MBA 737 Assignment: Equity Analyst Project

Assignment:Equity Analyst Project: Individual Asset
Allocation Exercise

Purpose
To enable the student to demonstrate proficiency
in the first stage of a top-down, three-stage valuation analysis: analysis of
investment prospects in the U.S. macroeconomy.

Overview
This individual assignment involves an analysis
of general economic conditions or systematic risk, i.e., the risk that affects
all industries and companies, in the U.S. macroeconomy. You will be asked to
determine in percentage terms an optimal allocation of $1,000,000 among the
following three asset classes: U.S. equities, U.S. Treasury bonds, and cash.
The goal is to maximize your expected return over the next 12 months. You will
be asked to write a 1- to 2-page paper providing your analysis of the asset
classes’ prospects and your justification of your allocation among them.

Action Items
1. Read the
Equity Analyst Project document that your professor will distribute during Week
1.
2. Conduct
any necessary research so that you can make a proper analysis.
3. Write a
1- to 2-page paper that provides your analysis of the three asset classes’
prospects and your justification of your allocation among them. Format your
paper according the.franklin.edu/myfranklin/GetCourseView.do?sectionId=38851#course-object-1382448651071″>Academic
Paper Guidelines.

Questions
for Individual Asset Allocation Exercise:
1.
Allocate your fictional $1,000,000 among the
following three asset categories:

Asset

U.S.
Equities

U.S.
30-Year Treasury Bonds

Cash

Allocation

100%

2.
Justify your allocation based on your outlook for
systematic risk in the U.S. economy over the next year.
Individual
Asset Allocation Exercise
This exercise involves
an analysis of general economic conditions or systematic risk, i.e., the risk
that affects all industries and companies, in the U.S. economy. You are asked
to determine in percentage terms an optimal allocation of $1,000,000 among the
following three asset classes: U.S. equities, U.S. Treasury bonds, and cash.
The goal is to maximize your expected return over the next 12 months. You are
asked to write a 1-2 page paper providing your analysis of the asset classes’
return prospects and your justification of your allocation of monies among
them.
First,
consider historical returns on various asset classes in the U.S. Look at Figure
10.4 on p. 305 of your textbook. Also, in Table 10.2 on p. 312 you can see that
historically equities outperform bonds in terms of average return but they also
carry more risk as defined by their standard deviations. These historical
results show that on average the return on equities is highest but in some
specific years this may not be true. For example, look at Table 10.1 on pp. 308-309
and you can see that in three out of the five years from 2000 to 2004 the
annual return on large-company stocks (defined in the text as the S&P 500).docx#_ftn1″ title=””>[1]
was negative.
In
this exercise your investment horizon is one year. In considering your
allocation among U.S. equities, long-term Treasury bonds, and cash to maximize
your prospective return over the next twelve months, we might next more
precisely define these asset classes. We can define U.S. equities as the
Standard and Poor’s (S&P) composite index [“At present…includes 500 of the
largest (in terms of market value) stocks in the United States.” (p. 304)].
More detailed information is available directly from Standard & Poor’s:.standardandpoors.com/portal/site/sp/en/us/page.topic/indices_500/2,3,2,2,0,0,0,0,0,0,0,0,0,0,0,0.html”>http://www2.standardandpoors.com/portal/site/sp/en/us/page.topic/indices_500/2,3,2,2,0,0,0,0,0,0,0,0,0,0,0,0.html
Excel spreadsheets of Index returns dating from 2009 back to
the late 1980’s are available at
.standardandpoors.com/spf/xls/index/MONTHLY.xls”>http://www2.standardandpoors.com/spf/xls/index/MONTHLY.xls.

Web-based finance sites also
customarily carry data on the S&P 500. For example, –at Yahoo!
Finance:.yahoo.com/q?s=%5EGSPC”>http://finance.yahoo.com/q?s=%5EGSPC
–at CNNMoney.com:.cnn.com/data/markets/sandp/”>http://money.cnn.com/data/markets/sandp/?
–At MSN:.msn.com/detail/stock_quote?Symbol=$INX”>http://moneycentral.msn.com/detail/stock_quote?Symbol=$INX

We
can define long-term Treasury bonds as 30-year U.S. government bonds.
Historical data on yields on debt claims are available from the Federal Reserve
at.federalreserve.gov/releases/h15/data.htm”>http://www.federalreserve.gov/releases/h15/data.htm. For
historical on the 30-year T-bond, defined as “Market yield on U.S. Treasury
securities at 30-year constant maturity, quoted on investment basis” go to
http://www.federalreserve.gov/datadownload/Output.aspx?rel=H15&series=b56abb6d9cc35f28ccf86b8a0188e948&lastObs=&from=&to=&filetype=csv&label=include&layout=seriescolumn
Long-bond
Treasury rates are also available from the following sites:

— http://www.ustreas.gov/offices/domestic-finance/debt-management/interest-rate/yield.shtml

–.bloomberg.com/markets/rates/index.html”>http://www.bloomberg.com/markets/rates/index.html
The
third alternative is cash. Assume no return on that share of your monies held
in cash.
This analysis necessarily
involves your assessment of systematic risk, i.e., the risk that affects all
industries and companies, in the U.S. economy over the next twelve months.
Let’s more fully define systematic risk. According to the textbook, systematic
risk “…influences a large number of assets, each to a greater or lesser
extent…[and is] sometimes called market
risk…Uncertainties about general economic conditions, such as GDP, interest
rates, or inflation, are examples of systematic risks. These conditions affect
nearly all companies to some degree” (p. 343).
Your task is to consider your investment alternatives in light of systematic
risk expected over the coming year.
Your considerations about
investing in U.S. equities will thus involve your determination of the
near-term prospects for the U.S. economy and the implications of these
prospects for U.S. equities.
A useful site for recent
and upcoming U.S. macroeconomic data releases is http://www.bloomberg.com/markets/economic-calendar/.
Click on the highlighted report or “Consensus” next to any particular report to
get data (either recently reported or the near-term consensus, respectively),
the schedule of future data releases, a definition, and, importantly for our
purposes, a section entitled “Why Do Investors Care?” More generally, many other sites provide
information on macroeconomic data, such as:
— .wsj.com/classroom/Indicators/guide.html”>http://info.wsj.com/classroom/Indicators/guide.html
— .bea.gov/”>http://www.bea.gov/
–.gpoaccess.gov/indicators/index.html”>http://www.gpoaccess.gov/indicators/index.html

–.stlouisfed.org/fred2/”>http://research.stlouisfed.org/fred2/

Finally, the decision to
invest in 30-year U.S. T-bonds importantly involves expectations about future
inflation and the term structure of interest rates, i.e., “the relationship between short- and
long-term interest rates” (p. 162). On p. 161 of the textbook the distinction
is made between “real” interest rates and “nominal” interest rates. “Nominal” interest rates are the rates that
are quoted in the financial press; they are the rates at which we borrow and
lend. Per the approximated Fisher equation (Eq. 5.4 on p. 162), the nominal
rate includes the so-called inflation premium, h, so that the higher the
expected inflation, h, the higher the nominal rate, all else equal. In
considering longer-term T-bonds one must also be aware that, in addition to expected
long-term inflation, there is greater interest rate risk: “…longer term bonds
have much greater risk of loss resulting from changes in interest rates than do
shorter-term bonds” (p. 164). Specifically, should interest rates increase, the
market value of 30-year bonds will fall and the fall will be more dramatic for
a 30-year T-bond than for a 10-year Treasury bond. Conversely, price gains from
any drop in rates will be more dramatic the longer the term to maturity on a
bond. One should also keep in mind that while in general longer-term rates are
typically higher than short-term rates for the same level of overall risk,
there have been occasions when the reverse is true, and the term structure of
interest rates is inverted. (Please see Figure 5.5 on p. 163 on the historical
relationship between long-term and short-term U.S. interest rates.) Finally, in
finance we assume that there is no credit or default risk on Treasury
securities. It is assumed that there is no risk that the U.S. government will
fail to meet its outstanding debt obligations. This is, of course, not the case
for corporate issuers.
Finally, what are
the implications of interest rate changes for the equity market? Here is one
response to this question: .investopedia.com/articles/06/interestaffectsmarket.asp”>http://www.investopedia.com/articles/06/interestaffectsmarket.asp
Questions
for Individual Asset Allocation Exercise:
3.
Allocate your fictional $1,000,000 among the
following three asset categories:

Asset

U.S.
Equities

U.S.
30-Year Treasury Bonds

Cash

Allocation

100%

4.
Justify your allocation based on your outlook for
systematic risk in the U.S. economy over the next year.

.docx#_ftnref1″ title=””>[1]
For a brief history of the S&P 500 see .cftech.com/BrainBank/FINANCE/SandP500Hist.html”>http://www.cftech.com/BrainBank/FINANCE/SandP500Hist.html.