Finance and Financial Management.

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  • 1. Main Body Word Count: 7402Finance and Financial Management. Page 1 Main Body Word Count: 8900
  • 2. TABLE OF CONTENTS1 INTRODUCTION ........................................................................................................................................... 62 FIRST QUESTION ........................................................................................................................................ 73 SECOND QUESTION ................................................................................................................................. 114 THIRD QUESTION ...................................................................................................................................... 215 FOURTH QUESTION .................................................................................................................................. 306 CONCLUSION ............................................................................................................................................ 377 APPENDIX .................................................................................................................................................. 388 WORK CITED ............................................................................................................................................. 429 BIBLIOGRAPHY ......................................................................................................................................... 45Finance and Financial Management. Page 2
  • 3. TABLE OF FIGURESFigure 1: Profit and Loss Account (Group.1, 2012) ............................................................................................ 7Figure 2: Cash Flow Statement (Group.1, 2012) ................................................................................................ 8Figure 3: Price Variations (Group.1, 2012) ......................................................................................................... 9Figure 4: Volume of Sales Variations (Group.1, 2012) ....................................................................................... 9Figure 5: Determinants of Profitability (Group.1, 2012) .................................................................................... 10Figure 6: Price, Volume, Direct Cost and Investment Variations (Group.1, 2012) ............................................ 10Figure 7: Price and Earning ratio ...................................................................................................................... 11Figure 8: P/E Ratio & Stock Price of Burberry (Morningstar, 2012) .................................................................. 12Figure 9: P/E Ratio and Stock Price of Easy Jet (Morningstar, 2012) .............................................................. 13Figure 10: P/E Ratio of Marks & Spencer (Left) and Debenams (Right) (Morningstar, 2012) .......................... 13Figure 11: P/E Ratio of HSBC (Left) and Barclays (Right) (Morningstar, 2012) ............................................... 14Figure 12: PEG (Historical Growth) 2011 (Yahoo UK & Ireland Finance, 2012) ............................................... 14Figure 13: Beta Value per Company (Telegraph, 2012) ................................................................................... 15Figure 14: Price per Share of the Companies (Telegraph, 2012) ..................................................................... 15Figure 15: EPS Values of the Companies (Telegraph, 2012) ........................................................................... 16Figure 16: Tesco Equity Evaluation Using PE Ratio. (Group.1, 2012)............................................................. 17Figure 17: Tesco Equity Evaluation Using Dividend Discount Model Utilising 0% Growth (Group.1, 2012) ..... 18Figure 18: Dividend Discount Model with 2% Growth (Group.1, 2012)............................................................. 19Figure 19: Comparisons Equity Valuation (Group.1, 2012) .............................................................................. 20Figure 20: Risk Vs Profitability Matrix (Group.1, 2012) ..................................................................................... 22Figure 21: Portfolio Monthly Return Variation (Group.1, 2012) ......................................................................... 23Figure 22: Diversification of Risk through Portfolio Creation (Group.1, 2012) .................................................. 23Figure 23: Strong Positive Correlation (Group.1, 2012) .................................................................................... 25Figure 24: Weak Positive Correlation (Group.1, 2012) ..................................................................................... 26Figure 25: Negative Correlated Stock (Group.1, 2012) .................................................................................... 26Figure 26: Aggreko Beta value vs. FTSE (Group.1, 2012) ............................................................................... 27Figure 27: Relationship between the Variance of a Portfolio Return and the Number of Securities in thePortfolio (Hillier et al., 2010) ............................................................................................................................. 29Finance and Financial Management. Page 3
  • 4. Figure 28: Distribution of Equity Price at Expiration for both Security A and Security B. Options on the TwoSecurities have the Same Exercise Price (Hillier et al, 2010) ........................................................................... 30Figure 29: Increase in Call premium rate (Group.1, 2012) ............................................................................... 31Figure 30: Straddle Strategy at Exercise Price 210 (Group.1, 2012) ................................................................ 32Figure 31: Covered call strategy at exercise price of 205 (Group.1, 2012)....................................................... 34Finance and Financial Management. Page 4
  • 5. TABLE OF ABBREVIATIONS ABREVIATION DESCRIPTIONNPV Net Present ValueP&L Profits and LossS&P Standard & PoorFTSE Financial Times Stock ExchangeFinance and Financial Management. Page 5
  • 6. 1 INTRODUCTIONThe following report considers various models used for evaluating companies by investors. The report startswith an analysis of a company and the attractiveness of investing and future opportunities for the investment.The analysis is completed with the use of Capital budgeting, net present value and the internal rate of return ofthe investment.The second part of the report analyses the PE ratios of five different companies registered in FTSE. Theresearch goes on to compare the companies within themselves, with competition and the industry average.This section also considers different ways of valuation of the equity of a company, Tesco Plc and furthermorecompared with the market valuation.The report goes on to analyse the returns of a given set of companies, over a period of sixty months as well asmonthly. The report determines the average monthly return for the portfolio and its standard deviation of theselected companies. The co-variances or correlation coefficient is also derived for the selected securities.Using this information and portfolio equations, the standard deviation of the portfolio is calculated. Theanalysis ends with a discussion on naïve diversification and randomly selected securities in a portfolio.The final section of the report completes a study on differing strategies employed for options including straddleand covered call. The same is done with a given data of Marks and Spenser’s. Finally Corporate Governanceis considered with respect to Australia’s regulatory environment and the regulations impact on corporatedecision making.Finance and Financial Management. Page 6
  • 7. 2 FIRST QUESTIONa) Determine the investment’s net present value and the internal rate of return. All key assumptions should be specified and explained.The following assumptions were made during the analysis: 1) The investment of the company in a profit and loss account (P&L) report has been evaluated in order to calculate the expected cash flows of tax payments. In the P&L the investment outlay of £9.00 million is not included; however it is discounted in 6 periods of £1.50 million as capital allowances. 2) Regarding direct cost, the manufacturing cost of £12.00 per unit was taken; the company has allocated an Overhead Cost of 10%. This is not included in the P&L analysis or in the Cash Flow Statement, since is not directly attributable to the production of this new product. 3) As a fixed cost, there is a £90,000 per annum cost is directly attributable to this product and an annual charge of £10,000 for the location. The product is charged £50,000 per annum for this space, but only 20% of this amount is results from the potential adoption of the investment. 4) The work already undertaken on the product of £1.3 million was considered as a sunk cost, since historic costs are not relevant for decision taking; however further development work of £200,000 is included as R&D cost, as well as a marketing campaign of £150,000. 5) In period 6, a capital gain of £2 million as a re-sale value of the investment is shown. The aforementioned details are included in Figure 1. Figure 1: Profit and Loss Account (Group.1, 2012)For capital purposes, the total amount of investment outlay is £9.18 million, since there is some finishingequipment that could be sold today for £180,000. Therefore the difference between investing or not, includesan opportunity cost, which is added as well as the investment outlay in the Cash Flow Statement.Finance and Financial Management. Page 7
  • 8. For working capital, 25% of expected sales is required on each period, therefore two outflows are considered,one of £1.425 million in period 0 and another one of £475,000 in period 1. These two outflows are offset inperiod 6 at the termination of the project.To conclude, the Net Present Value (NPV) figure of £3,728,964 is proof that the project is financially viable toinvest in. “Furthermore, the IRR figure of 24.28% gives enough scope to secure an investment when a rate ofreturn of 14% is expected. Figure 2: Cash Flow Statement (Group.1, 2012)Finance and Financial Management. Page 8
  • 9. b) Undertake a sensitivity analysis for the assumed price and volume of expected sales and interpret your results carefully. Provide a brief general discussion of the potential risks associated with this investment.The information derived from the sensitivity analysis concluded that this is a low risk investment. This was dueto the following reasons; 1) The price of the new valve can be reduced by 23.67% and sold at £29.01; this will still result in a positive NPV as shown in Figure 3. This variance of 23% in price is sufficiently large enough to ensure that the project remains profitable regardless of the volatility of the oil and gas industry. (Krauss, 2008) Figure 3: Price Variations (Group.1, 2012) 2) In terms of volume, sales of the new item can be reduced by 35.61% and still record a positive NPV as shown in Figure 3. As the product has a strong relationship with the oil industry, a drop on sales is very unlikely since the industry has growth projections of 37% by 2030 over 2006 levels (Krauss, 2008). However, if the objectives are not reached, the company can still reduce prices in order to increase demand as was previously suggested. Figure 4: Volume of Sales Variations (Group.1, 2012)Finance and Financial Management. Page 9
  • 10. 3) As seen in Figure 5, direct cost and investment outlay have low impact in reasonable variations since each one independently can still result in positive NPV when increased up to 70% for direct cost and 56% for the investment outlay. Figure 5: Determinants of Profitability (Group.1, 2012) 4) If all the variables are evaluated together as shown in Figure 6, it can be identified that: a. If it is necessary to reduce one of two factors, sales targets or price, the decision maker should reduce the volume of units as this shows a higher NPV below 0%. Whereas, b. If it is necessary to increase the NPV, increases in price rather than in volume produce higher returns. Therefore, for price management purposes, the decision maker should understand that for each 1% of price reduction, the correlation of sales volume should increase by 1.53%.Conversely, if sales volume decreases by 1%, then a price increase of 0.67% will return the project to the same NPV. Figure 6: Price, Volume, Direct Cost and Investment Variations (Group.1, 2012)It can be concluded from the sensitivity analysis, that the range of variation from actual targets to thebreakeven point is proof of the low risk of this investment. The volatility of the oil and gas industry, whichprobably has a direct impact on the demand of this new product, requires investments of high IRR such as thisone. Therefore it is strongly recommended to invest in the high pressure valve.Finance and Financial Management. Page 10
  • 11. 3 SECOND QUESTIONa) The price earnings ratios on September 9th 2011 for five companies traded on the London Stock Exchange are listed below. Discuss the factors that might explain the differences between these price earnings ratios. (You should make as much use of the theory relating to the determination of price earnings ratios as possible.) COMPANY PRICE/EARNINGS RATIO Burberry 20.50 EasyJet 8.90 Marks and Spencer 8.80 HSBC 7.50 Lomin 37.90 Table 1: Companies chosen by group 1 (Group.1, 2012)The formula utilised to calculate the PE ratio is as follows: PE Ratio = Market value per share / Earning per share (Atrill and McLaney, 2011)PE ratio is one of major methods to judge the attractiveness of a particular stock of a company againstanother. P/E ratio, or the price per earnings ratio gives an indication of how much investors are willing to payfor a $1 of earnings in that particular company. This suggests that the higher the ratio, the more the investor iswilling to pay. Theoretically, a lower PE ratio means that the company gives a much higher ratio of returns onits price of the share. In layman’s terms, a PE ratio of over 15 is considered as a risky venture because thismeans that either the share price for the company is really high or the earning per share is really low. Whereasany stock with a ratio below 15 is considered both safe and productive as the price would either be low orearning per share will he higherHowever, like any analysis of data there are multiple ways of looking at both the outcomes and the co-relations. With any live market financial data, the similarity or variability of PE ratio needs to be judged after amuch deeper research through multiple ways as there are many impacting parameters’ for the same. Figure 7: Price and Earnings ratioFinance and Financial Management. Page 11
  • 12. In the set of P/E ratio’s the intuitive way is to compare the PE’s of the five companies and understand whythey vary from one another to this degree. Given this primary definition of PE ratio it is easy to bring out someapparent information from the data. From the graphs is apparent that HSBC has the lowest PE ratio and thusshould have the highest rate of growth or earning. Whereas Lomin at 37.90 seems to be high both on relativeterm as well as on the accepted parameter and signifies that an investor will have to pay $37.90 to earn $1return.PE ratio variation compared to the stocksThe examples below are two companies from the list, Burberry and EasyJet. Here there is a comparison withthe share price over the last few years and a chart of the PE ratio behaviour during the same period. Thesecompanies have been chosen for the difference in the co-relation of the price and the PE ratio.BurberryThe two charts below show the relation of share price and PE ratio. In the year 2009 the share prices were thelowest of the five years range and this is complimented by the PE ratio also dropping significantly. In the sameyear the profits declared were also the lowest for the time frame (Morningstar, 2012). Figure 8: P/E Ratio & Stock Price of Burberry (Morningstar, 2012)The comparison above shows clearly the share price to be the impacting factor in the PE ratio. As the pricedropped in year 2009, the PE ratio also dropped equally. This clearly shows that while the price (numerator)was dropping in 2009, the earnings (denominator) remained the same.Easy JetFinance and Financial Management. Page 12
  • 13. Figure 9: P/E Ratio and Stock Price of Easy Jet (Morningstar, 2012)In contrast to the Burberry, the charts of Easy Jet shows an increase of PE ratio in the year 2009 despite ofthe share price being the lowest in the same year. This shows that while the share price went down, thedenominator, which is the earnings, would also have dropped at a higher rate. It is important to mention thatthere are other reasons for the PE to increase. For example, in 2003, Genentech DNA, a biotech firm had ashare price of $35.02 and the earning for the last four quarters were $0.12 per share, which resulted in anextremely high P/E of 292. However, further research would have shown that the companies 2002 earningwas reduced by expenses incurred in litigation and redemption of its stock. If this has not happenedGenentech would have $0.92 a share in earnings for the year 2002, and giving it a P/E of 38. This while notideal, is not that different from 292.However, like any real life data it is important not to get carried away and to understand the parameters for thisdifference and to analyze the reasons. The P/E ratio has some important drawbacks. A P/E ratio of 15 doesnot intrinsically mean much, unless looked at in the context in which it is used. To understand the PE ratio it isimportant to note the following; 1) While comparing P/E ratios from two companies, it is important to compare companies from the same industry and same characteristics. For example; utilities companies typically have low multiples because they are within a low growth and stable sector. Whereas, the technology industry is characterized by high growth rates and constant variations. Comparing a tech company to a utility will not give value to either. The comparison should only be of high-growth companies with others in the same industry, or with the industry average. 2) The historical speed of the growth of the company and the expected trends of the growth in the future should be considered. A company which has shown a growth of only 5% in the past but has a disproportionate P/E means that the projected growth rates dont correlate to the P/E, and the stock might be overpriced. 3) The PE ratio is only meaningful if taken in context. There can be periods when entire industries are overvalued like in year 2000; Internet stocks with a P/E of 75 were looking cheap while the industry was at an average P/E of 200. Retrospectively, neither the price of the particular stock nor the industry benchmark gave the reality. This means that less expensive than industry average does not mean something cheap, as the average itself may be greatly overpriced.The theory above gives a deeper view on the companies selected and some more parameters for judging theperformance and the relevance of PE in the various contexts. While looking at any of the companies it isimportant to ensure that we have a correct context for comparison. As mentioned earlier it is important tocompare the companies with companies of the same industry. In the two graphs below we have a comparisonof the two companies with their competitors in the industry. Figure 10: P/E Ratio of Marks & Spencer (Left) and Debenams (Right) (Morningstar, 2012)Finance and Financial Management. Page 13
  • 14. Here the PE ratio of Marks & Spencer’s is compared with Debenhams over a period of four years. The chartsshow that M&S has over the last four years been showing a higher PE and has consistently remained above.Debenhams, even at its peak has remained lower than the lowest PE shown by M&S. Figure 11: P/E Ratio of HSBC (Left) and Barclays (Right) (Morningstar, 2012)The stocks in the banking industry understandably would not have been the most lucrative from 2008 which isreflected in the past three years PE ratios. However, when compared to the PE ratio of Barclays the figurelook high and gives the investor a reason to look at more criteria than just the PE.Beyond PE for the selected companiesGiven below are some of the other factors which are relevant in judging a stock along with the PE of the share.The graphs below also show a comparison with the other factors.PEG ratioPEG is widely used to calculate potential value. Some favour it over the price/earnings ratio because it alsoaccounts for growth. Similar to the P/E, a lower PEG means that the stock is more undervalued. The PEGRatio uses the P/E Ratio of a stock, and compares it with the company’s annual growth rate (Yahoo UK &Ireland Finance, 2012). Figure 12: PEG (Historical Growth) 2011 (Yahoo UK & Ireland Finance, 2012)Finance and Financial Management. Page 14
  • 15. BetaOne of the most popular indicators of risk is a statistical measure called beta. Beta conveys the measure ofvolatility in the stock in relation to the market. The market as a norm has a Beta of 1, and individual stocks arerated on the basis of how much they deviate from the market. A beta above 1.0 would mean that the stock isswinging above the market movement. If a stock moves less than the market, the stocks beta will be less than1.0. High-beta stocks are supposed to be riskier but provide a potential for higher returns; low-beta stockspose less risk but also lower returns. Stock analysts use this measure to get an understanding of a stocks riskprofiles (Telegraph, 2012). Figure 13: Beta Value per Company (Telegraph, 2012)The beta analysis of HSBC shows a high ratio, this suggests that the share value of HSBC is more volatilethan the market. However, the volatility the PE ratio is one of the lowest. This confirms what has been statedearlier that low price earnings ratios do not necessarily mean that the share is of good value or safer to buy.Another reason could also be that investors are avoiding the stock as its expected future earnings may bepoor. Lomin on the other hand has a high PE ratio and a very high beta factor which indicates that it is bothover priced and has a higher market risk. Figure 14: Price per Share of the Companies (Telegraph, 2012)Finance and Financial Management. Page 15
  • 16. EPS Figure 15: EPS Values of the Companies (Telegraph, 2012)The formula utilised to calculate the earnings per share is as follows: Earnings per share = Earnings available to ordinary shareholders / Number of ordinary shares in issues (Atrill and McLaney, 2011)The earnings per share in the chart above show that the net income per share can be equal even while the PEratio for the companies may differ. For example Burberry and HSBC have similar earnings per share, but theirPE ratios are vastly different. The inference from the data is that the PE ratio does not reveal the volume of theshares being traded or the net income and hence difficult to conclude on the earnings per share.b) Choose a company from the FTSE 100 and carry out a full valuation of the firm’s equity. Use financial websites and your chosen company’s financial reports to full use when collecting the data for your analysis. You should use several estimates for each input into your valuation models. How do your estimates compare to the company’s market equity valuation? How do you interpret the difference?The following study shows the full equity evaluation of Tesco based on the current market standing of theshares. There are multiple ways to complete the valuation based on multiple parameters. The analysis belowhas been completed with five methodologies which arrive at different conclusions on the valuation. Equity evaluation using PE ratioThe evaluation using PE ratio is completed based on the ratio of Tesco’s PE as against the retail. Asdiscussed in this report earlier, the P/E ratio of a company is calculated using the following formula,P/E ratio = Price per share / Earnings per ShareUtilising the above formula (Hillier et al, 2010) the current P/E ratio of Tesco is 9.53 whereas the P/E ratio ofretail sector in UK is 9.85. To understand the same in the context of the overall market it is also important toknow the PR ratio of the overall UK market, which is at 11.46.Finance and Financial Management. Page 16
  • 17. The EPS of Tesco is 33.10pence so the following formula could be used for deriving the price per share ofTesco; Price per share = P/E ratio * EPS (Morningstar, 2012)Since the PE ratio of Tesco is lower and has been behaving that way for the last few years it was important tolook at the valuation of the company in comparison with the market. Taking retail sector P/E ratio intoconsideration the price per share of Tesco would be; 9.85 * 0.33 = 3.25 (Morningstar, 2012)The number of shares in issue for Tesco is 8014.47 million as declared in the financials of the company(Yahoo UK & Ireland Finance, 2012). The equity value of the company can be arrived at by multiplying thenumber of shares and price per share. This gives a valuation of 8014.47*3.25 = 26,051.03 million or 26.05Billion.Whereas the market capitalization of Tesco given in the financial websites comes to 25,706.40 million or 25.70billion (Morningstar, 2012), there is a difference of circa £350 million in our estimation. Data displayed in Billions 27 EQUITY VALUE 26 26.05 25.70 * 25 MARKET VALUE PE EVALUATION Figure 16: Tesco Equity Evaluation Using PE Ratio. (Group.1, 2012)While Tesco has outperformed its competitors in the past there has been a reduction in the PE ratio of Tescorecently due to the profit warning sounded in the third quarter. Since in this evaluation calculation of the shareprice is based on the EPS* PE ratio, the price per share has come out lower, which would explain the variationof 350 million between both the valuations of Tesco. Using dividend discount modelThe valuation of a company can also be done based on its dividend. The value of a firm’s equity for theinvestor would be equal to the present value of all the expected future dividends. The equity of Tesco can alsobe evaluated by the dividend discount model. The dividend discount model could be used in two methods.The value of equity with constant dividend is given by the formula: 1) Zero growth :P0 = Div/RWhen the dividends grow at rate g the equity is valued by the following formula; 2) P0 =Div/(R-g) where P0 is the present value of share.The R in the formula can be calculated using the Capital asset pricing model (CAPM). Capital asset pricingmodel is used to find the discount rate. This would mean expected return on the stock would be equal to riskfree interest rate plus the multiplication of beta with market premium. This could be described in the followingformula;Finance and Financial Management. Page 17
  • 18. R=Rf +beta (Rm - Rf), where beta being the beta of the security, Rf is the risk free rate and Rm is theexpected market return.The 10 year UK government bond (Rf) yield is 3.75; the current beta of Tesco security is 0.58 (Morningstar,2012)The last 5 year declared dividend of Tesco is 9.64, 10.90, 11.96, 13.05 and 14.46 pence, which gives anaverage dividend of 12 pence for the period. Zero growth : P0 = Div/RIf the analysis is completed at various levels of sensitivity of rate of market return (Rm) there are differentvaluations for the company. Given below are three different valuations arrived at with three separate marketreturn rates. a) Market return – 7%With the same formula R=Rf +beta (Rm - Rf) would give R=3.75+.58(7-3.75)=5.635Using the dividend growth mode P=Div/r we could get the present value of share as 214.28.P=12/.056=214.28.Therefore Equity value=8014.47 *214.28=17,150 million or 17.15 billion. b) Market return=5%R=3.75+.58(5-3.75) therefore R=4.47P=12/.044=272.22Therefore Equity value=8014.47 *272.22=21799.35 million or 21.79 billion. c) Market return=9%R=3.75+.58(9-3.75) = 6.79P=12/.067=179.10Therefore Equity value=8014.47 *179.10=14,353.91million or 14.35 billion. Data in Billions 25 EQUITY VALUE 20 15 21.79 10 17.15 14.35 5 0 4.47 5.63 6.79 RATE OF DISCOUNT WITH 0% GROWTH Figure 17: Tesco Equity Evaluation Using Dividend Discount Model Utilising 0% Growth (Group.1, 2012)Finance and Financial Management. Page 18
  • 19. The chart above gives a picture of the different valuations generated through varying rate of discount. Thisgoes on to show that the valuation can change by nearly 52% or 7.44 billion with a change of 2.32% in the rateof discount.The formula utilised to derive dividends with growth is as follows:Dividends with growth: P0 =Div/(R-g) where P0 is the present value of share with g being the dividend growthrate. For the calculation of the formula there has to be a future growth projection. For this method of valuation towork the g has to be less than R, so as an assumption the g is taken as 2%. Given below are the threedifferent valuations when the three different rates of discounts (R) are used (calculated using CAPM model); a) Rate of discount= 6.79% and g = 2%12/(0.067-.02) = 12/.047 =255.31 Pence per shareTherefore at a share price of 255.31 pence and an issued share of 8014.47 million the total valuation forTesco will be 20436.89 million or 20.45 billion. b) Rate of discount = 4.47% and g =2%12/(0.047-.02) = 12/.027 =444.44 Pence per share and thus giving a valuation of 35584.24 million or 35.55billion. c) Rate of discount = 5.63% and g = 2%12/(0.056-.02)=12/.036 =333.3 Pence per share and thus giving a valuation of 26688.18 million or 26.69billion. Data displayed in Billions 40 35 EQUITY VALUE 30 25 20 35.55 15 26.69 20.45 10 5 0 4.47 5.63 6.79 RATE OF DISCOUNT WITH 2% GROWTH Figure 18: Dividend Discount Model with 2% Growth (Group.1, 2012)As the chart shows a change of 2.32% in the rate of discount can make a change of 15.1 billion or 73.8%. Thegraph when compared with Figure 17 of zero growth also gives out the stark change in the valuation when agrowth of even 2% is added on to the rate of discount. The variance of valuation between the highest andlowest among the two graphs is 21.2 billion.Finance and Financial Management. Page 19
  • 20.  Final Comparison Data displayed in Billions 26.05 35.55 25.71 26.69 21.79 20.45 17.15 14.35 4.47 5.63 6.79 RATE OF DISCOUNT RATE OF DISCOUNT WITH 2% GROWTH MARKET PE EVALUATION Figure 19: Comparisons Equity Valuation (Group.1, 2012)The green line shows the current market. Of the seven different valuations the chart shows valuation by PEratio (industry) seems to be the nearest of the actual valuation. The reason is that the PE ratio of Tesco is nottoo different from the PE ratio of the industry. The rate of discount without growth is giving the lowest valuationat all sensitivities. The graph illustrates and explains how the same company’s valuation can differ so muchthrough different approaches.Finance and Financial Management. Page 20
  • 21. 4 THIRD QUESTIONa) Determine the average returns over the 60 month period for each of the five securities and their respective standard deviations using Excel. Determine the returns for the five share portfolio for each month in the period. On this basis determine the average monthly return for the portfolio and its standard deviation. Discuss briefly the standard deviation of the portfolio returns in relation to the standard deviations of the securities making up the portfolio.An equally weighted portfolio is a group of shares in which the same amount of money has been invested ineach stock (Berk, DeMarzo and Harford, 2009), this is also known as naïve diversification whereby no analysishas been completed in the stock selection.The drawing below shows the five companies which were selected at random to create a equally weightedportfolio. The companies selected are as follows; Aggreko, Barclays, Johnson Matthey, Pearson, Vodafonegroup.The average return over the 60 month period was calculated for each of the 5 companies and the portfolio asshown below. NAME OF THE COMPANY AVERAGE STANDARD DEVIATIONAGGREKO 3.62% 10.83%BARCLAYS 0.42% 17.38%JOHNSON MATTHEY 1.30% 8.37%PEARSON 1.07% 5.27%VODAFONE GROUP 0.63% 6.34% Table 2: Portfolio Average Return (Group.1, 2012)The standard deviation of the returns of the individual security measures how risky the security would be ifheld in isolation (Hillier et al., 2010)In the context of this diagram it can be seen that the organisations which have been chosen have beenpositioned into the four quadrants. Barclays is shown to be high risk, low profitability which may seem counterintuitive, however that within this matrix the risk/profitability of the company is relative to the other companieswhich have been chosen.Finance and Financial Management. Page 21
  • 22. Figure 20: Risk Vs Profitability Matrix (Group.1, 2012)The month on month average returns from 5 companies in the equally weighted portfolio are shown below inthe table. MONTH 2005 2006 2007 2008 2009 Jan -1.49% 0.61% 3.37% -4.10% -11.41% Feb 0.84% 1.41% -0.75% 1.27% -4.83% Mar 1.57% 6.11% 5.08% 1.46% 21.53% Apr -1.42% 2.03% 3.96% -0.34% 25.84% May 3.26% -8.38% 3.39% -1.93% -1.50% Jun 2.47% 1.30% 1.32% -4.17% -3.98% Jul 5.20% -0.61% -3.74% 0.07% 10.76% Aug 1.67% 2.23% -3.64% 3.44% 13.14% Sep 3.14% 6.99% 4.20% -14.69% 1.96% Oct -0.87% 5.61% 5.94% -19.61% 0.19% Nov 2.48% 0.23% -7.53% 0.37% -0.72% Dec 5.14% 5.82% 1.05% 6.21% 7.41% Table 3: Portfolio Monthly Average ReturnsFor clarity these figures have been plotted on a graph, as can seen the returns were fairly steady ifunspectacular, however, from September 2008 September 2009 the market became volatile and there havebeen large fluctuations between gains and losses.Finance and Financial Management. Page 22
  • 23. Figure 21: Portfolio Monthly Return Variation (Group.1, 2012)The average monthly portfolio returns are summarised as below. Please refer to the appendices for moredetail. PORTOFOLIO STATISTICS PERCENTAGEAverage 3.99%Standard Deviation 12.20%Variance 1.49% Table 4: Summary of Portfolio Statistics Figure 22: Diversification of Risk through Portfolio Creation (Group.1, 2012)Finance and Financial Management. Page 23
  • 24. From the analysis within the graphic above, the standard deviation 6.78% of the portfolio is less than the sumof weighted average of the standard deviations of the individual securities 9.64% (Hillier et al., 2010). It can beconcluded from this analysis that by diversifying the amount of stocks in a portfolio the exposure to risk isreduced.b) i. Using Excel derive the co-variances or correlation coefficient for each pair of securities. On the basis of this information and using portfolio equations, based on the average covariance and average variances calculate the standard deviation of the portfolio. Compare your results to those obtained in (a). Explain the basis of the derivation of the standard deviation of portfolio returns.The co-variances and the correlation coefficient for each pair of securities are given below. AB AC AD AE BC BD BE CD CE DE AverageCovariance 0.010 0.004 0.002 0.001 0.006 0.002 0.001 0.001 0.002 0.001 0.003 Correlation 0.517 0.417 0.429 0.218 0.428 0.257 0.061 0.329 0.303 0.265 0.322 Table 5: Covariance & Correlation Among CompaniesThe company key is as follows: CODE COMAPNY A AGGREKO B BARCLAYS C JOHNSON MATTHEY D PEARSON E VODAFONE GROUP Table 6: Code of CompaniesThe formula utilised to derive the variance of the portfolio is as follows; Variance (Return of portfolio) = 1/n [average variance of the individual stocks]+[1- 1/n)[average covariance between the stocks]] (Berk, DeMarzo and Harford, 2009)The data for the equation above have been extrapolated from the raw data given and are shown in the tablebelow; if any further reference is required it may be made within the appendices. TITLE VALUENumber of Stocks (N) 5Average variance of individual stocks 0.0110Average cov between stocks 0.00301/n (Average variance of individual stocks) 0.0022[1-1/n)[Avge covariance between the stocks]] 0.0024 Table 7: Portfolio Variance CalculationFinance and Financial Management. Page 24
  • 25. Thus:Variance (Return of portfolio) = 0.0022+0.0024 = 0.0046From the aforementioned, we find that the variance of the portfolio derived through the co-variances is thesame as that found by calculating the returns directly which were determined in Question 3, part a. This is asshown below; PORTOFOLIO STATISTICS PERCENTAGE Variance 0.46% Standard Deviation 6.78% Table 8: Portfolio Statistics SummaryThe basis of this derivation is as follows:var(Return of portfolio) = 1/n [avge variance of the individual stocks]+[(1-1/n)[avge covariance between the stocks]] (Berk, DeMarzo and Harford, 2009)The following assumptions are made in order to calculate the variance of the portfolio using the aboveequation. 1) The variance of all securities in the portfolio is considered to be equal and for this purpose the value has been taken as the average variance of 0.0109 (Hillier et al., 2010). 2) The covariance between any two stocks in the portfolio is considered to be equal and for this purpose the value has been taken as the average covariance of 0.0030 (Hillier et al., 2010) 3) The given portfolio is equally weighted. Because there are 5 securities, the weight of each stock is 1/5 = 0.20 (Hiller et al., 2010)For deeper analysis the pairs of stocks were plotted graphically and the highest and lowest positivelycorrelated pairs are shown below. Figure 23: Strong Positive Correlation (Group.1, 2012)Finance and Financial Management. Page 25
  • 26. Highest positively correlated pairs. 50% 40% 30% 20% 10% 0% -10% -20% -30% -40% -50% 01/01/2005 01/03/2005 01/05/2005 01/07/2005 01/09/2005 01/11/2005 01/01/2006 01/03/2006 01/05/2006 01/07/2006 01/09/2006 01/11/2006 01/01/2007 01/03/2007 01/05/2007 01/07/2007 01/09/2007 01/11/2007 01/01/2008 01/03/2008 01/05/2008 01/07/2008 01/09/2008 01/11/2008 01/01/2009 01/03/2009 01/05/2009 01/07/2009 01/09/2009 01/11/2009 B E Figure 24: Weak Positive Correlation (Group.1, 2012)For analytical purposes stock B (Barclays) above was replaced with the National Grid stock values todetermine what effect this would have on the portfolio. National grid was chosen as it was felt that it would bepolar opposite to Aggreko which is a temporary generator solution company. The results are as shown below. Figure 25: Negative Correlated Stock (Group.1, 2012) PORTOFOLIO STATISTICS PERCENTAGE Variance 0.21% Standard Deviation 4.57% Table 9: Re-Calculated Portfolio StatisticsThe conclusion from this diagram and table is that by using one negatively correlated stock, instead of a 0.5correlated stock (Barclays), the standard deviation of the portfolio has further reduced from 6.78% to 4.5%,thus reducing the portfolio risk.Finance and Financial Management. Page 26
  • 27. b) ii. Provide an estimate of the beta for one of the securities and discuss the meaning and reliability of the estimate you have derived. Comment on the possible differences between your estimate and those provided by commercial concerns on the internet.The Beta value of a stock is the sensitivity of a specified stock return in relation to the fluctuation of the marketindex. For example a stock with a beta value of 1 means that the stock rise and falls at the equivalent rate tothe index.The Beta value of Aggreko has been considered and its returns have been compared against the FTSEreturns provided. The beta value of Aggreko is greater than 1 and thus can be considered to be an aggressivestock.From the given data set the Beta value of Aggreko has been determined as 1.32 (refer to the appendices forthe method of deriving this figure). This means that if the market performance improves by 1%, the stock valueincreases by 1.32%. The same is true for a drop in stock performance relative to market performance asshown in the diagram below. PERCENTAGE GROWTH 2.64% 2.00% FTSE 100 Aggreko FTSE 100 Aggreko -1.00% -1.32% Decrease Increase Figure 26: Aggreko Beta value vs. FTSE (Group.1, 2012)The reliability of Beta values may be questioned due to;  Beta values are for historical data and not a representation of future performance (Little, n.d.).  If the organisation is going through changes, for example new product lines or new market penetration the Beta value will not represent these changes (Little, n.d.).  The index which Beta values are derived from may affect the reliability, if companies are out with the index utilised, for example the FTSE may not the best index to derive data for non UK markets (McNulty, 2009).  The time period of given Beta values may be unknown, thus long term investors have a different risk profile to those traders who have a short term risk perspective thus leading to difficulties for those investors who use Beta to gauge their respective portfolio risk (McNulty, 2009).The Beta value from the internet is 1.19 (Reuters, 2012). The beta displayed on Reuters.com is calculatedbased on trailing 5-year prices, on a monthly basis, relative to the S&P 500 (Reuters, 2012). Hence the Betavalue changes with every new month recorded as the moving average changes.Finance and Financial Management. Page 27
  • 28. The differences between the Beta figures are attributable to the following reasons; 1) The data set provided for the assignment is for the period between 31/01/2005 and 31/12/2009. The Beta value taken from Reuters.com is calculated from the periods of the past 5 years. 2) Furthermore, the Beta value calculated is against FTSE values whereas those listed are relative to S&P 500 values.The returns of Aggreko are taken for the past 5 years from yahoo finance and Beta values are calculatedagainst the FTSE index. The results are summarised in the below table, as can be seen the indexes, periodsand betas are all different.It can be concluded that regardless of the data utilised in deriving the Beta values of Aggreko, the stockremains aggressive. SOURCE YAHOO FINANCE CALCULATION REUTERS Period 2008-2012 2005-2009 2008-2012 Index FTSE FTSE S&P Beta 1.312 1.32 1.19Conclusion Aggressive Aggressive Aggressive Table 10: Variation of the Beta Values (Group.1, 2012)c) Explain what is meant by naive diversification and explain the consequences of increasing the number of randomly chosen securities in a portfolio.Naive Diversification is a strategy whereby an investor simply invests in a number of different assets in thehope that the variance of the expected return on the portfolio is lowered. The investment portfolio is builtthrough a random or naive selection of assets regardless of any mathematical formula. (Harvey, 2011)Although computerized models can look impressive, the benefits of advanced mathematical modelling areunclear. Investigations into optimization theory have argued against the effectiveness of sophisticated models."Optimal Versus Naive Diversification: How Efficient is the 1/N Portfolio Strategy," conducted by Dr. DeMiguelis a good example of them. The difference between them and the naive approach is not statistically significant;they point out that basic models perform well, thus complexity does not always help. (Bloch, 2011)In relation to investments there are systematic and unsystematic risks. The systematic risk arises with a singlesecurity only, whereas the unsystematic risk is diversified away in a large portfolio. Though both the riskscannot be eliminated completely, studies show that for an infinite population of stocks, a portfolio size of 20 isrequired to eliminate 95% of the diversifiable risk on average. (Hiller et al., 2010)By increasing the number of randomly chosen securities in a portfolio will result in the variance being moredependent on covariance between individual securities than on the variances of the individual securities. Thus,if the number of securities included in a portfolio were to approach the numbers of securities in the market,one would expect the variation of the portfolio return to approach the level of systematic variation-that is, thevariation of the market return, suggesting a relationship which behaves as a decreasing asymptotic function ascan be seen in Figure 1. (Evans and Archer, 1968)Finance and Financial Management. Page 28
  • 29. Figure 27: Relationship between the Variance of a Portfolio Return and the Number of Securities in the Portfolio (Hillier et al., 2010)An addition of 80 stocks is required to eliminate an extra 4% (i.e., 99% total) of diversifiable risk on average.This result does not depend on the sampling periods, the investment horizons or the markets involved. For afinite population of stocks, the corresponding portfolio size required will be smaller (Tang, 2004).However, recent researches conclude that forty to fifty stocks is all that is needed to achieve diversification.Previous studies took into account the time series variability of returns but ignored the cross sectionalvariability and the possibility of alternative weighting schemes. Benjelloun resolves this matter by addressingall these issues simultaneously. (Benjelloun, 2010)Finance and Financial Management. Page 29
  • 30. 5 FOURTH QUESTIONPrices of Calls and Puts Options the shares of Marks & Spencer SHARE EXERCISE CALLS PUTS PRICE PRICE Sep Oct Nov Sep Oct Nov 205 12.0 24.0 27.0 6.0 17.5 19.5 2010 210 9.5 21.5 24.5 8.5 20.0 22.0a) Explain carefully why the November calls are trading at higher prices than the September calls.The following are the possible reasons for the November call options trading at higher premium than theSeptember call option.Assumption: The option type is American call.Expiration date: The longer period the call has until it expires, the longer the period for the option holder toexercise the option. The longer which this expiration is the greater the call option price.Volatility: The volatility of the underlying share price is an important determinant of an options underlyingvalue. The greater the variability of rate and magnitude of the underlying asset, the more valuable the calloption will be. Buyers of the call option expect that the probability that share value will remain higher than theexercise price is higher during November than during September. A PROBABILITY B Exercise Price PRICE OF EQUITY AT EXPIRATIONFigure 28: Distribution of Equity Price at Expiration for both Security A and Security B. Options on the Two Securities have the Same Exercise Price (Hillier et al, 2010)Finance and Financial Management. Page 30
  • 31. As can be seen from the above diagram option B is more valuable than A as there is a higher probability thatthe share price of B will fluctuate outside of Curve A.Change in implied volatilityApart from changes in the price of the actual underlying commodity or security, the price of an option is mostaffected by changes in implied volatility. Implied volatility measures the aspect that option traders expect thehistorical volatility will be in the future. The actual option price will determine implied volatility. The volatility isimplicit in the price of the option.For example:High implied volatility means that sentiment is extremely bullish or bearish and that option traders believethere is a greater likelihood of higher or lower prices being reached in the future (Katiforis, n.d.).If sentiment in the commodity textile and trading market becomes bullish, the prices of Marks and Spenser’scall options will rise even before the actual price of crude oil does.Option buyers will be prepared to pay more for the option as there is the perception of the market making alarge move in their favour.Increase in Share Price: The increase in the call price for a given change in the share price is greater whenthe share price is high than when the share price is low. It is expected that the share price for November willhigher than that of September and hence making the call option more profitable. The higher the share price,the more valuable the option. Hence the call option buyers are expecting the share price to rise over theperiod and the difference between the share price and exercise price to increase. Moreover, the buyers expecta sharp rise in share price between September and October which is in fact higher than the premium paid andhence profitable to the buyer.Interest rate: Call prices are a function of the interest rates. The ability to delay payment is more valuablewhen the interest rates are high and less valuable when the interest rate is low. A higher interest rate of theNovember call options than the September call options could be a reason for the higher premium.It is observed that there is a spike in the premium between September and October. This indicates that thereis an expected rise in the share price during that period which will make these calls to be profitable. A spike inthe share price over a short period could be due to many reasons, some of which are as below. Figure 29: Increase in Call premium rate (Group.1, 2012) 1) Imminent declaration of favourable results, Marks and Spencer declare their half yearly results in November (Marks and Spencer, 2011), so traders are willing to pay a higher premium for this monthsFinance and Financial Management. Page 31
  • 32. option. Research undertaken by Amin and Lee state that “option traders initiate a greater proportion of positions before earnings news” 2) Imminent acquisitions/takeovers 3) New projects in near future 4) Impending profits due to Christmas salesb) Draw a diagram illustrating a straddle, using calls and puts expiring in November and an exercise price of 210. Explain the circumstances in which an investor might consider it worthwhile to invest in a straddle.Used mainly as a market neutral strategy, the straddle is employed by investors where the market is expectedto become volatile in the future. The strategy is primarily dependent on four parameters – strike price, volatility,premium and time.The idea is to buy a call option and a put option at the same strike price. The most important aspect of theprice is the volatility in the market, not the rise or fall of the share price. The timing of the option purchase isalso important as an option bought for a stock which is already in a state of volatility may be as profitable asthe premium to buy the option will already be high. The final profit is calculated after deducting both thepremiums paid, thus the premium price has a direct impact on the strategy. Time decay is also a threat to thestrategy as there is a finite shelf life to the options. This means that there is a real time threat to the straddlebecoming worthless as the time limit approaches. The diagram below gives a projection of the straddle strategy where the exercise price (strike price) of 210and a premium of 24.5 and 22 for call and put, respectively. Figure 30: Straddle Strategy at Exercise Price 210 (Group.1, 2012)As previously mentioned, the net profit from the strategy is calculated after deducting the premiums from thegross profit. For an exercise price of 210 and with zero premiums, the call option would be profitable if theshare price rises above 210 for a call option, the put option will be profitable if the share price falls below 210.However, in this case there are two varied premiums payable for the call and put options. A straddle isprofitable if the option exercised (put/call) brings about a return greater than the sum of premium prices paidfor buying the put and call options.Finance and Financial Management. Page 32
  • 33. Here the premium paid for put and call option = 22.0 + 24.5= 46.5.From the diagram above, we can identify that the straddle achieves breakeven in the following scenarios;1. Share price falls below 210-46.5 = 163.52. Share price rises above 210+46.5=256.5While the potential maximum profits remain infinite, the share price volatility must be high in order for thestraddle to be profitable as a strategy. If the share price remains within a price range of 163.5 and 256.5 theoption will be worthless and would result in a loss of 46.5. This also means that each passing day towardsNovember without movement of the stock would erode the value of the option.The share price volatility must be high in order for the straddle positioning to be profitable.c) Develop a covered call using the data provided and discuss the nature of the payoffs produced and the potential uses of the strategyA covered call is one in which 100 shares are purchased at the current price (210) and the call is sold on thesame stocks for a premium and an exercise price is set.For example:The expenditure would be cost of 100 shares = 210*100=21000The premium for each of the call options is taken from the table given. Hence for 100 stocks, the premiumscharged would be; EXERCISE PRICE SEPTEMBER OCTOBER NOVEMBER 205 1200 2400 2700 210 950 2150 2450 Table 11: Revenue due to option premiums (Group.1, 2012)The returns would be what we get if the stock price remains the same.If the stock price increases;If the price of the stock increases beyond the exercise price, the call would be exercised and the cost of thestocks would be; EXERCISE PRICE SEPTEMBER OCTOBER NOVEMBER 205 20500 20500 20500 210 21000 21000 21000 Table 12: Selling price of stocks at exercise price (Group.1, 2012)Finance and Financial Management. Page 33
  • 34. Hence the profit for each of the cases would be (premium price + cost of goods sold - expenditure to buy thestocks). EXERCISE PRICE SEPTEMBER OCTOBER NOVEMBER 205 700 1900 2200 210 950 2150 1950 Table 13: Profits during stock price increase (Group.1, 2012)If stock price decreases;The following are the minimum values that the stock price must go down to in order for a loss to occur. In otherwords, the below are the break even points of share price for the various covered call options.EXERCISE PRICE SEPTEMBER OCTOBER NOVEMBER 205 198 186 183 210 200.5 188.5 185.5 Table 14: Break even prices for covered calls (Group.1, 2012)The owner of the shares should sell before the share price drops to these prices, as otherwise the covered callwill not be profitable.Eg: Consider the September option at excise price of 205. Profit = 205*100 + 12*100 – 210*100=700 PROFIT 198 205 Break Even Point Exercise Price SHARE PRICE Figure 31: Covered call strategy at exercise price of 205 (Group.1, 2012)Finance and Financial Management. Page 34
  • 35. The covered call strategy gives a cushion against a predetermined fall in share price in exchange for theprofits gained in case of market price difference to buying price.This strategy is considered to be conservative as it offers limited exposure to the decline of the underlyingstock price and the decreases the risk of stock ownership. The counterpoint to this is that there is limitedpayoff potential due to the “cover” of the stock price. Income is forthcoming from the premium gained fromwriting the call. Furthermore, the benefits from owning the stock such as dividends and voting rights aregained by the investor.d) Focus on one country (not the UK) and review the main corporate governance regulations in place (www.ecgi.org). The regulatory environment can have a massive impact on the way in which corporations do their business, how they are financed, and the popularity of banks and the financial markets. Review the main regulatory features (investor protection, etc.) for your chosen country and their overall impact on corporate decision-making.Australia, like other countries has suffered corporate failures through the preceding decades, the highestprofile cases have been one.tel and HIH, the latter losing Aus $5.3 billion. From these failures a robustCorporate Governance standard was formulated in 2004 named Corporate Law Economic Reform ProgramAct 2004, commonly called CLERP9. The CLERP act proposed three bodies to ensure that the principles ofCorporate Governance could be monitored and adhered to; the Financial Reporting Council to overseestandard setting for audit and accounting, the Australian Securities Exchange’s (ASX) Corporate Governancecouncil to ensure the development of best practice for listed companies and the Shareholders and InvestorsAdvisory Council to ensure retail investors had a forum to air issues. Shareholder rights are not set out inthese guidelines; these items are contained in the Commonwealth Corporation Act 2001.There are six main principles of Corporate Governance; these are discussed below from an Australianperspective. 1) Ensuring the basis for an effective corporate governance framework.As discussed in the introduction the basis for an effective corporate governance framework is to ensure thatthere is sufficient and clear legislation which guides organisations to best practice. The formation of the ASXCorporate Governance council in 2002 laid the foundations of a robust, practical and transparent system.More than two thousand organizations participate in the reporting process laid out in the guidelines.Furthermore, the ASX guidelines require companies to follow the “if not, why not” principle, this requires listedcompanies to state that if they are not adhering to the recommendations laid out, it is necessary for theorganization to disclose the reasons for non-compliance in their annual report.The impact which these regulations have on corporate decision making is that any listed company has clearand comparatively strict regulations, without the prescriptive requirements laid out, for example, under theSabanes-Oxely act of the USA. The premise of “if not, why not” is, in the authors opinion a method of givingsome latitude as organisations merely have to state reasons for noncompliance with the recommendations butdoesn’t implicitly improve governance. However, the fact that any noncompliance has to be disclosed in theannual report gives transparency and allows shareholders to question the board/management on thesesubjects. 2) Rights of shareholders and key ownership functions and 3) The equitable treatment of shareholders.Principle 6 of the ASX Corporate Governance Principles is entitled “Respect the rights of shareholders”however the main thrust of this article is to ensure that the shareholders are communicated with effectivelyand that the latest technology is used.However there is further legislation entitled the “Corporations act 2001.” The types of shares which arementioned are ordinary shares and voting shares. There is nothing stipulated as to specifics of the votingshares By not defining the criteria of these shares leaves the rules of ownership open to the organisationsinterpretation. From a corporate decision making perspective this flexibility should be advantageous to thecompany as it will give latitude of how to distribute the shares. However, from a governance view this could beFinance and Financial Management. Page 35
  • 36. construed as not entirely ethical. These rights would have to be written into the organisations constitution toensure that any potential shareholder were cognizant of their rights. 4) Disclosure and TransparencyPrinciples 4 “Safeguarding integrity in financial reporting” and 5 “Make timely and balanced disclosure” of theASX principles set out the requirements for disclosure and transparency.The main thrust of principle 4 is in regards to the audit committee, its composition and reporting procedures. Inessence the reporting committee should be sufficiently large enough with the appropriate technical expertiseto be able to understand the matters raised.Principle 5 states the guidelines for reporting and disclosure of all items pertinent to the company. It breaksdown the requirements of what and how the information should be reported.From a corporate decision making perspective the challenge will be to find suitably qualified and independentdirectors who are able to understand the requirements of a modern day organisation. 5) The responsibilities of the board.Principle 2 covers the structure of the board and their responsibilities. This article is very detailed, however thekey points are as follows:“Companies should have a board of effective composition, size and commitment to adequately discharge isresponsibilities and duties.”The detail of this principle splits into six points detailing the specifics, for example what is an independentdirector, the selection process of directors. The other points cover the various required committees and theircomposition.The principle of “if not, why not” comes into the fore with the various reporting requirements. Due to the levelof the detail specified if a company was to follow the letter of the principles then there would be some difficultyin finding the appropriate people with the right qualifications. Furthermore the level of paperwork that would begenerated will require a robust administration team. 6) The role of stakeholders in Corporate governance.Under the terms of Principle 3 “Promote ethical and responsible decision making” stakeholders are identified.The term used is “organisations should comply with their legal obligations and also consider the reasonableexpectations of their stakeholders”. This is a subjective phrase and allows a certain degree of latitude fororganisations to work in.The challenge for an organisation is to understand who their stakeholders are. The stakeholder is dependentupon context and timing. The easily identifiable stakeholders are staff and shareholders, however as was seenin the recent BP Gulf of Mexico disaster the stakeholders who became involved were the US President,senate and congress.Finance and Financial Management. Page 36
  • 37. 6 CONCLUSIONAs mentioned in the start of the report, the different sections of the report look at various methods of analysisfor judging a company or security on its appeal for investors. The analysis also delves on some of the toolsused by newer investors like straddle and covered call options. While there have been some of the commonlyused and popular methods of analysis have been focussed on in the study, it is important to point out thatthese are neither comprehensive nor exhaustive.Finance and Financial Management. Page 37
  • 38. 7 APPENDIXa) Variance CalculationFinance and Financial Management. Page 38
  • 39. b) Covariance Calculation Covariance A B C D E A 0.012 0.010 0.004 0.002 0.001 B 0.010 0.030 0.006 0.002 0.001 C 0.004 0.006 0.007 0.001 0.002 D 0.002 0.002 0.001 0.003 0.001 E 0.001 0.001 0.002 0.001 0.004 Correlation coeff A B C D E A 1 0.51654 0.41674 0.42879 0.21799 B 0.51654 1 0.42816 0.25706 0.06066 C 0.41674 0.42816 1 0.32894 0.30299 D 0.42879 0.25706 0.32894 1 0.26527 E 0.21799 0.06066 0.30299 0.26527 1 AB AC AD AE BC BD BE CD CE DE Average Covariance 0.010 0.004 0.002 0.001 0.006 0.002 0.001 0.001 0.002 0.001 0.003 Correlation 0.517 0.417 0.429 0.218 0.428 0.257 0.061 0.329 0.303 0.265 0.322Finance and Financial Management. Page 39
  • 40. c) Beta Value CalculationFinance and Financial Management. Page 40
  • 41. d) Using Negative Correlated StockFinance and Financial Management. Page 41
  • 42. 8 WORK CITEDAmin, L. and Lee, C. (1997) Option Trading, Price Discovery, and earnings News Dissemination, ContemporyAccounting Research, vol. 14, no. 2, Summer.Anon (2008) The luxury brand with a chequered past, Burberrys shaken off its chav image to become thefashionistas favourite once more, 2 Jun, [Online], Available: HYPERLINK "www.dailymail.co.uk/femail/article-1023460/Burberrys-shaken-chav-ima" www.dailymail.co.uk/femail/article-1023460/Burberrys-shaken-chav-ima [20 Nov 2011].Atkins, W. (2011) Annual Report.Atrill, P. and McLaney, E. (2011) Accounting and Finance for Non-Specialists, 7th edition, Essex.Benjelloun, H. (2010) Evans and Archer – forty years later, Investment Management and FinancialInnovations, vol. 7, no. 1.Berk, J., DeMarzo, P. and Harford, J. (2007) Corporate Finance, 1st edition, Boston: Pearson Education.Bloch, B. (2011) Naive Diversification Vs. Optimization, 22 Nov, [Online], Available: HYPERLINK"http://www.investopedia.com/articles/stocks/" http://www.investopedia.com/articles/stocks/ [29 Jan 2012].Bockstette, V. and Stamp, M. (2011) Creating Shared Value: A How-to Guide for the New Corporate(R)evolution, 16 September, [Online].Burton, M. (2011) Righting the Wrongs of Panic Pricing, 21 Jan, [Online], Available: HYPERLINK"http://www.holdenadvisors.com/news/news_0111.htm" http://www.holdenadvisors.com/news/news_0111.htm[15 Nov 2011].Cocoran, I. (2007) The Luxury Media, in Allworth (ed.) The Art of Digital Branding, 1st edition, London:Allworth.Elmerraji, J. (2006) Investopedia, 1 Dec, [Online], Available: HYPERLINK"http://www.investopedia.com/articles/stocks/06/ratios.asp" l "axzz1k3G1uOCN"http://www.investopedia.com/articles/stocks/06/ratios.asp#axzz1k3G1uOCN [15 Jan 2012].Evans, J.L. and Archer, S.H. (1968) DIVERSIFICATION AND THE REDUCTION OF DISPERSION: ANEMPIRICAL ANALYSIS*, The Journal of Finance, vol. 23, Dec, pp. 761-767.Group.1 (2012) Glasgow.Harvey, C.R. (2011) The Free Dictionary, [Online], Available: HYPERLINK "http://www.financial-dictionary.thefreedictionary.com" http://www.financial-dictionary.thefreedictionary.com .Hillier, D., Ross, S., Westerfield, R., Jaffe, J. and Jordan, B. (2010) Corporate Finance, First European edition,New York: McGraw Hill.Jr., C.O.H. (209) Walking the Talk, Glasgow: Diaz Incorporated.Kaplan, R.S. and Norton, D.P. (1996) The Balanced Scorecard: Translating Strategy into Action, Boston, MA.:Harvard Business School Press.Katiforis, N. trading-plan.com, [Online], Available: HYPERLINK "http://www.trading-plan.com/options_volatility.html" http://www.trading-plan.com/options_volatility.html [1 February 2012].Keller, K.L. (2008) Strategic Brand Management, 3rd edition, New Jersey: Pearson Prentice Hall.Finance and Financial Management. Page 42
  • 43. Keller, K.L. (2009) Building strong brands in a modern marketing communications environment, MarketingCommunications, pp. 15:2-3, 139-15.Kiley, D. (2007) How five names in this years rankings staged their turnarounds, 6 Aug, [Online], Available:HYPERLINK "http://www.businessweek.com/magazine/content/07_32/b4045401.htm"http://www.businessweek.com/magazine/content/07_32/b4045401.htm [15 Nov 2011].Krauss, C. (2008) Oil Demand Will Grow, Despite Prices, Report Says, 2 July, [Online], Available:HYPERLINK "http://www.nytimes.com/" http://www.nytimes.com/ [30 January 2012].Little, K. About.com Stocks, [Online], Available: HYPERLINK"http://stocks.about.com/od/evaluatingstocks/a/beta120904.htm"http://stocks.about.com/od/evaluatingstocks/a/beta120904.htm [1 February 2012].Marks and Spencer (2011) Marks and Spencer, 8 November, [Online], Available: HYPERLINK"http://corporate.marksandspencer.com/media/press_releases/half_year_results_201112"http://corporate.marksandspencer.com/media/press_releases/half_year_results_201112 [4 February 2012].McNulty, D. (2009) Inverstopedia, 24 July, [Online], Available: HYPERLINK"http://www.investopedia.com/articles/financial-theory/09/calculating-beta.asp" l "axzz1kyrFwM93"http://www.investopedia.com/articles/financial-theory/09/calculating-beta.asp#axzz1kyrFwM93 [1 February2012].Morningstar (2012) Morningstar, 15 Jan, [Online], Available: HYPERLINK "http://tools.morningstar.co.uk"http://tools.morningstar.co.uk [15 Jan 2012].Morningstar.co.uk (2012) Morning Star Marks and Spencer, 12 January, [Online], Available: HYPERLINK"http://tools.morningstar.co.uk/uk/stockreport/default.aspx?tab=7&SecurityToken=0P00007OL2]3]0]E0WWE$$ALL&Id=0P00007OL2&ClientFund=0&CurrencyId=GBP"http://tools.morningstar.co.uk/uk/stockreport/default.aspx?tab=7&SecurityToken=0P00007OL2]3]0]E0WWE$$ALL&Id=0P00007OL2&ClientFund=0&CurrencyId=GBP [12 January 2012].Paton, S., Clegg, B., Hsuan, J. and Pilkington, A. (2011) Operations Managment, New York: McGraw-HillEducation.Porter, M.E. and Kramer, M.R. (2011) Harvard Business Review, JANUARY-FEBRUARY, [Online].Reuters (2012) Reuters Uk, 1 February, [Online], Available: HYPERLINK"http://uk.reuters.com/business/quotes/overview?symbol=AGGK.L&exchange=XXCX"http://uk.reuters.com/business/quotes/overview?symbol=AGGK.L&exchange=XXCX [1 February 2012].Reuters (2012) Reuters.com FAQ, 1 February, [Online], Available: HYPERLINK "http://reuters-en.custhelp.com/app/answers/detail/a_id/1075/~/what-method-does-reuters-use-to-calculate-the-beta-displayed-on-your-website%3F" http://reuters-en.custhelp.com/app/answers/detail/a_id/1075/~/what-method-does-reuters-use-to-calculate-the-beta-displayed-on-your-website%3F [1 February 2012].Ross, S., Hillier, D., Westerfield, R., Jaffe, J. and Jordan, B. (2010) Risk and Return: The Capital AssetPricing Model, in Education, M.-H. (ed.) Corporate Finance, Berkshire: McGraw-Hill Education.Statman, M. (1987) How Many Stocks make a Diversified Portfolio, Journal of Financial and QuantitativeAnalysis, vol. 22, no. 3, September, pp. 352-363.Stelzner, M.A. (2011) How Marketers Are Using Social Media to Grow Their Businesses, April, [Online],Available: HYPERLINK "http://www.socialmediaexaminer.com/SocialMediaMarketingReport2011.pdf"http://www.socialmediaexaminer.com/SocialMediaMarketingReport2011.pdf .Tang, G.Y.N. (2004) How efficient is naive portfolio diversification? an educational note, Omega, vol. 32, no.2, April, p. 155–160.Finance and Financial Management. Page 43
  • 44. Telegraph (2012) Telegraph, 12 January, [Online], Available: HYPERLINK"http://shares.telegraph.co.uk/fundamentals/?epic=ezj" http://shares.telegraph.co.uk/fundamentals/?epic=ezj[12 January 2012].Telegraph Newspaper (2012) Telegraph Finance, 12 January, [Online], Available: HYPERLINK"http://shares.telegraph.co.uk/fundamentals/?epic=MKS"http://shares.telegraph.co.uk/fundamentals/?epic=MKS [12 January 2012].West, Ford and Ibrahim (2010) Strategic Marketing 2e, Oxford University Press, p. Chapter 9.Yahoo UK & Ireland Finance (2012), 15 Jan, [Online], Available: HYPERLINK "http://uk.finance.yahoo.com"http://uk.finance.yahoo.com [15 Jan 2012].Finance and Financial Management. Page 44
  • 45. 9 BIBLIOGRAPHYAmin, L. and Lee, C. (1997) Option Trading, Price Discovery, and earnings News Dissemination, ContemporyAccounting Research, vol. 14, no. 2, Summer.Anon (2008) The luxury brand with a chequered past, Burberrys shaken off its chav image to become thefashionistas favourite once more, 2 Jun, [Online], Available: HYPERLINK "www.dailymail.co.uk/femail/article-1023460/Burberrys-shaken-chav-ima" www.dailymail.co.uk/femail/article-1023460/Burberrys-shaken-chav-ima [20 Nov 2011].Atkins, W. (2011) Annual Report.Atrill, P. and McLaney, E. (2011) Accounting and Finance for Non-Specialists, 7th edition, Essex.Benjelloun, H. (2010) Evans and Archer – forty years later, Investment Management and FinancialInnovations, vol. 7, no. 1.Berk, J., DeMarzo, P. and Harford, J. (2007) Corporate Finance, 1st edition, Boston: Pearson Education.Bloch, B. (2011) Naive Diversification Vs. Optimization, 22 Nov, [Online], Available: HYPERLINK"http://www.investopedia.com/articles/stocks/" http://www.investopedia.com/articles/stocks/ [29 Jan 2012].Bockstette, V. and Stamp, M. (2011) Creating Shared Value: A How-to Guide for the New Corporate(R)evolution, 16 September, [Online].Burton, M. (2011) Righting the Wrongs of Panic Pricing, 21 Jan, [Online], Available: HYPERLINK"http://www.holdenadvisors.com/news/news_0111.htm" http://www.holdenadvisors.com/news/news_0111.htm[15 Nov 2011].Cocoran, I. (2007) The Luxury Media, in Allworth (ed.) The Art of Digital Branding, 1st edition, London:Allworth.Elmerraji, J. (2006) Investopedia, 1 Dec, [Online], Available: HYPERLINK"http://www.investopedia.com/articles/stocks/06/ratios.asp" l "axzz1k3G1uOCN"http://www.investopedia.com/articles/stocks/06/ratios.asp#axzz1k3G1uOCN [15 Jan 2012].Evans, J.L. and Archer, S.H. (1968) DIVERSIFICATION AND THE REDUCTION OF DISPERSION: ANEMPIRICAL ANALYSIS*, The Journal of Finance, vol. 23, Dec, pp. 761-767.Group.1 (2012) Glasgow.Harvey, C.R. (2011) The Free Dictionary, [Online], Available: HYPERLINK "http://www.financial-dictionary.thefreedictionary.com" http://www.financial-dictionary.thefreedictionary.com .Hillier, D., Ross, S., Westerfield, R., Jaffe, J. and Jordan, B. (2010) Corporate Finance, First European edition,New York: McGraw Hill.Jr., C.O.H. (209) Walking the Talk, Glasgow: Diaz Incorporated.Kaplan, R.S. and Norton, D.P. (1996) The Balanced Scorecard: Translating Strategy into Action, Boston, MA.:Harvard Business School Press.Katiforis, N. trading-plan.com, [Online], Available: HYPERLINK "http://www.trading-plan.com/options_volatility.html" http://www.trading-plan.com/options_volatility.html [1 February 2012].Keller, K.L. (2008) Strategic Brand Management, 3rd edition, New Jersey: Pearson Prentice Hall.Finance and Financial Management. Page 45
  • 46. Keller, K.L. (2009) Building strong brands in a modern marketing communications environment, MarketingCommunications, pp. 15:2-3, 139-15.Kiley, D. (2007) How five names in this years rankings staged their turnarounds, 6 Aug, [Online], Available:HYPERLINK "http://www.businessweek.com/magazine/content/07_32/b4045401.htm"http://www.businessweek.com/magazine/content/07_32/b4045401.htm [15 Nov 2011].Krauss, C. (2008) Oil Demand Will Grow, Despite Prices, Report Says, 2 July, [Online], Available:HYPERLINK "http://www.nytimes.com/" http://www.nytimes.com/ [30 January 2012].Little, K. About.com Stocks, [Online], Available: HYPERLINK"http://stocks.about.com/od/evaluatingstocks/a/beta120904.htm"http://stocks.about.com/od/evaluatingstocks/a/beta120904.htm [1 February 2012].Marks and Spencer (2011) Marks and Spencer, 8 November, [Online], Available: HYPERLINK"http://corporate.marksandspencer.com/media/press_releases/half_year_results_201112"http://corporate.marksandspencer.com/media/press_releases/half_year_results_201112 [4 February 2012].McNulty, D. (2009) Inverstopedia, 24 July, [Online], Available: HYPERLINK"http://www.investopedia.com/articles/financial-theory/09/calculating-beta.asp" l "axzz1kyrFwM93"http://www.investopedia.com/articles/financial-theory/09/calculating-beta.asp#axzz1kyrFwM93 [1 February2012].Morningstar (2012) Morningstar, 15 Jan, [Online], Available: HYPERLINK "http://tools.morningstar.co.uk"http://tools.morningstar.co.uk [15 Jan 2012].Morningstar.co.uk (2012) Morning Star Marks and Spencer, 12 January, [Online], Available: HYPERLINK"http://tools.morningstar.co.uk/uk/stockreport/default.aspx?tab=7&SecurityToken=0P00007OL2]3]0]E0WWE$$ALL&Id=0P00007OL2&ClientFund=0&CurrencyId=GBP"http://tools.morningstar.co.uk/uk/stockreport/default.aspx?tab=7&SecurityToken=0P00007OL2]3]0]E0WWE$$ALL&Id=0P00007OL2&ClientFund=0&CurrencyId=GBP [12 January 2012].Paton, S., Clegg, B., Hsuan, J. and Pilkington, A. (2011) Operations Managment, New York: McGraw-HillEducation.Porter, M.E. and Kramer, M.R. (2011) Harvard Business Review, JANUARY-FEBRUARY, [Online].Reuters (2012) Reuters Uk, 1 February, [Online], Available: HYPERLINK"http://uk.reuters.com/business/quotes/overview?symbol=AGGK.L&exchange=XXCX"http://uk.reuters.com/business/quotes/overview?symbol=AGGK.L&exchange=XXCX [1 February 2012].Reuters (2012) Reuters.com FAQ, 1 February, [Online], Available: HYPERLINK "http://reuters-en.custhelp.com/app/answers/detail/a_id/1075/~/what-method-does-reuters-use-to-calculate-the-beta-displayed-on-your-website%3F" http://reuters-en.custhelp.com/app/answers/detail/a_id/1075/~/what-method-does-reuters-use-to-calculate-the-beta-displayed-on-your-website%3F [1 February 2012].Ross, S., Hillier, D., Westerfield, R., Jaffe, J. and Jordan, B. (2010) Risk and Return: The Capital AssetPricing Model, in Education, M.-H. (ed.) Corporate Finance, Berkshire: McGraw-Hill Education.Statman, M. (1987) How Many Stocks make a Diversified Portfolio, Journal of Financial and QuantitativeAnalysis, vol. 22, no. 3, September, pp. 352-363.Stelzner, M.A. (2011) How Marketers Are Using Social Media to Grow Their Businesses, April, [Online],Available: HYPERLINK "http://www.socialmediaexaminer.com/SocialMediaMarketingReport2011.pdf"http://www.socialmediaexaminer.com/SocialMediaMarketingReport2011.pdf .Tang, G.Y.N. (2004) How efficient is naive portfolio diversification? an educational note, Omega, vol. 32, no.2, April, p. 155–160.Finance and Financial Management. Page 46
  • 47. Telegraph (2012) Telegraph, 12 January, [Online], Available: HYPERLINK"http://shares.telegraph.co.uk/fundamentals/?epic=ezj" http://shares.telegraph.co.uk/fundamentals/?epic=ezj[12 January 2012].Telegraph Newspaper (2012) Telegraph Finance, 12 January, [Online], Available: HYPERLINK"http://shares.telegraph.co.uk/fundamentals/?epic=MKS"http://shares.telegraph.co.uk/fundamentals/?epic=MKS [12 January 2012].West, Ford and Ibrahim (2010) Strategic Marketing 2e, Oxford University Press, p. Chapter 9.Yahoo UK & Ireland Finance (2012), 15 Jan, [Online], Available: HYPERLINK "http://uk.finance.yahoo.com"http://uk.finance.yahoo.com [15 Jan 2012]. < END OF THE DOCUMENT >Finance and Financial Management. Page 47