Portfolio manager decision Brexit Coursework

Question 1. (40 Marks)

  • The referendum on Brexit took place on 23 June 2016, with the following vote to leave the European Union leading to widespread chaos and uncertainty in financial markets. After an incredible career to date, you have just started as a portfolio manager (with specific responsibility for selected investments in the banking, insurance and transport sectors) at a leading European investment bank in Dublin. The company made significant private investments in Ireland in the three sectors you are responsible for in 2015 (of approximately €2.5 billion), and they are now presenting losses in excess of 45% mainly due to Brexit uncertainty. The head office has been in contact and is threatening mass layoffs should an exit plan not be presented. Your new manager wants your opinion about the following:

  1. What are the key risks to the Irish economy in the short, medium and long term given the result of the Brexit referendum?

  1. How correlated is the Irish economy and the sectors you are responsible to the behavior of similar economic and sectorial benchmarks in the UK?

  • What financial products are available to gauge the probability of each event occurring?

  1. Did these same financial products present any evidence of the Brexit referendum passing in the weeks and months before 23 June 2016 and can they be trusted in the future?

  1. Should we accept our losses of 45% of the total portfolio or is there a chance of a recovery?What information are financial markets presenting to us?

  1. What specific steps can we take to hedge the company against immediate international contagion risk stemming from the Brexit vote and the oncoming triggering of Article 50?

  • What theoretical models are available to assist us in our immediate risk mitigation strategies?

Please compile a full report to answer each of his concerns in detail.

Question 2 (30 Marks)

(a) Explain and analyse the differences between Fama and French’s 3-Factor and 5-Factor models. Has the 5-Factor model been received as an appropriate replacement for the 3- Factor model? Or has there been discontent with its production? Please explain. (5 Marks)

(b) The current value of a stock portfolio is €55.4 million. A financial analysts summarises the uncertainty about next year’s holding-period return using the scenario analysis in the following table.

  1. What are the annual holding-period returns of the portfolio in each scenario?

  1. Calculate the expected holding period return, the standard deviation of returns and the 5% VaR?

  1. What is the VaR of a portfolio with normally distributed returns with the same mean and standard deviation as the stock?

  1. Suppose that the worst three rates of return in a sample of 36 monthly observations are 7%, 3% and -5%. Estimate the 5% VaR.

(5 Marks)

  • Explain and critique the Capital Asset Pricing Model (CAPM) and Arbitrage Pricing Theory (APT). When answering, consider explaining both of the models, the key differences between the two and the benefits and pitfalls of each when used industrially.
(5 Marks)

  • Keown and Pinkerton (1981) provided a figure clearly representing cumulative abnormal returns for stocks before takeover attempts (a link to their paper is here http://e-m-h.org/KePi81.pdf and the discussed graph is figure 1 in the paper).

  1. I want you to replicate their graph (also found in figure 8.1 in Bodie, Kane and Marcus, 9th edition) for any type of announcement of your choosing (eg: terrorist attacks, dividend announcements etc.). Please select a minimum of three plausibly related stocks to build your graphs and investigate the period 90 days before the announcement and 30 days after.
  2. Briefly outline the Efficient Market Hypothesis (EMH) and explain whether it holds after analysis of your selected sample of stocks. (15 Marks)

Question 3. (30 Marks)

  • You are an investment manager with a large financial institution in Ireland (on the 1st of December 2006) that has a portfolio of €1.5 billion.

(i) You have been directed to obtain positions with a total value of €1.2 billion in oil, gold and aluminium (€0.4 billion in each asset). Using any specific ETF (or combination of ETFs), explain how you could obtain this position? In your answer also explain (with a graph) how this position would have performed until December 2010?

(ii) With the remaining €0.3 billion, you have also been instructed to hedge the positions risk effectively. What action would you have taken? How would this position have performed?

(15 Marks)

{Note: useful data sources are the Bloomberg terminal, Thomson Reuters DataStream, www.finance.yahoo.com, www.finance.google.com. A concise searchable list of ETFs is available at http://etfdb.com/. }

  1. b) There have multiple cases of trader-related fraud over the past twenty years. Through investigation of the cases relating to John Rusnack (AIB), Jerome Kerviel (SocGen) and Nick Lesson (Barings Bank), please identify some of the common characteristics of each case. Your answer should add two further cases to the above list while considering what internal procedures may have mitigated the substantial risk, or indeed have deterred the trader’s chosen actions. What actions have international regulators taken to reduce the probability of rogue traders?

(5 Marks)

  1. c) The international financial crisis beginning in 2007 originated in the US subprime market. Explain how an asset-backed security (ABS) is designed and briefly explain how these products eventually led to the deterioration of the US and European real economies.

(5 Marks)

  1. d) You are an investment manager with a large financial institution (this time on the 1st of December 2007). Financial equities are in rapid decline with the onset of numerous international crisis episodes (subprime, sovereign, European {PIIGS}, etc.). A shortingban had been implemented on bank stocks, but you have been mandated to hold a short position. Explain the implications of this shorting-ban on your role as investment manager and also how you can obtain a net-short banking position without directly shorting banking stocks? Use data from the selected financial instrument to graphically present your answer.

(5 Marks)

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