Investment Simulation Project

FIN 435

Section: 1

Fall 2010

Prepared For

Saif Rahman

Prepared By

Group: 1

M Zahid Hossain                            ID 081 370 030

Nabila Tasmim                        ID 081 328030

Shija Shamsia                         ID 082 058 030

Marjana Khatum                     ID 082 130 030

Ridi Shahariar Hussain          ID 082 060 030

Date: 9 December, 2010

Table of Contents

Executive Summary

Our imaginary investment started form 3^rd October, 2010. We have invested Tk. 1,000,000 in our portfolio to buy stocks from Dhaka Stock Exchange (DSE). It was spread over a number of stock and in total 22 stocks from different industries for the actual diversification. We have divided our investment horizon in 3 phases.

The performance of our portfolio is quite good. The realized gain in the first phase was 13.80%, in second phase it was 3.57% and third phase it is 6.22%. As the first phase has the longest duration, it has heights return, and then we have started taking risk. Our final holding period return is 1.05, and holding period yield 259.22% annually.

We have acquired superlative returns from BIFC, Northern Insurance, Provati Insurance, ILFSL, EXIM Bank, ALARA BANK. The return from BIFC is 44.65% which is the highest in our portfolio.

We have nominated stocks on the basis of chronological return, dividend, bonus, and right information, and speculation on upcoming AGM. For these we have taken help from DSE website, stockbangladesh.com, and Newspapers.

The project has helped us how to make well diversified and efficient portfolio. What is more it has given us the idea of Dhaka stock exchange, the market environment and about the industries. With the regular monitoring of the market we have also learned the lot about the functioning of the stock market and why and how the price of stocks increase or decrease.

Introduction

The journey of our imaginary portfolio of Tk.1000,000 was started on the third of October for our investment simulation project for the course. The time horizon for the project was from October 3, 2010 to December 2, 2010. We started the project as a part of our FIN 435 course, where the main aim was to get a proper understanding of portfolio management through creation of a well-diversified and hypothetical portfolio. Our objective of trading was to maximize the after tax wealth. Throughout the project we tried to manage a less impulsive portfolio through maximum diversification. Along with we have emphasized on some sectors which can give us smart return.

Our project was divided in three phases. Although we are amateur in stock market, we have tried our best to select best portfolio thorough research and analysis. We have calculated the historical return, risk, beta of each stocks we have selected. Also we have given importance on news from secondary sources. After second phase we have better understanding of the measures of risks and returns and therefore we could make better diversifications. But that time we have taken more risk because of our confidence, as we our realized gain at the end of the first phase was extraordinary.  So that time we have applied different approach and added more industries in our portfolio. This helped us to earn a a good knowledge how returns come in different approaches. For selling and purchasing stocks we emphasized on both macroeconomic issues as well as firm specific issues. One thing needs to add that in every phase we have sold the stocks which have the best returns. As we have time restrictions, we do not want miss the return from those stocks. All these analyzing helped us to reduce the volatility of our portfolio through diversification as we were able to invest in stable stocks as well as stocks with greater returns. Our emphasis was mainly on the Banking, insurance and financial sectors. The other stocks was to create highly diversified portfolio.

Objective

Our main objective in managing and selecting this portfolio was to maximize after tax wealth and ensure as much diversification as possible so that the volatility of the portfolio can be minimized. In order to reduce the risk of our portfolio we spread our fund over a large number of stocks from different industries which included Banking, Finance, Insurance, Cement, Fuel and Power, Telecommunication, travel etc. We were reliant that by spreading our investment fund over different stocks we can be able to manage a well-diversified portfolio with a prospective of good portfolio return.

Asset Allocation

Initially we have invested amount of Tk.1,000,000 in stocks of different companies to create a higly-diversified portfolio. Our aim in asset allocation was to invest in stocks of companies from different industries in order to reduce the volatility of our portfolio through diversification. In the beginning of the investment horizon we invested in stocks of 22 companies belonging to 10 different industries. Later on we sold and purchased stocks in two more phases by analyzing the risk and return of the stocks. We have calculated historical returns, risk and correlation. We also used the important ratios such as Sharpe, Treynor, Appraisal and Jensen’s alpha to make decisions involving the purchase and selling of stocks. We followed a top-down approach by analyzing macroeconomic factors with the fundamental of the company, and historical trend of the industries.

Macroeconomic & Industry Scene

During our investment horizon the Government and political issues was not so impressive to effect the market. But the market was very active regarding changes. Too many changes occurred by DSE and SEC. They have taken many steps for corrections. The important changes in market was

• Decreasing margin loan for investors
• Increasing the security money for brokerages.
• Stopping the netting benefit.
• Recommendation of increasing paid up capital
• Suspending about 20 companies for investigation of unusual price hike
• Different approaches by SEC and DSE to control the price hike of stocks
• Government announces that they are going to introduce shares of some public limited companies in public.
• Stopped the opportunity of buying share with check
• Also DSE introduced the system that new investor cannot get margin benefit within first 30 days.
• SEC have recommended Government to withdraw less amount money from Stock market.

Trading Strategies

Our trading strategy was essentially focused on diversification and fundamentals of the companies for which we spread our investment amount of Tk. 1000,000 over stocks of 15 dissimilar companies in each phase and in overall 22 companies and ten industries. Our investment prospect was from 3rd October 2010 to, 2^nd december2010. Over this episode we purchased and sold stocks in three phases, each time demanding to gain a higher return. And to achieve that goal, we have taken lots of risk. But, we haven’t taken any unjustified or enormous risk what would be a gambling. We have taken risks with the help of our diversified and balanced portfolio. We used the following approaches:

• Firstly we applied top-down approach and P/E ratio, EPS and net income of the companies to determine the stocks
• We also considered the microeconomic and macroeconomic factors
• Calculations 1.5 years daily returns(1^st January,2009 to 30^th September,2010)
• Calculations 1.5 years’ markets and individual stock’s standard deviation, variance, covariance.
• The behavior of the individual stocks with the changes of market, through calculating co-relation and beta.
• We have also shown the regression of each 22 stocks
• We considered the historical trends of each company
• We followed the dividend and right share news of the stocks
• We really got a lot of support from the stock Bangladesh’s technical analysis-
  • Aroon Oscillatior
  • Aroon up/down
  • Average durational index
  • Next average true range
  • Bollinger
  • Bandwidth
  • Chaikin money flow
  • Chaikin oscillator
  • Chaikin volatility
  • Close location value
  • Commodity channel index
  • Detrendeed price osc
  • Donchian channel width
  • Ease of movement
  • Fast stochastic
  • MACD
  • Mass index
  • Momountum
  • Money flow index
  • RSI
  • Volume
  • Candle analysis

Our trading strategy was mainly focused on diversification for which we spread our investment amount of Tk. 1000,000 over stocks of different companies and industries. Our investment horizon was from June 1, 2010 to August 1, 2010. Over this period we purchased and sold stocks in three phases, each time trying to reduce risk through diversification and at the same time also trying to balance the portfolio with stocks which had good return prospective. We used a top-down approach to selection where initially the microeconomic and macroeconomic factors were analyzed and the stocks subsequently chosen through careful selection of the respective industries.

Phase 1

In the first phase we purchased stocks of 15 companies belonging to 7 different industries.

We have focused on banking industries, because

• Low paid up capital,  they need to increase paid up capital. So right share and bonus announcement may come
• ALARABANK and EXIMBANK announced right share, we have taken that opportunity.
• Undervalued regarding the other industries in the market. So price might increase

Our another main focus was Insurance industries where we have invested 22.23% money of our portfolio. The main reasons were:

• The price increasing trend in the insurance industries
• Historical return

Another good weight was in Financial Institutions. Because:

• Low paid up capital
• Undervalued
• The historical average return and risk of BIFC, UTTARAFIN
• Upcoming AGM of UTTRAFIN where we assumed that rights share might be announced due to low paid up capital. Our peculation was accurate and they did so.

We have also invested in a risky share, which belongs to Z category and known as Junk share, it is Provati Insurance. Because it needs to declare dividend to change the category, as they are fundamentally strong, having good EPS, they might declare good dividend.

Phase 2

In the second phase we sold off 6 of the stocks we selected in our first phase as these stocks had provided very good returns 44%-20% during only 4 weeks. We do not want to miss this opportunity of profit taking and increase our capital.

We have not sold the stocks which have negative cash flow, because we do not want to incur loses, and wanted to wait for price increasing.

In this phase we have bought new 5 companies:

• AFTABAUTO: They had announced 30% stock dividend
• LAFARGE SURMA CEMENT: This is Junk share. People afraid of buying this stock because of the allegation against Lafarge Surma cement. Our secondary research from newspaper and the companies performance indicates they may overcome this. So if they overcome, the price may increase at higher amount, because the other companies in this sectors have 5-6 times higher prices than Lafarge Surma.
• Square Pharma: Fundamentally very strong, and net income is very high.
• BATBC: Same as Square Pharma
• United Air: Only one company in the Travel Industry. The new company GMG Airlines was approved to issue shares in public with the face value of BDT 10. It may influence to increase the share price.

Phase 3

This time we had sold 2 stocks Confident cement, and RUPALI Insurance which gives 18% and 55% returns respectively. Again for taking profit we have sold these. Regarding confident cement as right share has approved, the price may decrease after the record date. We have bought 2 new companies GP and PADMA OIL. We had selecting GP as the technical analysis in stock Bangladesh shows that the risk of GP is very low. The reason behind buying Padma oil is the SEC’s recommendation to Government to decrease the withdrawal amount of money from government shares.

Diversification

As we have mentioned in the previous section, our objective throughout has been to maintain a well diversified portfolio and minimize firm-specific risks affecting the portfolio. Since we have academically learnt that diversification assists in assuring resistance from swings or fluctuations in the market, over the investment horizon, we tried our best to balance on the risk and return factors and gain maximum returns at the lowest risk exposure.

We think 10 different industries and 22 companies have maximized our diversification.

Economic Rationale for picking/selling stock

Our aim was to maximize our utility alongside maximizing profits. Thus, at every phase, we have also taken utility measure, which played a significant role in our stock selection process. We used a relatively low risk aversion factor of 2.3 points since we took an optimistic approach. Also we have calculated historical performance measures and risks.

Portfolio Performance

In this section, we will provide a critical evaluation of the three phases of investments, taking into consideration all the performance measure that we derived to assist in our portfolio selection process at the different phases. To begin with, we should honestly confess that initially, we had very little idea about the dynamics of the Dhaka stock market. All we had as back were the basics learnt from previous finance courses and being amateurs in this field, we composed our portfolio as carefully as possible, through a basic comparative study of the data at hand (websites and newspapers) and via all the advice and speculations gathered from some regulator investors in the market. At this point, our knowledge of diversification strategies was minimal and we banked on all the knowledge we had about economics and its related stock market dynamics.

The performance of portfolio in different phases:

Risk and Return of the Portfolio

Given the volatility of the stock market over the past couple of months, we are actually quite satisfied with the returns we achieved, given the portfolio risk and the market risk at hand. Being less risk-averse, we did take some risk of moving along strongly with the financial sector, that is banks and non-bank financial institutions, which usually remain positively correlated with the market.

PHASE 1 RISK:       1.35% (daily basis)             RETURNS:   4.43% (daily basis)

PHASE 2 RISK:       0.06% (daily basis)             RETURNS:   2.31% (daily basis)

PHASE 3 RISK:       0.06% (daily basis)             RETURNS:   2.31% (daily basis)

Overall Return: 23.59% in 2 months, annually 141.58%

Holding Period Return                                                                  1.05

Net Profit Before Tax                                                                    233934.25

Tax                                                                                                     81876.99

Net Prfofit After Tax                                                                       152057.26

Overall holding period return for entire time horizon           1.23

Investment Period (Years)                                                           0.16

Annualized HPR                                                                             3.59

HPY                                                                                                    259.22%

Lessons Learned from Trading

We have learnt the following lessons

ü  The price of Stocks in DSE is highly depending on speculation, rather the analysis and fundamental of the company.

ü  There are gambler for whom the stocks which many stocks are undervalued and overvalued

ü  The dividend does not influence the increase of price, what we have learnt from AFTAB AUTO. In spite of 30% stock dividend, the price decreases.

ü  How to form and manage portfolio.

ü  How historical data impact the current market

ü  Capital asset pricing model

Conclusion

We have learnt a lot from the investment simulation project. Although it was fictitious, but it has given the experience of trading in real market, thorough regular monitoring and analysis. It was so interesting that I have (M Zahid Hossain), started investing in real market. We had only bookish knowledge before this assignment, but thorough this we have gained the first-hand knowledge about the share market. Today we also know the behavior and environment of Dhaka stock exchange.

Our investment horizon was for 2 months, where we have tried our best to make maximum profit. Our main strategy was taking profit, as a result we sold the stocks having good returns, and keep stocks which have negative cash flow. At the end of the investment horizon, our profit was 23.59% in 2 months, annually 141.58%.  We got best profit from banking and insurance sector. We could have done better, but because of taking risk in investing junk shares we have to incur loses. We hope we can earn more return by creating logical portfolio in real life.