Construct a portfolio without utilizing any investment principles. Please discuss briefly (Discussion 1) how you constructed the näıve” portfolio. Please limit your discussion to one page of double-spaced text.

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FIN 320: Fall 2020

Individual Project

Due Date: Wednesday, November 18, 2020.

Data: The data you need to complete this project can be obtained from any financial web

site (e.g., http://finance.yahoo.com). Another useful data source is Ken French’s Data Li-

brary (http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data library.html).

I Portfolio Construction: Three Stock Portfolios

Suppose you had $100,000 to invest. Construct three stock portfolios, where each portfolio

contains at least 5 stocks:

1. A “näıve” portfolio: Construct a portfolio without utilizing any investment principles.

Please discuss briefly (Discussion 1) how you constructed the näıve” portfolio. Please

limit your discussion to one page of double-spaced text.

2. A “practical” portfolio: use the ideas discussed in Peter Lynch’s book to construct a

second portfolio. Explain clearly (but briefly) the ideas which motivated your decisions.

You must at least indicate the chapters and/or the page numbers from the text. For

full credit, you must indicate the “rules” (e.g., buy small stocks, never buy stocks with

high analyst coverage, etc.) you derived from Peter Lynch’s ideas. Please limit your

discussion (Discussion 2) to 3 pages of double-spaced text.

3. A “theoretical” portfolio: Applying the basic concepts from portfolio theory, construct

a theoretical stock portfolio. For simplicity, use the stocks from the “näıve” and the

“practical” portfolios to perform this analysis. You can use the mean-variance analysis

or you can construct the theoretical portfolio by simply observing the correlations

among the stocks in the “näıve” and the “practical” portfolios.

After obtaining the theoretical portfolio, compute the correlation matrix separately for

each of the three (näıve, practical, and theoretical) portfolios and attach the results as

Exhibit 1. Please discuss briefly (Discussion 3) how you constructed the theoretical

portfolio and comment on the structure of the three correlation matrices. Please limit

your discussion to one page of double-spaced text.

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For each stock in the three portfolios, provide the following information:

1. Name of the company,

2. Ticker symbol,

3. Stock price at the end of the most recent month,

4. Return in the most recent month,

5. Annual return in 2019,

6. Number of analysts covering the stock,

7. Consensus analyst recommendation, and

8. Price-To-Earnings (P/E) ratio using the price and earnings information from the most

recent quarter.

Present this information in a tabular form (Exhibit 2) so that I can easily compare the key

characteristics of your portfolios.

II Risk Measurement

Compute the following three risk measures for each of your three portfolios:

1. Total risk (or portfolio variance),

2. Systematic risk, and

3. Idiosyncratic risk using CAPM.

You can use either daily, weekly or monthly data to compute these risk measures. Please

justify your choice and mention clearly the time-period you used to estimate the three risk

measures. Attach your calculations and results as Exhibit 3. Please highlight the final

results.

III Performance Evaluation

Compute the following performance measures for each of your three portfolios:

1. Mean monthly return,

2. Sharpe ratio,

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3. Relative Sharpe ratio (SR of a portfolio relative to the SR of the market),

4. Jensen’s alpha,

5. Four-factor alpha,

6. Treynor-Mazuy ratio,

7. M2 measure, and

8. T 2 measure.

You can use either daily, weekly or monthly data to obtain the performance measures.

Please justify your choice and mention clearly the time-period you used to estimate the

three performance measures. Attach your calculations and results as Exhibit 4. Please

highlight the final results.

IV Additional Discussions

In light of your findings, please discuss your views on:

1. Benefits of security selection, i.e., can investors successfully pick stocks? (Discussion

4);

2. Relation between portfolio diversification and portfolio performance, i.e., does diversi-

fication lead to better risk-adjusted performance? (Discussion 5);

3. Market efficiency, i.e., are financial markets efficient or inefficient? (Discussion 6).

Please limit each of your discussions to one page of double-spaced text.

Note: Please prepare your report in a professional manner because 10% of the grade for the

project will be based on your presentation style. Please attach additional material (data,

formulas, calculations, etc.) in an appendix and only present your discussions and exhibits

in the main part. Obviously, the appendix is optional.