Maximizing Returns With Portfolio Diversification: Sharpe, Markowitz and MPT - Essay Sample

Introduction

In an ideal circumstance, an investor would like to invest in a portfolio of asset that is defined by low risks and high returns. However, the ideal does not coexist and just like the ideal portfolio. This comprehension gave birth to many theories on portfolio. The most notable individuals that made significant contributions to portfolio are William Sharpe and Harry Markowitz. In the modern theory of MPT as it is popularly known, the theorists stressed on the significance of portfolio diversification as the diversification of risks. The theory holds the opinion that it is never sufficient to search for the expected risk and return of a single investment asset. Instead, the capacity to invest in at least two assets enables the investor to reap the merits of portfolio diversification.

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Comment on the individual and portfolio returns and on any information/events (market-wide or firm-specific) that may have contributed to the performance of your stocks. Describe and explain any trades you made.

I see the main motive of observing stock of corporations in many fields of fast food, retail, and electronic sector as I thought that the stocks can easily change their value due to the social, economic, and other national aspects and that if you invest in one business. I will not be sufficiently prepared for a real-life scenario. Firstly, I focused on corporations that are easy to discover in our daily lives as it is a corporation that is easily conceived by consumers like us that it is a corporation that has been accessed into our lives a lot. I judged that these corporations would produce high level of profits in the lack of significant social issues as they were is similar stable position in their industry. . However, for companies that are already in stable positions in the market, it is hard to buy a large number of shares because of the high value of stocks, but now with an investment of $1,000,000, I chose these five companies because we thought they were the most stable strategies to avoid losses.

The stocks of the different companies performed differently. Target Company suffered a decrease in returns by $600 which is equivalent to total negative return of 0.31%.

The stock of CVS Health enjoyed a positive return of $380 which reflected an increase of total return by 0.28%.

The stock of Best Buy is $72.92 has a positive return of $440 which reflected a positive annual return by 0.30%. BBY is one of biggest retail company in the USA, because the characteristic of the market which is retail company it is difficult for the company to make a big change, it maintains a steady stock value.

The stock of Mc Donald's decreases its return by $4,425 and a negative annual return of 1.50%. The number of decreases of stock value is not so huge, but the amount of investment loss was higher than expected due to the large stock value of the company. Mc Donald's is a biggest fast food company in the world. A world-famous company is also important for its social image. Steve Easterbrook a CEO of Mc Donald's was resigned due to a feud with a company employee. The incident dealt a heavy blow to Mc Donald's corporate image. I think this has had a huge impact on the decline in stock value.

The stock of Walmart has a positive return of $720 and a negative annual return of 0.41%.

Events That Affect the Stock Prices

Stock Dividend

There are various events that affected the stock prices. Firstly, dividends dictate the direction of the stock prices. After the declaration of a stock dividend, the prices of the stock increases. However, as the stock dividend increase the number of shares outstanding whereas the value of the corporation remains stable, it dilutes the book value per common share and the prices of stock is decreased accordingly. Stock divided affected stock prices in that if dividends are paid by the corporation then the price of the stock declined by a similar amount as the dividend paid per share the subsequent day (Sharif 56).

Earnings

The net income is directly proportional to the price of a stock. When the net income increases, then the stock price will increase as well.

Bonus Issue

Bonus issue affects the price of a stock. It is providing extra shares to the existing shareholders in the ration of their coexisting holding. Here, the price of the share decreases and adjusts the bonus.

Buy-Back

Buy-back affects the price of the stock. When the company purchases the stock using its reserves then it is showing good liquidity of the corporation. This results to the increase in the price of the stock.

Stock-Split

Stock-split affects the price of the stock. It has the similar influence as bonus issue though it is not the issue of fresh shares. It is decreasing the present face value of the share.

An instance of this is my trade of Walmart Stock. It is a three month daily chart of DAL. The exponential moving average demonstrates the general trend of the stock. It is a major upward trend; therefore sell short term signal is minor. It is crucial to acknowledge minor signal. On Nov 14, the MACD (grey line) crossed beyond the signal line (black line) demonstrating a buy signal, I penetrated the position, and maintained the track of closing prices till the MACD crossed below signal line, I reduced my position and earned 21.9%. to assist with this indicator, I looked at candlestick patterns and the present volumes on the stock. I looked at the similar direction of volumes traded, the divergence trend and the bullish news of the latest purchase of this stock from Walmart. Sometimes, I gaze at the cap range of the company, and the financial performance when comparing with the peers. Amazon Inc is the perfect illustration; I had to review the fundamental side to select the correct stock among lots of retail companies.

Remaining Money

After withdrawing the S & P 500, the money that would have remained is $1000, 000. This implies that $1, 000, 000 would be invested more in the stocks.

Comparison Between Portfolio and Index in Terms of Risks

Markowitz illuminated that the risk for any specified investment asset is categorized into two classes. Systematic risk is intrinsic in the market and tends not to be diversified. The risk is intrinsic in the danger of inflation, interest rates, and risk of an economic recession. Conversely, there is the unsystematic risk that is particular to any specified investment asset. The risk can be diversified away by rising the number of investment assets or stock portfolio. In a portfolio that is effectively diversified, the systematic risk on every asset makes a low impact to the portfolio risk. The comprehension offered a room for the development of the theory by Markowitz and illumination of the efficient frontier which shows the integration of assets that would result to an efficient portfolio. To begin with, Sharpe and Markowitz came up with presumptions of a risk averse investor when testing the theories. Bearing in mind that the presumptions are held constant, the risk averse portfolio was used to test the theories as presented in the table below.

In this assessment, we presumed that the average return of the risk averse portfolio (Rp) as illustrated above is at 13.65%, the market return (Rm) equals 12%, the beta of the portfolio (Bp) is at 0.72, and that the beta of the market is equivalent to one. In addition, the risk-free rate is presumed to be equal to the t-bill rate on the U.S 91-days T-bill at 2.26%. The data is captured in the following table.

Rm= market return (yield S & P 500) 12%

Rp=portfolio return 13.65%

Rf=Risk-free rate 2.26%

Bp=Beta of the portfolio 0.72000

The data in the aforementioned table was used to calculate the expected return using CAPM and followed by the standard deviation of the portfolio as shown below.

CAPM

Ra=rf+Bp(Rm-Rf)

Where

Ra=Return on asset

Ba=Beta of the asset

Rm=Market return

Rf=Risk free rate

Using CAPM, the expected return on the portfolio would be computed as follows:

ER=2.26%+0.72(12%-2.26%)ER=2.26%+0.72(9.74%)ER=9.61%The standard deviation on the portfolio was calculated using the expected return from CAPM.

StdDev=13.65%-9.61%StdDev=4.04%William Sharpe improved the theory and developed the capital asset pricing model that assisted in the computation of the beta of the portfolio or a stipulated asset and the implications of the time value (Chen 895). The beta is regarded as a tool of measuring risk. The latter can be gauged using other indices that entail the Sharpe ratio. Below, is an illustration of the application of the Sharpe ratio is our case study.

S(p)=(Rp-Rf)/StdDev(p)

Where

P=Portfolio

Rp=Average return of the portfolio

Rf=risk free rate

StdDev (p)=Standard Deviation of portfolio

S(p)=(13.65%-2.26%)/4.04%S(p)=2.8193From the calculations above, the Sharpe ratio was 2.8193. The ratio draws a comparison between the risk that the investor absorbs. In this scenario, the investor nets extra returns to the tune of 2.8193% for surplus unit of risk absorbed in the portfolio. The Sharpe ratio shows that the portfolio performance is good as there is a greater return for every extra unit of risk. The lower the Sharpe ratio, the lower the return that the investor reaps in every extra unit of risk. On the other hand, the higher the Sharpe ratio, the more the risk that the investor absorbs.

This is due to the fact that the analysis shows a good portfolio performance with the returns on the portfolio being more than 13% as compared to the returns on market index S & P at 12%. In addition, the portfolio is well diversified as the assets are designated from the distinct sectors of the economy. However, it is significant to realize that the systematic risk is not well diversified and therefore it will be crucial to monitor the economic factors including interest rates and inflation as they might have repercussions on the portfolio.

Plans

Stock Name Ticker Stock Price # Shares Total Cost Dividend Per Share Dividend Date Dividend Growth Rate Beta Risk-Free Rate Market Value when 8% Market Return Market Value when 12% Market Return required rate of return when Rm =8% required rate of return when Rm =12%

Target TGT $ 108.15 2,000 $ 216,300.00 $ 0.66 Aug. 2019 1.20% 0.62 2.26% $ 14.46 $ 9.41 5.82% 8.30% CVS CVS $ 67.05 2,000 $ 134,100.00 $ 0.50 Oct. 2019 1.80% 0.99 2.26% $ 8.29 $ 5.04 7.94% 11.90% Best Buy BBY $ 72.70 2,000 $ 145,400.00 $ 0.50 Sep. 2019 4.96% 1.67 2.26% $ 7.62 $ 3.87 11.85% 18.53% McDonald's MCD $ 196.89 1,500 $ 295,335.00 $ 1.16 Aug. 2019 1.57% 0.33 2.26% $ 45.59 $ 30.18 4.15% 5.47% Walmart WMT $ 118.10 1,500 $ 177,150.00 $ 0.53 Aug. 2019 0.50% 0.65 2.26% $ 9.70 $...