?

5. Graph the minimum variance frontier.

6. Do your portfolio weights seem reasonable? Would you feel comfortable recommending this investment portfolio to a client?

7. Why does it make sense to use historical information (returns, standard deviations and covariances) as inputs to portfolio theory? Also give at least one argument against using historical information.

8. What is your optimal portfolio if you do not allow short sales? Use historical inputs. Are the weights more reasonable? Would you restrict short sales? Why or why not? Graph the MVF in this case. How does it compare to #5? Why?

9. You are an investor with an ‘ethical agenda.' Eliminate two stocks from your portfolio. Explain why you found these companies to be ‘bad' or ‘objectionable.' What is the optimal portfolio now? Use historical information. How does this portfolio compare? What is the cost to you as an investor?

Make a title page that includes your name and section number and anything else you deem helpful. You should hand in a hard-copy at the beginning of class. Include answers to all the questions and any supporting material you think is helpful. Make it presentable to a "client," or a prospective employer. It should be user friendly, concise, well-written, neat and convincing. Print only the relevant parts of the spreadsheet. The answers should be brief, but convincing. Make it easy to find your answers. Include supporting material in the appendix. Practice good printing etiquette. Write well. The assignment should be maximum eight pages (including any appendix, but excluding the title page). Longer is not always better.