PORTFOLIO ANALYSIS

Portfolio Analysis

QUESTION 1

Requirement A: Portfolio Analysis

Portfolio A

Annual Rate Of Return %

Probability %

Expected Rate Of Return

6

0.3

1.8

13

0.4

5.2

20

0.3

6

Expected Return = 6(0.3)+13(0.4)+20(0.3)

13%

Standard Deviation

7%

Coefficient Of Variance

0.54

Portfolio B

Annual Rate Of Return %

Probability %

Expected Rate Of Return

5

0.4

2

15

0.2

3

25

0.4

10

Expected Return = 5(0.4)+15(0.2)+25(0.4)

15%

Standard Deviation

10%

Coefficient Of Variance

0.67

Expected return

Expected return of the portfolio A is 13%, where as the expected rate of return of the portfolio B is 15%. Solely base on this criterion, portfolio B is performing well in terms of expected return. But we can not take our decision based solely on such criterion. We should also consider the risk involved in these portfolios (Chen and Chia-Hsuan, 2002). Therefore, for measurement of risk, we have calculated the standard deviation of the portfolios.

Standard deviation

Standard deviation of a portfolio measure the risk involved in the portfolio. Higher the value of standard deviation means the portfolio have higher risk, therefore, portfolio with lower standard deviation is always preferred. In our case, portfolio A (STD = 7%) has lower standard deviation than portfolio B (STD = 10%). Therefore, portfolio A has lower risk and should be preferred over portfolio B is terms of risk. However, deciding solely on this measure would not be a rational decision (Gouree and Hommes, 2000). Therefore, we will calculate coefficient of variance, which measure risk associated with per unit of expected return.

Coefficient of Variance

The coefficient of variance is a normalized measure of dispersion around the mean and is usually expressed as a percentage. It is often used when the units being compared are different. The coefficient of variance cannot provide the confidence intervals for the mean, unlike standard deviation. Lower value of C.V of the portfolio is always preferred. In our case, portfolio A has lower CV (CV = 0.54) than portfolio B (CV= 067), therefore, portfolio A is better than portfolio

B (Brands, Brown and Gallagher, 2005).

Decision

Based on above discussion, Ztech should invest its £1,000,000 in portfolio A.

Requirement B

Task 1 (a): Current price of bond on 30th June 2017

Task 1(b):Yield to maturity of bond on 30th June 2020

Formula used

Bond Price = Par Value × Coupon Rate × [1 - (1 + r)-m×n/r] + [Par Value r(1 + r)m×n/r]

Coupon Rate

Maturity

Current Price

Yield To Maturity

Par Value

Years To Maturity

7.25%

30-Jun-17

£104.88

6.25%

100

6

5.45%

30-Jun-20

£93.26

6%

100

10

Requirement C

Task 1

Coupon Rate

0

0

0

0

0

Par Value

100

100

100

100

100

Current Price

95.52

91.15

86.83

81.56

76.32

Years To Maturity

1

2

3

4

5

Yield To Maturity

4.69%

4.74%

4.82%

5.23%

5.55%

Task 2

The above graphs shows that the bond that have 1 year to maturity has YTM of 4.69%, and as the maturity period is increasing the YTM is also increasing. The bond that has 5 years to maturity has YTM of 5.555 highest among all (Arnold, 2010).

Task 3: Financing implication of yield to maturity curve for Xenon plc

Yield curve of bond is showing the relationship between cost of borrowing and time period. Xenon plc should float its bond in the market to raise a fund of £2,000,000 for four years. Yield to maturity curve shows that this source of funding will cost on 5.23%, whereas the fixed rate of interest is 5.75% and market rate of borrowing would be even higher 6.75% (fixed rate + risk premium) (Brands, Brown and Gallagher, ...