Global Financial Management

Assignment 1A

Assignment 1: Global Equity, Futures and Options Markets

This problem set is to be completed separately by each student. You can discuss the portfolios and the methodology with other students. Please do not be intimidated by this assignment if you are a novice investor. You will not be graded on the sophistication or profitability of your investment strategy. You are not required to make use of any particular strategy in buying and selling equities, futures and options. This assignment is a good opportunity to get into the habit of following the markets on a day-to-day basis and to learn how to track and evaluate a portfolio of securities.

Part A: Global Equity Markets Due date: Beginning of Class 1

It is recommended that you keep your portfolio simple. If you transact 20 different securities your record keeping will be quite extensive. You should spend most of your initial work building a spreadsheet which will allow you to easily track your portfolio. Once this spreadsheet has been assembled, you should be able to track your portfolio by simply entering security prices each day and any trades you may have made. When you need to analyze the daily value of the securities in your portfolio at the end of the assignment, all of the required information should be easily accessible in your spreadsheet.

A.1 You have been given US $1,000,000 to invest in a global portfolio of stocks. You enter the market using prices from the day before you are required to hand in your initial positions. If you go slightly over the US $1,000,000 then you can borrow at 7% (annualized). If you are under, then you can invest in a money market account at 5% (annualized). If there are big differences, you will have to downsize/upsize your trades. You must close your portfolio no later than the trading day before class 12. You must invest at least US $900,000 in stocks, thereby implying that no more than US $100,000 can remain invested at the money market rate of 5%. You can also borrow up to US $100,000 allowing you to invest up to US $1,100,000 in stocks.

Your US $1,000,000 should be used to purchase stocks in any of the world markets. You must buy and sell stocks in round lots of 100 shares. Convert all figures into U.S. dollars using exchange rates listed in the Wall Street Journal (WSJ) or retrieved from the internet. Short sales of stocks are allowed, but not required. If you short stocks, 50% of the value of the stock must be placed in a money market account earning 5% (annualized). Furthermore, you do not receive the proceeds from the short when it is executed. For example, if you short 100 shares of IBM at $100 per share, then this is a cash out transaction of $5000.

Shorting a stock involves selling a security that you do not own at the present time. In order to close out the short sale, you purchase the security in the future. In this way, you profit if a stock price goes down because you sell high (now) and buy low (later). You lose money if the stock price goes up. For example, if you short sell 100 shares of IBM at US $100 per share on Nov. 1, you must place 0.5x100x100=$5000 cash into your money market account, which will start earning interest at 5% annualized from Nov. 1. If you close out the short sale on Dec. 1 when the IBM stock price is $90 per share, your account is credited for the gain on the short sale: 100x(100-90) = $1,000. You can also retrieve the cash from your money market account: 5,000x(30/365x0.05)=$5,020.55.

Click here for more information on short-selling.

Some stocks do not trade as frequently as others. You may not buy or sell more than 10% of the total share volume in any given day. In addition, you can trade at any point during the day. Appendix A lists internet resources for accessing stock price data throughout the day.

To initiate a trade, use the following TRADE FORM

You should record your trades at the mid of the bid-ask spread if this information is available. If bid-ask spread information is not available, you can record your trade at the most recent trade price. In the U.S., bid-ask spread information is available for NASDAQ stocks but is not available for NYSE stocks. You are free to trade out of existing and into new positions throughout this assignment.

The bid-ask spread indicates the prices at which market makers or dealers are willing to buy and sell securities. The bid is the price at which dealers are willing to buy securities from investors (i.e., the price at which you, the investor, can easily sell to a dealer), and conversely, the ask is the price at which dealers are willing to sell a given security. Dealers make their profit by buying (bid) at a price slightly below the price at which they sell (ask).

You will have to track dividend payouts during the period for which you hold stocks long or short. If you hold a long stock position then you should accrue dividend payouts to your money market account. Corporations announce dividends in advance and also announce the ex-dividend date. Dividend revenue or expenses occur if you hold a position in a stock throughout the day preceding the ex-dividend date.

If you hold a short position then you have to pay out cash to cover dividend obligations. This obligation arises because the original owner of the stock (i.e. the individual or institution from which you have borrowed the stock) would receive a dividend payment if they had not lent you the stock. Because you have sold their stock to another party, this other party receives the dividend which accrues on the ex-dividend date. As a result, you have to “make-up” dividend payments to the original stockholder during which your short-sale is outstanding.

A.2 You are responsible for creating a spreadsheet which tracks the daily price and total value of each stock in your portfolio as well the total value of your portfolio. Your must also keep track of a “benchmark” portfolio in your spreadsheet. This portfolio will be US $1,000,000 invested in the Morgan Stanley Capital Index (MSCI) World Index. Daily quotes are available from Morgan Stanley web site (http://www.ms.com/mscidata/index.html) or at the end of the World Markets section in the print edition of the WSJ. Benchmark portfolios are a standard tool against which money managers evaluate their performance.

Turn in a printout of this spreadsheet listing the stocks in your initial portfolio.

A.3 Not required -- but encouraged! To make the stock, futures and option assignments more interesting, clip five dollars to your hand-in. If everyone participates, we should have approximately $600 that will be awarded to the people that make the most combined money in assignment 1 (stocks, futures and options). Of course, if you choose not to attach the $5, then you are not eligible for the prize. Note: your grade is not determined by the amount you make.