CORPORATE FINANCE I

CASE ANALYSIS
ALEX SHARPE’S PORTFOLIO

Submitted by,

Abisheik B

Anbukkarasi P

Vignesh P

Vimal Jesuraj A
CASE SUMMARY

Alex Sharpe had invested in Vanguard 500 Index Fund, A no-load mutual
fund constructed to track the performance of the S&P 500. S&P 500 index consists
of 500 chosen for market size, liquidity and industry grouping, among other groups.
It is a market value-weighted index, i.e., each stock’s weight in the index is
proportionate to its market value.

Sharpe had been considering changing her passive investment strategy to one that
was more active. So, she considers investing in the following two stocks.

i. Hasbro:
It was an American toy and game company that was the second largest toy
maker in the world.
ii. R.J.Reynolds Tobacco Company:
It was the second largest tobacco firm in the world, with a share of
approximately 30 percent of the cigarette market.

The objective is choosing a stock with less risk, high return, considering the
performance of the stock individually and along with the market.

OBJECTIVES

1. To estimated and compare the return and risk (i.e. annual standard deviation
over the past five years) of Reynolds and Hasbro with that of the S&P Index.
And give the riskiest.

2. To estimate the returns and risk of stocks when Alex invested his amount 99%
of the amount in S&P 500 and 1% in Reynolds and 99% in S&P 500 and 1%
in Hasbro.

3. To perform a regression of each stock’s monthly return on the Index returns

to compute a “Beta” for each stock. And to relate answer in question 2.

4. To find the return of each stock relates to its riskiness.

5. To find in which stock should Sharpe invest.

Capital Asset Pricing Model

The capital asset pricing model (CAPM) is a model used to determine the
required rate of return of an asset, to make decisions about adding assets to a well-
diversified portfolio. The CAPM is a model for pricing individual security or
portfolio. For individual securities, we make use of the security market line (SML)
and its relation to expected return and systematic risk (beta) to show how the market
must price individual securities in relation to their security risk class. The SML
enables us to calculate the reward-to-risk ratio for any security in relation to that of
the overall market. The below equation indicates the equation of the CAPM.

𝐸(𝑅𝑖 ) = 𝑅𝑓 + 𝛽𝑖 (𝐸 (𝑅𝑚 ) − 𝑅𝑓 )

Where,

E(𝑅𝑖 ) is the expected return

𝑅𝑓 is the risk free return

β is the average market return

𝑅𝑚 is the market return

RESULTS:

1. The monthly return and risk and annual return and risk are calculated.

S&P 500 Reynolds Hasbro

Monthly Return 0.57% 1.87% 1.18%
Monthly Risk 0.0360171 0.0936646 0.0811583
Annual Return 6.84 22.44 14.16
Annual Risk 0.124767 0.3244636 0.281141

According to the results, the Annual Risk and Returns of Reynolds were high
so when the stocks with higher risk have higher returns.
R.J.Reynolds seems to be more riskiest.
2. Alex Sharpe invests 99% of her investments in S&P500 and 1% in either
Reynolds or Hasbro. The table indicates the risk values of the stock.

99%+1% 99%+1%
Stock 100% S&P Reynolds Hasbro

Risk 12.4767 12.6763 12.6330

In this the risk is high in the portfolio of S&P 500 and Reynolds. Hence, he
can invest the shares in this portfolio.

3. To calculate the systematic risk to find the “Beta” value by running

regression.

A) The Beta value of Reynold’s and S&P 500 is 0.73576

Intercept value is 0.0145

Hence, the regression equation is expressed as,

E(Rp) = 0.0145 + 0.73576(x)

The correlation value is 0.282925189

B) The Beta value of Hasbro and S&P 500 is 1.41979

Intercept value is 0.003683

Hence, the regression equation is expressed as,

E(Rp) = 0.0037 + 1.41979(x)

The correlation value is 0.630090448

4. The return of each stock relates to its riskiness

This can be used as an instrument to determine the best possible risk with the
least possible risk.
S&P 500 and Reynolds has lower beta value compared to that of S&P 500 &
Hasbro.
 To hold an asset over a period will help to avoid the riskiness. Investment in
portfolio rather than the single investment is better which will give lesser risk.

5. In what stocks should Sharpe Invest?

In this the portfolio method is a best choice, because investing all the money
in a single stock if there occurs any loss all the money incurred in it will get into
loss. Where as in Diversification (or) Portfolio is all about reducing the risk because,
when the price of one stock declines eventually the price of the other stock increases.
Comparing with the two portfolios the risk is lower for S&P and Reynolds.
Hence, it will have a lower return.
So, investing in S&P and Reynolds is a better choice.

ANALYSIS

S&P500 is an index, which has lower risk and at the same time lower returns.
Individually, Reynolds has higher returns at the same time higher risks, but Hasbro
has a comparatively lower amount of risk but lower returns.

The obtained regression helps us understand the increase in index value along with
the stocks, Reynolds and Hasbro.

Correlation analysis indicates a relationship between the Individual stocks and its
indices. Hasbro influences S&P500 better than Reynolds as the correlation value is
higher for Hasbro than for Reynolds.

CONCLUSION

After a complete analysis of the data, it is suggested that Alex Sharpe can invest in
S&P500 along with Reynolds as it has higher market returns.