please bid if you can deliver quality work, otherwise don't. I will ask for refund

STUDENT NAME

Finance 567

Final Project

Professor Henry

DATE

Executive Summary

This proposal will outlay a strategy using the following methods to come up with a sound portfolio. We are bullish on the market overall but the general consensus over the next 18- 24 months is that the market will be relatively flat with some downside potential. The goal will be to try and maximize return and hedge the risk against any market drops.

 $500,000 - 10 stocks picked from the Dow Jones Industrial Average  A hedging strategy options to protect against a significant price drop,  Several bonds ranging in maturity of 2 to 5 years, and a risk free investment in a

money market account. The anticipated outlook of the market was for the next 18 to 24 months was bullish but there were concerns about possible price drops.

 We will also deposit $500,000 into a money market yielding 1.27%.

The investment in the 10 equities positions were chosen based on their current dividend yield and potential growth opportunity – see the spreadsheet data section for equity information. Some stocks, such as Cisco (CSCO) have started paying dividends with a realization that it is difficult to achieve the growth rates they once had in the late 90’s. The stocks and bonds are listed on the spreadsheet in the spreadsheet data section. The bonds are U.S. treasuries with maturity dates for the next 2 to 5 years. The investment in the money market account is a risk free investment at USAA bank of San Antonio, Texas.

The average Rate of return for the equities position is approximately 4% annually. The same rate of return is expected after the cost of the hedging positions is taken into account for the entire two year anticipated holding period. The bonds range in return from 1.25% to 9.88%. The risk free money market account at USAA has an annual rate of return of 1.27%.

Hedging Strategy

After looking at several different hedging strategies, it was determined that the most inexpensive while optimizing the possibility of a return, was an overall one covering all of the stocks in our portfolio plus the other 20 in the Dow Jones Industrial average. This was accomplished by a straddle for 15 contracts on an Exchange Traded Fund by the symbol of DIA which is a fund that mimics the Dow Industrials. For this strategy we buy 15 contracts of DIA Jan15 125 calls. This is a call option for January 2015 for a strike price of $125 per share, each contract is for 100 shares. For a call the person who sells the call has the obligation to sell the listed stock to us for the agreed upon strike price, which in this case is $125 per share times the 100 shares for each contract. The other side of the straddle we bought 15 contracts of DIA Jan15 155 puts in this case we have the option to sell 100 shares of the listed stock at the agreed upon strike price which is also $155. With this strategy we are looking for the market to either remain stable or if there is a significant increase or decrease we will be able to profit from it. (Kolb & Overdahl, 2007)

Spreadsheet Data

Risks and Rewards

From risk/reward perspective, the equities are pretty self explanatory. If the price drops below the purchase price, money is lost. If the price goes up, money is made. The hedging strategy is where we try to mitigate some of the risk in market trends and we’ve done this, as mentioned above, by purchasing a straddle on the entire Dow Jones Average. Since our basic theory is that the market will remain relatively stable with some downside risk, the straddle is intended to protect against the drop, and maximize profit on any upside swing. For this to be profitable the break even points are as follows. For the calls we need the price of DIA to rise above $168.82 per share in order to recover the premium that was paid, any rise above $68.82 per share leads to a profit. For the puts the price of DIA needs to fall to less than $111.18 per share. If the market remains neutral we will have spent a total of $65,730 for the insurance.

The coupon payments for the bonds alone will be $24,130 per year. So if we held those for the two year period, that would bring us $48,260. If we subtract out the $41,280 the bonds cost us over and above the face value, we net $6,980. We can add an additional $8,750 to that for the third year of the three year note, bringing our total “income” from the bonds to $15,730.

We will earn $6,350 per year in interest on the money market and a “what if “ scenario on the individual equities tells us that, for every dollar the stock price for each equity rises (this scenario requires all equities to rise by one dollar at the same time, for examples sake), the total value of the equities rises $12,200.

Conclusion

Based on the projected returns we are looking to make an overall return on investment of 3.6% per year. Since we are bullish on all of our stock positions for the 18 month mark this is not a bad investment to be in. The combinations of the risk free money market return of 1.27% and the returns on the bonds will help offset the expenses incurred to purchase the options strategies employed to cover the equity positions. The anticipated dividend returns will also help offset any potential losses from the insurance hedges employed.

All bond and stock prices are based on the closing of the markets on Monday June 3rd, 2013. (finance.yahoo.com)

Works Cited

Bankrate.com. (n.d.). Retrieved June 3, 2013, from http://www.bankrate.com/funnel/savings/savings-results.aspx?local=false&prods=37

Yahoo. (n.d.). Retrieved June 3, 2013, from http://finance.yahoo.com

Kolb, R. W., & Overdahl, J. A. (2007). Futures, Options, And Swaps. Malden, MA: Blackwell Publishing.