a. Download 5 years of monthly closing prices for any ten companies. You can use any database to obtain the prices e.g. datastream, yahoo finance (click the Investing tab followed by the Historical Prices tab) etc. For each stock, calculate the monthly return over the last five years (use the adjusted close prices). Draw a graph (using Excel) showing these monthly returns. (Don’t include the entire Excel file with all your stock prices and monthly returns. Also, the data does not count towards the word limit).

b. Calculate the average (annualized) return and the standard deviation of the monthly return for each stock. Show your working clearly and make a table showing these values. Discuss whether there is any violation of riskreturn trade-off relationship.

c. Compute the correlation matrix and the variance-covariance matrix of the 10 stocks. Discuss the relationship between covariance and correlation coefficient.

d. Draw on the same graph, all combinations of risk and return for three different portfolios containing two of the stocks in your sample and show the efficient frontiers for the portfolios, where:

(i) Portfolio One contains the two stocks with the highest positive correlation,

(ii) Portfolio Two contains two stocks with a correlation close to zero and

(iii) Portfolio Three contains two stocks with the largest negative correlation. Explain your observation on this graph. Interpret your answer taking into consideration the effects of diversification by comparing the frontiers that you have derived. 

Notes:

The total word count must be printed on the front page. There is a maximum limit of 1,500 words ± 10%.

Referencing in your assignment should take the following forms:

The structural approach of Gilbert (1989) demonstrated that two demand side variables…..

The behaviour of primary commodity prices is particularly important to many developing countries where a significant proportion of national income is generated by a small number of primary products (see Cashin et al., 2000).

A good explanation of the concept of cointegration can be found in Engle and Granger (1991).

These would be listed in the bibliography is follows:

Cashin, P., Liang, H. and C. McDermott (2000) How persistent are shocks to world commodity prices?, IMF Staff Papers, 47, 177-217.

Engle, R.F. and C.W.J. Granger (1991) Long-run economic relationships: readings in cointegration, Oxford University Press, Oxford.

Gilbert, C.L. (1989) The impact of exchange rates and developing country debt on commodity prices, Economic Journal, 99, 773-84.