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Franklin University MBA737 Equity Analyst Project

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Question;Franklin University;MBA 737;Equity Analyst Project;The Equity Analyst Project involves a total of three assignments;1.;Individual Asset Allocation;Exercise;2. Team Analysis of Select Industry;Groups;Team;Analysis of Companies within an Industry GroupThe intent of the project is to simulate a top-down, three-stage approach;to security analysis that proceeds with, first, an analysis of general economic;factors, then industry comparisons, and finally the analysis of individual;companies within a particular industry. Here;is justification for this approach;The results of several academic;studies have supported this technique. First, studies indicated that most;changes in an individual firm?s earnings;could be attributed to changes in aggregate corporate earnings and changes in;the firm?s industry, with the aggregate earnings changes being more;important...;Second, studies?[have] found a;relationship between aggregate stock prices and various economic series, such;as employment, income, or production?;Third, an analysis of the;relationship between rates of return;for the aggregate stock market, alternative industries, and individual stocks;showed that most of the changes in rates of return for individual stocks could;be explained by changes in the rates of return for the aggregate stock market;and the stock?s industry.[1];The following is provided as a guide to your analysis in these three;assignments;Individual Asset Allocation Exercise;This;exercise involves an analysis of general economic conditions or systematic;risk, i.e., the risk that affects all industries and companies, in the U.S.;economy. You are asked to determine in percentage terms an optimal allocation;of $1,000,000 among the following three asset classes: U.S. equities, U.S.;Treasury bonds, and cash. The goal is to maximize your expected return over the;next 12 months. You are asked to write a 1-2 page paper providing your analysis;of the asset classes? return prospects and your justification of your;allocation of monies among them.;First, consider historical returns on various asset classes in the U.S.;Look at Figure 10.4 on p. 305 of your textbook. Also, in Table 10.2 on p. 312 you can see that historically equities outperform;bonds in terms of average return but they also carry more risk as defined by;their standard deviations. These historical results show that on average the;return on equities is highest but in some specific years this may not be true.;For example, look at Table 10.1 on pp.308-309 and you can see that in three out of the five years;from 2000 to 2004 the annual return on large-company stocks (defined in the;text as the S&P 500)[2];was negative.;In this exercise your investment horizon is one year. In considering your;allocation among U.S. equities, long-term Treasury bonds, and cash to maximize;your prospective return over the next twelve months, we might next more;precisely define these asset classes. We can define U.S. equities as the;Standard and Poor?s (S&P) composite index [?At present?includes 500 of the;largest (in terms of market value) stocks in the United States.? (p.304)]. More detailed information is;available directly from Standard & Poor?s:http://www2.standardandpoors.com/portal/site/sp/en/us/page.topic/indices_500/2,3,2,2,0,0,0,0,0,0,0,0,0,0,0,0.html;Excel spreadsheets of Index returns dating from;2009 back to the late 1980?s are available at;http://www2.standardandpoors.com/spf/xls/index/MONTHLY.xls.;Web-based finance sites also;customarily carry data on the S&P 500. For example, --at Yahoo!;Finance:http://finance.yahoo.com/q?s=%5EGSPC;--at CNNMoney.com:http://money.cnn.com/data/markets/sandp/?;--At MSN: http://moneycentral.msn.com/detail/stock_quote?Symbol=$INX;We can define long-term Treasury bonds as 30-year U.S. government bonds.;Historical data on yields on debt claims are available from the Federal Reserve;at http://www.federalreserve.gov/releases/h15/data.htm.;For historical on the 30-year T-bond, defined as ?Market yield on U.S. Treasury;securities at 30-year constant maturity, quoted on investment basis" go to;http://www.federalreserve.gov/datadownload/Output.aspx?rel=H15&series=b56abb6d9cc35f28ccf86b8a0188e948&lastObs=&from=&to=&filetype=csv&label=include&layout=seriescolumn;Long-bond Treasury rates are also available from the following;sites;-- http://www.ustreas.gov/offices/domestic-finance/debt-management/interest-rate/yield.shtml;-- http://www.bloomberg.com/markets/rates/index.html;The third alternative is cash. Assume no return on that share of your;monies held in cash.;This analysis necessarily;involves your assessment of systematic risk, i.e., the risk that affects all;industries and companies, in the U.S. economy over the next twelve months.;Let?s more fully define systematic risk. According to the textbook, systematic;risk ??influences a large number of assets, each to a greater or lesser extent?[and;is] sometimes called market risk?Uncertainties;about general economic conditions, such as GDP, interest rates, or inflation;are examples of systematic risks. These conditions affect nearly all companies;to some degree? (p. 343). Your task is to consider your investment alternatives in;light of systematic risk expected over the coming year.;Your;considerations about investing in U.S. equities will thus involve your;determination of the near-term prospects for the U.S. economy and the;implications of these prospects for U.S. equities.;A useful site for;recent and upcoming U.S. macroeconomic data releases is http://www.bloomberg.com/markets/economic-calendar/.;Click on the highlighted report or ?Consensus? next to any particular report to;get data (either recently reported or the near-term consensus, respectively);the schedule of future data releases, a definition, and, importantly for our;purposes, a section entitled ?Why Do Investors Care?? More generally, many other sites provide;information on macroeconomic data, such as;--http://info.wsj.com/classroom/Indicators/guide.html;--http://www.bea.gov/;-- http://www.gpoaccess.gov/indicators/index.html;--http://research.stlouisfed.org/fred2/;Finally, the;decision to invest in 30-year U.S. T-bonds importantly involves expectations;about future inflation and the term structure of interest rates, i.e., ?the relationship between short- and long-term;interest rates? (p. 162). On p. 161 of the textbook the distinction is made;between ?real? interest rates and ?nominal? interest rates. ?Nominal? interest rates are the rates that;are quoted in the financial press, they are the rates at which we borrow and;lend. Per the approximated Fisher equation (Eq. 5.4 on p. 162), the nominal;rate includes the so-called inflation premium, h, so that the higher the;expected inflation, h, the higher the nominal rate, all else equal. In;considering longer-term T-bonds one must also be aware that, in addition to;expected long-term inflation, there is greater interest rate risk: ??longer;term bonds have much greater risk of loss resulting from changes in interest;rates than do shorter-term bonds? (p. 164). Specifically, should;interest rates increase, the market value of 30-year bonds will fall and the;fall will be more dramatic for a 30-year T-bond than for a 10-year Treasury;bond. Conversely, price gains from any drop in rates will be more dramatic the;longer the term to maturity on a bond. One should also keep in mind that while;in general longer-term rates are typically higher than short-term rates for the;same level of overall risk, there have been occasions when the reverse is true;and the term structure of interest rates is inverted. (Please see Figure 5.5 on;p. 163 on the historical relationship between long-term and short-term U.S.;interest rates.) Finally, in finance we assume that there is no credit or;default risk on Treasury securities. It is assumed that there is no risk that;the U.S. government will fail to meet its outstanding debt obligations. This;is, of course, not the case for corporate issuers.;Finally;what are the implications of interest rate changes for the equity market? Here;is one response to this question: http://www.investopedia.com/articles/06/interestaffectsmarket.asp;Questions for Individual Asset Allocation Exercise;1.;Allocate your fictional;$1,000,000 among the following three asset categories;Asset;U.S. Equities;U.S. 30-Year Treasury Bonds;Cash;Allocation;100%;2.;Justify your allocation based on;your outlook for systematic risk in the U.S. economy over the next year.;Team Analysis of Select Industry Groups;This analysis is;a team assignment that requires your team to analyze a select group of;alternative industries to determine which is most likely to perform best in terms;of growth and earnings over the next 12 months. Your instructor will create;your teams, ideally based on similar views about the near-term prospects for;the U.S. economy expressed in the Individual Asset Allocation Exercise.;To guide this;second stage analysis, you are asked to rely on theNorth;American Industry Groups database available at Yahoo! Finance. The system is;comprised of 9 macroeconomic sectors, 31 business segments and 215 industry;groups.This;database is readily accessible via Yahoo! Finance at;http://biz.yahoo.com/ic/ind_index.html;To simplify the exercise the 215 industry;groups within the database have been reduced to a more analytically manageable;24 industry groups (each with public firms listed at Yahoo! Finance totaling no;less than 5 and no more than 15 companies) in 7 macroeconomic sectors as;follows;Basic Materials;AluminumMajor Integrated Oil &GasNonmetallic Mineral Mining;Consumer;Goods;AppliancesConfectionersOffice;SuppliesFinancial;REIT-Healthcare;FacilitiesREIT-Hotel/MotelREIT-IndustrialHealthcare;Drugs-GenericHome;Health CareHospitalsIndustrial;Goods;Manufactured;HousingPollution;Treatment ControlsServices;Advertising;AgenciesAir;Delivery & Freight ServicesDrug StoresElectronic;StoresHome;Improvement StoresJewelry;StoresTechnology;Computer;Based SystemsLong;Distance CarriersPersonal;ComputersUtilities;Water;UtilitiesTo access more details on these groups go;to http://biz.yahoo.com/ic/ind_index.html;and click on any of the names of the 24 groups to go to each industry?s;?Industry Center? page. Additional useful information is available via the link;to ?Industry Browser? on the left. Also, on each industry?s summary page click;on ?Company Index? and then on ?Public? on the subsequent page next to ?View:?;to get the list of public companies in this industry. Our focus is on publicly;listed companies in which we might ultimately invest. The list of public;companies is provided alphabetically. Following each name is the company?s;ticker symbol in brackets. See http://www.investopedia.com/terms/s/stocksymbol.asp;or http://www.investorwords.com/4968/ticker_symbol.html;for brief definitions of stock/ticker;symbols.;Please note that on occasion the ticker symbol may also be followed by other letters;such as PK or OB (see http://www.investopedia.com/ask/answers/04/022004.asp or http://www.investopedia.com/ask/answers/120.asp;for explanations). It is recommended that we ignore stocks so designated in;these exercises.;The goal of;this second stage in our equity analyst project is to select one industry out;of this list of 24 whose performance prospects you determine are best over the;next year. Here are some factors to consider when comparing industry groups:[3];Degree of Competition in the IndustrySupply/Demand Dynamics for the Industry?s ProductsIndustry Cost StructureDegree of Government Regulation-Favorable or NotExposure to the Business CycleRelative Financial Norms and StandardsYour team;is asked to write a 5-10 page paper providing your analysis of the issues;involved in your selection of the industry group that you conclude is most;likely to prosper in the coming months and your justification of your choice of;that industry.;Assignment:Equity Analyst Project: Individual Asset Allocation Exercise;Purpose;To enable the student to;demonstrate proficiency in the first stage of a top-down, three-stage valuation;analysis: analysis of investment prospects in the U.S. macroeconomy.;Overview;This individual assignment;involves an analysis of general economic conditions or systematic risk, i.e.;the risk that affects all industries and companies, in the U.S. macroeconomy.;You will be asked to determine in percentage terms an optimal allocation of;$1,000,000 among the following three asset classes: U.S. equities, U.S.;Treasury bonds, and cash. The goal is to maximize your expected return over the;next 12 months. You will be asked to write a 1- to 2-page paper providing your;analysis of the asset classes' prospects and your justification of your;allocation among them.;Action;Items;1. Read the;Equity Analyst Project document that your professor will distribute during Week;1.;2. Conduct;any necessary research so that you can make a proper analysis.;3. Write a;1- to 2-page paper that provides your analysis of the three asset classes;prospects and your justification of your allocation among them. Format your;paper according theAcademic;Paper Guidelines.;Questions for Individual Asset Allocation Exercise;1.;Allocate your fictional;$1,000,000 among the following three asset categories;Asset;U.S. Equities;U.S. 30-Year Treasury Bonds;Cash;Allocation;100%;2.;Justify your allocation based on;your outlook for systematic risk in the U.S. economy over the next year.;Individual Asset Allocation Exercise;This;exercise involves an analysis of general economic conditions or systematic;risk, i.e., the risk that affects all industries and companies, in the U.S.;economy. You are asked to determine in percentage terms an optimal allocation;of $1,000,000 among the following three asset classes: U.S. equities, U.S.;Treasury bonds, and cash. The goal is to maximize your expected return over the;next 12 months. You are asked to write a 1-2 page paper providing your analysis;of the asset classes? return prospects and your justification of your;allocation of monies among them.;First, consider historical returns on various asset classes in the U.S.;Look at Figure 10.4 on p. 305 of your textbook. Also, in Table 10.2 on p. 312;you can see that historically equities outperform bonds in terms of average;return but they also carry more risk as defined by their standard deviations.;These historical results show that on average the return on equities is highest;but in some specific years this may not be true. For example, look at Table;10.1 on pp. 308-309 and you can see that in three out of the five years from;2000 to 2004 the annual return on large-company stocks (defined in the text as;the S&P 500)[1];was negative.;In this exercise your investment horizon is one year. In considering your;allocation among U.S. equities, long-term Treasury bonds, and cash to maximize;your prospective return over the next twelve months, we might next more;precisely define these asset classes. We can define U.S. equities as the;Standard and Poor?s (S&P) composite index [?At present?includes 500 of the;largest (in terms of market value) stocks in the United States.? (p. 304)].;More detailed information is available directly from Standard & Poor?s:http://www2.standardandpoors.com/portal/site/sp/en/us/page.topic/indices_500/2,3,2,2,0,0,0,0,0,0,0,0,0,0,0,0.html;Excel spreadsheets of Index returns dating;from 2009 back to the late 1980?s are available at;http://www2.standardandpoors.com/spf/xls/index/MONTHLY.xls.;Web-based finance sites;also customarily carry data on the S&P 500. For example, --at Yahoo!;Finance:http://finance.yahoo.com/q?s=%5EGSPC;--at CNNMoney.com:http://money.cnn.com/data/markets/sandp/?;--At MSN:http://moneycentral.msn.com/detail/stock_quote?Symbol=$INX;We can define long-term Treasury bonds as 30-year U.S. government bonds.;Historical data on yields on debt claims are available from the Federal Reserve;athttp://www.federalreserve.gov/releases/h15/data.htm. For historical on the 30-year T-bond, defined as ?Market yield on U.S.;Treasury securities at 30-year constant maturity, quoted on investment;basis" go to;http://www.federalreserve.gov/datadownload/Output.aspx?rel=H15&series=b56abb6d9cc35f28ccf86b8a0188e948&lastObs=&from=&to=&filetype=csv&label=include&layout=seriescolumn;Long-bond Treasury rates are also available from the following;sites;-- http://www.ustreas.gov/offices/domestic-finance/debt-management/interest-rate/yield.shtml;--http://www.bloomberg.com/markets/rates/index.html;The third alternative is cash. Assume no return on that share of your;monies held in cash.;This analysis;necessarily involves your assessment of systematic risk, i.e., the risk that;affects all industries and companies, in the U.S. economy over the next twelve;months. Let?s more fully define systematic risk. According to the textbook;systematic risk ??influences a large number of assets, each to a greater or;lesser extent?[and is] sometimes called market;risk?Uncertainties about general economic conditions, such as GDP, interest;rates, or inflation, are examples of systematic risks. These conditions affect;nearly all companies to some degree? (p. 343).;Your task is to consider your investment alternatives in light of systematic;risk expected over the coming year.;Your;considerations about investing in U.S. equities will thus involve your;determination of the near-term prospects for the U.S. economy and the;implications of these prospects for U.S. equities.;A useful site;for recent and upcoming U.S. macroeconomic data releases is http://www.bloomberg.com/markets/economic-calendar/.;Click on the highlighted report or ?Consensus? next to any particular report to;get data (either recently reported or the near-term consensus, respectively);the schedule of future data releases, a definition, and, importantly for our;purposes, a section entitled ?Why Do Investors Care?? More generally, many other sites provide;information on macroeconomic data, such as;-- http://info.wsj.com/classroom/Indicators/guide.html;-- http://www.bea.gov/;--http://www.gpoaccess.gov/indicators/index.html;--http://research.stlouisfed.org/fred2/;Finally, the;decision to invest in 30-year U.S. T-bonds importantly involves expectations;about future inflation and the term structure of interest rates, i.e., ?the relationship between short- and;long-term interest rates? (p. 162). On p. 161 of the textbook the distinction;is made between ?real? interest rates and ?nominal? interest rates. ?Nominal? interest rates are the rates that;are quoted in the financial press, they are the rates at which we borrow and;lend. Per the approximated Fisher equation (Eq. 5.4 on p. 162), the nominal;rate includes the so-called inflation premium, h, so that the higher the;expected inflation, h, the higher the nominal rate, all else equal. In;considering longer-term T-bonds one must also be aware that, in addition to;expected long-term inflation, there is greater interest rate risk: ??longer;term bonds have much greater risk of loss resulting from changes in interest;rates than do shorter-term bonds? (p. 164). Specifically, should interest rates;increase, the market value of 30-year bonds will fall and the fall will be more;dramatic for a 30-year T-bond than for a 10-year Treasury bond. Conversely;price gains from any drop in rates will be more dramatic the longer the term to;maturity on a bond. One should also keep in mind that while in general;longer-term rates are typically higher than short-term rates for the same level;of overall risk, there have been occasions when the reverse is true, and the;term structure of interest rates is inverted. (Please see Figure 5.5 on p. 163;on the historical relationship between long-term and short-term U.S. interest;rates.) Finally, in finance we assume that there is no credit or default risk;on Treasury securities. It is assumed that there is no risk that the U.S.;government will fail to meet its outstanding debt obligations. This is, of;course, not the case for corporate issuers.;Finally;what are the implications of interest rate changes for the equity market? Here;is one response to this question: http://www.investopedia.com/articles/06/interestaffectsmarket.asp;Questions for Individual Asset Allocation Exercise;3.;Allocate your fictional;$1,000,000 among the following three asset categories;Asset;U.S. Equities;U.S. 30-Year Treasury Bonds;Cash;Allocation;100%;4.;Justify your allocation based on;your outlook for systematic risk in the U.S. economy over the next year.;[1] For a brief history of the S&P 500 see http://www.cftech.com/BrainBank/FINANCE/SandP500Hist.html.;[1] Reilly, Frank K., and Keith C. Brown. (2007). An Introduction to;Security Valuation. Equity and Fixed;Income CFA? Program Curriculum??Volume 5(pp. 115-153). (p. 264).;Boston: CFA Institute.;[2] For a brief history of the S&P 500 see http://www.cftech.com/BrainBank/FINANCE/SandP500Hist.html.;[3] Source: http://www.markrosa.com/economic_analysis.htm.;Please note that this site also contains helpful discussions about all three;stages of the top-down approach to security valuation.

 

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