Investment Analysis: CBA vs RIO

This assignment analyzes two investments, CBA and RIO, focusing on their risk and return profiles. It calculates monthly and annual returns, standard deviations, and uses the Capital Asset Pricing Model (CAPM) and Security Market Line (SML) to estimate expected returns. The analysis culminates in a recommendation for investment based on the calculated metrics and a comparison of CBA and RIO's performance.

By student name
Professor
University
Date: 27 August 2017.

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Contents
Question no 1…………………………………………………………………...2
Question no 2…………………………………………………………………...4
Question no 3…………………………………………………………….....….6
Refrences.....……………………………………………………………….......10
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Assessment 2
Question 1
Question a Amount in $
Amount earned after each half year 840
Numer of full payment 11.90476
11 approx
Last payment 760
Question b Amount in $
Total amount invested 180000 SI= PTR/100
Interest 72000
Total amount after four years 252000
Total amount in each payment 1400
Therefore size of each payment $1400
Question c Amount in $
Amount after 1 year 4200
Amount after 2nd year 8610
Proceeding like above in December 2017
she will have 59668.5
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Question d Amount in $
Amount at the end of each year 21200
Amount after ten years 212000
Amount given to sell her future rights 150000
This amount after investing for ten years 240000
As the amount given is more, so she should sell her future rights.
Question e Amount in $
Let X be the cost of annuity
Amount of annuity after 10 years 2x
Amount on $1000 at 12 % rate = 1120
Amount after 10 years 11200
Total cost of annuity after 10 years
2x 11200
x 5600
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Question no 2
(a) Maximisation of wealth implies increasing the value of the basket of goods, commodities or
shares held by the investor. In markets, it generally implies the increase in the value of the
company such that the value of the share or its market price is increased. Whereas,
maximisation of profit is a concept where profits earned by the company over a period is
maximised. The ultimate goal here is that the all the operating, investment and financing
decisions are aimed at maximisation of the profit of the shareholders. The concept of profit
maximisation is short term and that of wealth maximisation is a long-term concept. (Grenier,
2017)
Suppose for example, the earning per share of the firm is $ 4, book value per share increases by
$ 20 over a period but the market value decreases by $ 12, i.e., the share prices fall by $ 12, then
in this case, the share would be outrighly rejected as it is destroying the shareholders wealth.
The end objective of any investor in the market is to increase the market value of the share.
The other variable, which differ in case of these two concepts, is profit maximisation does not
takes into consideration risks and uncertainty whereas wealth maximisation does takes care of
it. Profit just acts a reward for the operational efficiency of the firm whereas wealth
maximisation focuses on gaining a larger market share. (Mahapatra, Levental, & Narasimhan,
2017)
From the above examples and explanation, it is clear that the undisputed objective of financial
management is to increase the value of market capitalization of the company and hence the
shareholders wealth. (Meroño-Cerdán, Lopez-Nicolas, & Molina-Castillo, 2017)
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(b) Risk aversion is nature of the investor based on what and how much amount of risk the investor
has the capacity to bear and is ready to take. It does not necessarily mean manager of the
corporate will only invest in the non-risk free investments. It perfectly depends on the risk
appetite and may vary person to person and situation situation. The more the risk, the higher
the returns and the less the risk, the lesser are the returns. (Wang, Cai, Tsay, & Vakharia, 2017)
The one with risk aversion will generally opt for the the securities with the sure returns
percentage and will invest in the debts or fixed deposits whereas the one with the no risk
aversion will opt for securities which may give higher returns. Many risk averse individuals make
their final selections by putting weightage on what could be the worst possible outcome in the
given circumstance and in the given investment. (Heminway, 2017)
Suppose there are 2 securities, one that has small ageing of 6 months and it may fetch or yield
20% half yearly or may give 5% too. The other option is a security, which again will be there for 6
months and will give a return of 8% half yearly for sure, whatever may be the circumstances.
The person with risk aversion will always go for the second security, as he/she would be
expecting and happy with the fixed return of 8% rather than taking risk and may be losing out at
5%. Thus, the statement given in the question is completed in disagreement with the reality.
Risk aversion generally comes into picture in case of an option to choose amongst the decision
to invest or not, or when there are multiple securities to choose from. (Jefferson, 2017)
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Question no 3
(i) The graph alongwith the computations is as follows:
The Formula for holding period return is {(Closing price – opening price) / opening price} *
100
2016
Months Opening Closing Holding period Return Opening Closing Holding period Return Opening Closing Holding period Return
Jan 84.46 78.67 -6.86% 44.63 39.13 -12.32% 5322.79 5056.60 -5.00%
Feb 78.67 70.14 -10.84% 39.13 40.28 2.94% 5056.59635 4947.95 -2.15%
Mar 70.14 74.92 6.81% 40.28 42.69 5.98% 4947.945123 5151.79 4.12%
Apr 74.92 73.89 -1.37% 42.69 51.55 20.75% 5151.787809 5316.00 3.19%
May 73.89 77.43 4.79% 51.55 44.69 -13.31% 5316.004204 5447.80 2.48%
Jun 77.43 74.37 -3.95% 44.69 45.50 1.81% 5447.802131 5310.41 -2.52%
Jul 74.37 77.35 4.01% 45.5 49.56 8.92% 5310.405268 5643.96 6.28%
Aug 77.35 71.81 -7.16% 49.56 47.60 -3.95% 5643.963442 5529.41 -2.03%
Sep 71.81 72.40 0.82% 47.6 51.61 8.42% 5529.407581 5525.15 -0.08%
Oct 72.4 73.39 1.37% 51.61 54.18 4.98% 5525.151351 5402.44 -2.22%
Nov 73.39 78.65 7.17% 54.18 57.75 6.59% 5402.441502 5502.38 1.85%
Dec 78.65 82.41 4.78% 57.75 59.90 3.72% 5502.381477 5719.14 3.94%
Returns on Shares
CBA RIO MKT
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
-20.00%
-15.00%
-10.00%
-5.00%
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
Chart Title
Returns on Shares CBA Holding period Return Returns on Shares RIO Holding period Return
Returns on Shares MKT Holding period Return
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(ii) The average monthly return for each month and overall on each of the investments is as
follows:
2016 CBA RIO MKT
Months Holding period Return Holding period Return Holding period Return
Jan -6.86% -12.32% -5.00%
Feb -10.84% 2.94% -2.15%
Mar 6.81% 5.98% 4.12%
Apr -1.37% 20.75% 3.19%
May 4.79% -13.31% 2.48%
Jun -3.95% 1.81% -2.52%
Jul 4.01% 8.92% 6.28%
Aug -7.16% -3.95% -2.03%
Sep 0.82% 8.42% -0.08%
Oct 1.37% 4.98% -2.22%
Nov 7.17% 6.59% 1.85%
Dec 4.78% 3.72% 3.94%
Average monthly return -0.04% 2.88% 0.65%
Average monthy Returns on Shares
(iii) The annual holding period return on each of the investments is mentioned below:
Year Opening Closing Holding period Return Opening Closing Holding period Return Opening Closing Holding period Return
2016 84.46 82.41 -2.43% 44.63 59.90 34.21% 5322.79 5719.14 7.45%
Returns on Shares
CBA RIO MKT
(iv) Calculation of the standard deviation of the monthly rates of return for both of them.
2016
Months Holding period Return (X-mean)^2 Holding period Return (Y-mean)^2 Holding period Return (Z-mean)^2
Jan -6.86% 0.46% -12.32% 2.31% -5.00% 0.32%
Feb -10.84% 1.17% 2.94% 0.00% -2.15% 0.08%
Mar 6.81% 0.47% 5.98% 0.10% 4.12% 0.12%
Apr -1.37% 0.02% 20.75% 3.20% 3.19% 0.06%
May 4.79% 0.23% -13.31% 2.62% 2.48% 0.03%
Jun -3.95% 0.15% 1.81% 0.01% -2.52% 0.10%
Jul 4.01% 0.16% 8.92% 0.37% 6.28% 0.32%
Aug -7.16% 0.51% -3.95% 0.47% -2.03% 0.07%
Sep 0.82% 0.01% 8.42% 0.31% -0.08% 0.01%
Oct 1.37% 0.02% 4.98% 0.04% -2.22% 0.08%
Nov 7.17% 0.52% 6.59% 0.14% 1.85% 0.01%
Dec 4.78% 0.23% 3.72% 0.01% 3.94% 0.11%
Average or mean -0.04% 2.88% 0.65%
Average of deviation 0.33% 0.80% 0.11%
Standard Deviation 5.74% 8.93% 3.31%
Standard deviation of the monthly rates of return for each share and the market
CBA (X) RIO (Y) MKT (Y)
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(v) Relationship between risk and return via graphical representation.
Particulars CBA RIO MKT
Standard Deviation 5.74% 8.93% 3.31%
Holding period return -2.43% 34.21% 7.45%
Risk and returns on the shares
CBA RIO MKT
-5.00%
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
35.00%
40.00%
Chart Title
Standard Deviation Holding period return
(vi) Calculation of expected rate of return on the shares using CAPM:
Particulars Rf Rm β Rf + β(Rm - Rf)
CBA 3.25% 7% 1.11 7.41%
RIO 3.25% 7% 0.95 6.81%
Calculation of expected returns
Capital Asset Pricing Model
Expected Return ( R ) = Rf + β(Rm - Rf)
Where, Rf= 10 year givernment bond interest rate
Rm = rate of market interest
β = Risk on the security
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(vii) Contraction of Security Market line for both CBA and RIO
Particulars Beta (β), risk on shares Expected Return using CAPM
CBA 1.11 7.41%
RIO 0.95 6.81%
Risk and returns on the shares using CAPM
Beta (β), risk on shares Expected Return using CAPM
-
0.20
0.40
0.60
0.80
1.00
1.20
Chart Title
CBA RIO
(viii) The estimated return and beta of the portfolio consisting of 60% CBA and 40% RIO is:
Particulars Ratio of portfolio (A) Beta (β), risk on shares (B) Expected Return using CAPM (C) Beta on portfolio (A*B) Return on portfolio (A*C)
CBA 60% 1.11 7.41% 0.67 4.45%
RIO 40% 0.95 6.81% 0.38 2.73%
Portfolio 1.05 7.17%
Risk and returns on the shares using CAPM
(ix) Based on the results that we see for both the CBA and RIO from both the CAPM and SML
perspective, I would be investing in CBA rather than in Rio because of the following 2
reasons:
a. The return on CBA is 7.41%, which is higher than RIO’s expected return using CAPM by
0.6%, though the risk is a bit high, the returns in lieu of it would be more. (Murray &
Markey Towler, 2017)‐
b. The second reason for investing CBA is the standard deviation, which is a meagre 5.74%
as compared to 8.93% for RIO. This shows that there may be fluctuation in returns given
by RIO to the extent of approximately 9% as compared to the calculated expected
returns per CAPM. (Macmillan, 2016)
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For taking this decision, the past returns and the average holding return during the last
one year as calculated above has not been taken into consideration.
References
Grenier, J. (2017). Encouraging Professional Skepticism in the Industry Specialization Era. Journal of
Business Ethics, 142(2), 241-256.
Heminway, J. (2017). Shareholder Wealth Maximization as a Function of Statutes, Decisional Law, and
Organic Documents. SSRN, 1-35.
Jefferson, M. (2017). Energy, Complexity and Wealth Maximization, R. Ayres. Springer, Switzerland .
Technological Forecasting and Social Change, 353-354.
Macmillan, P. (2016). Thomas Klikauer: Hegel’s Moral Corporation. Journal of Business Ethics, 302.
Mahapatra, S., Levental, S., & Narasimhan, R. (2017). Market price uncertainty, risk aversion and
procurement: Combining contracts and open market sourcing alternatives. International Journal
of Production Economics, 34-51.
Meroño-Cerdán, A., Lopez-Nicolas, C., & Molina-Castillo, F. (2017). Risk aversion, innovation and
performance in family firms. Economics of Innovation and new technology, 1-15.
Murray, C., & Markey Towler, B. (2017). A Theory of Return-Seeking Firms.‐ SSRN, 1-14.
Wang, L., Cai, G., Tsay, A., & Vakharia, A. (2017). Design of the Reverse Channel for Remanufacturing:
Must Profit-Maximization Harm the Environment? Production and Operations Management,
1585-1603.
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