N10236961 – Cindi Ting

Portfolio Construction

This portfolio was constructed with shares from four companies: Commonwealth Bank
(CBA), BHP, Rio Tinto (RIO) and Westpac (WES). These stocks were picked to analyse
whether they were a relatively safe investments and if they would perform against the market
given that these four companies are large companies in Australia. It was apparent that
throughout period =107%, CBA at 0.028 % and finally WES at 0.018%.

All four stocks had a similar standard deviation of approximately 1%-2% and this is to be
expected since all 4 stocks are very similar being in the same industry and having similar
returns.

The mean ret=urn, standard deviation and variance/covariance matrix are calculated as in the
figure. Figure 3 =is the covariance of the combination of each two companies including ASX
200 and the equally weighted portfolio.

The Sharpe Ratio

The Sharpe = can be used to compare the portfolios' risk-adjusted return with the individual
assets and the market.

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According to figure 4, this table shows sharpe ratio of each company. The formula of sharpe
ratio is sharpe ratio = (mean return – risk free rate)/standard deviation.

Based on the above table it is evident that the Sharpe ratio of the RIO and the market is the
highest. =

The Capital Market Line

I also construct the CML based on the market portfolio and risk-free rate.

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Portfolio Optimisation

By maximising the Sharpe Ratio using the solver function, it was found that the
Portfolio should contain the following weights.

It appears that to achieve the maximum return the optimal portfolio should consist of
32.55% of CBA, 21.12% of RIO and 46.29% of WES. This is not as expected as it
contradicted the Sharpe ratio figures. However, the result means that BHP stock is
not efficient enough to use in an optimal portfolio. The optimal portfolio has an
expected return of.7% and a standard deviation of 1.2%.

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Empirical Estimation with regression

The empirical estimation with regression shows the Beta of each stock and the =

a measure of the systematic risk of a security or portfolio when compared to the

market and can be used in the CAPM to provide expected returns. Here, the
regression analysis found the X-Variable or Beta of each share and the portfolio.

The Betas are as follows:

 CBA at 1.1636;
 BHP at 1.1998;
 RIO at 0.938;
 Westpac at 0.881501948; and
 The equally weighted portfolio at 1.0459.

This shows that Westpac shares are the least risky and in normal circumstances will
all provide higher expected returns than the market portfolio as investors expect
higher returns when faced with higher risk or Beta. CBA shares showed the riskiest.

The R squared values are as follows:

 CBA - 0.70500479;
 BHP - 0. 0.44908951;
 RIO - 0.336745455
 WES - 0.480633526; and
 The equally weighted portfolio at 0.751616943

These R values indicate how close the data is to the fitted regression line. For
example, the =; and
 The equally weighed portfolio – 0.0005498

The x-intercept shows that if the market value is 0 the above securities and portfolio
will still yield positive results. This is true as the Beta values for the securities and
portfolio are all above 1 or near and therefore a reasonable investor would expect a
higher return for bearing the extra-systemic risk.

Farma French Factor

The Farma French factor provides three betas to provide the (1) market risk, (2) the
outperformance of small versus big companies, and (3) the outperformance of high
book/= diversified portfolio.

By substituting the values in the regression model the returns can be calculated. For
example, the following information from the regression model of CBA can be

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substituted into the Beta values of the above formula to calculate the return of CBA if
SMB and HML were also provided.

Mkt-Rf 0.00170256
SMB -0.001182917
HML 0.000147595

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