FIN 4710 – S2DA Advanced Investment Analysis
Due End of Day on August 14th, 2021 on Blackboard
This assignment is a practice using excel (or other software or programming language of your choice) to build a trading strategy (portfolio) and evaluate its performance and risk.
What to submit?
Excel file: this should include your Excel calculations
Finance.yahoo.com (for individual stock and market index historical prices, or analysts’ forecasts, or market betas if you do not estimate beta yourself), Factiva (for comparable companies in the industry), Fed St. Louis (for risk-free rate), Prof. Kenneth French’s website (for factor portfolio returns), SEC EDGAR (for the list of Standard Industry Classification SIC Code). We can use https://siccode.com/page/how-do-i-find-a-companys-sic-code to find a company’s SIC code.
Select an industry of your choice. You can use the industry that your company is in from Homework 1. As demonstrated in class, you can use Factiva through Baruch library databases to find comparable companies in the same industry.
Form your portfolio using selected stocks in the industry (long-short, or long only), (and market portfolio, and risk-free asset, both are optional). There is no restriction of how you choose to form your portfolio. Ideally you will conduct fundamental research on the universe of companies and choose to long the ones that outperform (undervalued) compared to the benchmark and/or short the ones that underperform (overvalued) compared to the benchmark (i.e. some estimates of “true” value using CAPM, DDM, or other valuation methods). For our purpose, you can use simple rules like equal weights on two or more stocks of the same industry (long only).
Measure your portfolio’s factor exposures (as described in Lecture 12 and in the reading “Measuring Portfolio Factor Exposures: A Practical Guide”
Step 1: regression: “A common approach to measuring factor exposures is linear regression analysis; it describes the relationship between a dependent variable (portfolio returns) and explanatory variables (factors).” You should include the market risk premium, an industry factor, and some style factors of your choice. You can find factor mimicking portfolio returns from Prof. French’s website. Note: since the factor mimicking portfolio returns are calculated monthly, you should calculate monthly returns of your portfolio.
Step 2: We measure each factor’s contribution to portfolio returns by multiplying the factor’s beta by its respective average risk premium over the sample period. Decompose the portfolio returns by contributions from exposure to factors.
Step 3: discuss your findings: what are the main style risk factors that could impact your portfolio. How much of the variability in returns is accounted for by the factors used?
(optional) potential hedging strategies
Once we understand the factor exposure of our portfolio, we can include other assets to our portfolios to make the new factor beta equal to zero. For example, you can try to include (short) market index (using index ETFs) to make new portfolio market beta Σwi βi = 0.