How to lose the most money in 100 days
Companies Chosen: Barclays PLC, British Airways, General Motors, Honda Motoring Company, Llyods Banking Group
Future Value (Mar 10 2009) of Portfolio:
£78,556.00
What is Risk?
In general risk is related to the probability of a ‘disaster’ occurring. Risks are events that may occur, and whose occurrence, if it does take place has a negative or harmful effect. If this is the case, why take a risk? Taking a risk, involves a payout, usually a higher payout than if no risk or less risk is taken.
What is Financial Risk?
Financial risk is a measure of how “risky” an investment is, generally high risk investments have a higher return (payoff), but involve have higher probabilities of losing the initial investment. Where the trade of stocks is concerned financial risk is measured by the probability of change in the price of the stock, either an increase or a decrease.
Can Financial Risk Be Measured?
Financial risk can be measured in a number of ways; however for the purpose of this investigation risk will be measured using the following statistical values, mean, standard deviation, and variance. The mean is a predictive measure the trend in daily returns for a particular stock, and it is a good estimate of future values. The standard deviation is the measure of confidence in the future estimate of the stocks return. This investigation aims to use statistical analysis on a stock portfolio in an attempt to lose money rather than make any. The mean and standard deviation together provide an analysis of the probability if an event occurring, therefore in this investigation the mean and standard deviation will provide an analysis of the probability that money will actually be lost over the 100 days period from December 1st 2008 to March 10th 2009.
How can This Information Be Used?
The information provided by the statistical analysis can provide valuable guidance on how to invest or in this case how not to invest as the aim here is to lose money. The analysis can estimate the future value of a portfolio and the whether investing in the stocks in a specific diversification ratio is worthwhile or not.
Financial Crisis 2007 – Present
This “financial meltdown” of the global market was initiated by investors losing confidence in the value of securitised mortgages offered in the United States, (Wikipedia 2009). However this crisis does not just involve the US housing market, it caused the failure of large financial institutions all over the World, e.g. Goldman Sachs (US) and Northern Rock (UK). This global whirlwind effect caused high volatility in the world’s stock markets, and large declines were observed in the value of the global markets. For example, the Dow Jones (US) declined from approximate 14,500 in 2007 to approximately 8000 in 2009, similarly for the FTSE 100 index (UK), has dropped from approximately 6,500 to 4000.
The crisis was propagated by Banks lending to high risk customers and businesses, with little or chance of recovering the monies (bad debt). Banks often lend/borrow money between each other to cover the cost of loaning money to customers, for a fair return in interest. However the crisis was worsened by banks refusing to lend to money each other or demand extremely high rates of interest on money being lent. This prompted two major events in the UK, firstly the reduction of interest rates and secondly the bail out packages offered to banks to raise capital. The reduction in interest rates was supposed to encourage UK banks to lend more freely to each other, this didn’t happen, which in turn prompted the bail out package for financial institutions.
Individual Risk Assessment of Stocks
Single Stock Risk: This is essentially a historical analysis of the company’s performance in the stock market. It analyses the companies stock price over a period of 10 years and calculates the current price of a historical investment, and evaluates the “historical” risk associated with the investment, in terms of the standard deviation and the mean return and can be used to estimate future values of the same investment. See attached Excel files.
Value at Risk:
VaR is a measure of confidence in the stock market; it measures the amount of invested monies at risk with specified confidence levels, i.e. standard deviations of the mean return from the investment. Historic
VaR uses the historical returns data, and applies a cumulative frequency, to determine the confidence levels. Parametric is slightly different and uses a normal distribution to determine the confidence levels of the stocks returns.
Linear Regression: This is a measure of volatility of a security against the stock market index. It calculates the Beta value; it varies from the standard deviation in that Beta measure volatility against the entire markets where as the standard deviation measures the volatility against the returns of an individual stock. A beta value greater than 1 indicates that the stock is more volatile than the overall market, and a beta value of less than 1 indicates less volatility.
The above statistical analyses were carried out on the five individual stocks chosen for this investigation and the results can be viewed in the attached Excel files.
Why Barclays Bank PLC was Chosen:
Barclays is one of the vast number of banks involved in and directly impacted by the current global financial climate. The UK government had developed a bailout package for the UK banks, and Barclays had initially signed up for the scheme, which had 5 main points:
1) The banks would have to raise capital by at least £25 Billion, and can borrow from the government to do so.
2) An additional £25 Billion would be available in exchange for preference shares.
3) £100 Billion would be available in short term loans from the Bank of England.
4) Up to £250 Billion would be available in short term loans, to encourage banks to loan money to each other.
5) To participate in the scheme the banks would need to agree to government guidelines on executive pay and dividends.
Barclays did accept the initial bail out package, but have recently been required to raise a further £8 Billion in capital. They have refused to accept any further help from the UK government in order to do this, and have stated that they will be able to raise the capital alone. This revelation caused the price of Barclay’s shares to plunge to 51.2 pence each.
Single Stock Risk Analysis:
Individual stock analysis carried out on Barclays stocks showed that on December the 1st 2008 the value of a £1000 investment made 10 years earlier would be valued at £624.13, a loss of £375.87.
Value at Risk Analysis:
Historical:
1. 1% Confidence Level = £21,160.92
2. 2% Confidence Level = £16,163.65
3. 5% Confidence Level = £8,435,65
Parametric:
1) 1% Confidence Level = £12,740.90
2) 2% Confidence Level = £11,247.93
3) 5% Confidence Level = £9,008.50
These values are a measure of how much of the initial £100,000 investment is at risk on the first day of investment, assuming that all of the money is invested directly into Barclay’s stock.
Linear Regression:
The beta value for the Barclays security was determined to be 1.494. This indicates that the Barclays stock is more volatile than the overall market. See Excel File for linear regression analysis of individual stocks.
Why British Airways was Chosen:
British Airways has recently been in the news for posting operating losses of £150 Million, due to the weak nature of the pound. This factor is not likely to change in the foreseeable future due to the economic decline of the UK economy. This caused the share prices for British Airways to fall 8.5% in a single day. Also there is the factor of increased costs due to fuel prices and declining number of holiday makers, people are beginning to feel the credit crunch in their wallets. The forecast for airlines cannot be good in the current financial climate.
Single Stock Risk Analysis:
Individual stock analysis carried out on Barclays stocks showed that on December the 1st 2008 the value of a £1000 investment made 10 years earlier would be valued at £1,222.76, an gain of £222.76 over 10 years.
Value at Risk Analysis:
Historical:
1) 1% Confidence Level = £12,333.74
2) 2% Confidence Level = £11,586.21
3) 5% Confidence Level = £7,344.64
Parametric:
1) 1% Confidence Level = £10,233.87
2) 2% Confidence Level = £9,034.68
3) 5% Confidence Level = £7,235.90
These values are a measure of how much of the initial £100,000 investment is at risk on the first day of investment, assuming that all of the money is invested directly into British Airways stock.
Linear Regression:
The beta value for the Barclays security was determined to be 0.777. This indicates that the British Airways stock is essentially less volatile than the overall market.
Why General Motors was Chosen
General Motors was recently involved in a large bail out by the US government, and the companies stock price is currently $2.93 (Feb 2, 2009). As yet GM has not published the financial reports for 2008 on the GM corporate website. As part of the government bail out package the GM stocks ceased trading for a period between November and December 2008. When trading resumed the volume of available shares in GM had almost doubled, from 53,377,100 to 117,047200, suggesting that either a large volume of investors had relinquished (sold) their shares or a vast proportion of the company had been liquidated i.e. taken from the major stake holders to be sold, this is possibly one of the criteria of the bail out. GM is one of the US’s largest companies employing in excess of 250,000 people, if this company was allowed to go bankrupt it would have caused vast job losses, this is possibly one of the reasons that the bail out was offered to GM.
GM posted sales figures in 2008 which were down by 11% from the previous year, and they are no longer the top car seller in the world, they have been ousted by Toyota.
Single Stock Risk Analysis:
Individual stock analysis carried out on GM stocks showed that on December the 1st 2008 the value of a £1000 investment made 10 years earlier would be valued at £114.26 a loss of £885.74 over 10 years.
Value at Risk Analysis:
Historical:
1) 1% Confidence Level = £22,935.78
2) 2% Confidence Level = £13,095.24
3) 5% Confidence Level = £10,207.11
Parametric:
1) 1% Confidence Level = £15,049.71
2) 2% Confidence Level = £13,286.20
3) 5% Confidence Level = £10,640.96
These values are a measure of how much of the initial £100,000 investment is at risk on the first day of investment, assuming that all of the money is invested directly into GM stock.
Linear Regression:
The beta value for the Barclays security was determined to be 1.6013. This indicates that the GM stock is a lot more volatile than the overall market.
Why Honda Motor Company was Chosen:
The Honda Motoring Company was chosen as one of the stocks for analysis and investment due to the recent announcement that it was suspending production at its Swindon based plant. This is the longest shutdown in Britain’s recent industrial history. Honda will continue to pay employee 100% of their salary for 2 months and following that a reduction to 60%. This was prompted by the release of third quarter figures from Honda which showed that they had suffered from an 89% decrease in net profit. Lord Mandelson the business secretary has outlined a possible bail out package for the UK car industry, but there has not been any confirmation of this yet.
Single Stock Risk Analysis:
Individual stock analysis carried out on Honda stocks showed that on December the 1st 2008 the value of a £1000 investment made 10 years earlier would be valued at £1,299.87, a gain of £299.87 over 10 years.
Value at Risk Analysis:
Historical:
1) 1% Confidence Level = £13,755.28
2) 2% Confidence Level = £7,758.89
3) 5% Confidence Level = £5,867.13
Parametric:
1) 1% Confidence Level = £8,192.94
2) 2% Confidence Level = £7,232.90
3) 5% Confidence Level = £5,792.85
These values are a measure of how much of the initial £100,000 investment is at risk on the first day of investment, assuming that all of the money is invested directly into Honda stock.
Linear Regression:
The beta value for the Barclays security was determined to be 1.0577. This indicates that the Honda stock is marginally more volatile than the overall market.
Why Lloyds Banking Group was Chosen:
Like Barclays Bank, Lloyds Banking group was directly involved in the government bail out, but also they purchased the HBOS banking group which was the UK’s biggest mortgage lender, and took on the management of the bad debt associated with HBOS.
There has also been some recent scandal associated with the banks tracking of funds to Middle East via the United States, which reportedly cost the bank approximately $350 Million, to settle.
Single Stock Risk Analysis:
Individual stock analysis carried out on Lloyds stocks showed that on December the 1st 2008 the value of a £1000 investment made 10 years earlier would be valued at £1,448.72, a gain of £448.72 over 10 years.
Value at Risk Analysis:
Historical:
1) 1% Confidence Level = £19,230.77
2) 2% Confidence Level = £11,392.41
3) 5% Confidence Level = £8,038.59
Parametric:
1) 1% Confidence Level = £11,498.09
2) 2% Confidence Level = £10,150.76
3) 5% Confidence Level = £8,129.77
These values are a measure of how much of the initial £100,000 investment is at risk on the first day of investment, assuming that all of the money is invested directly into Lloyd’s stock.
Linear Regression:
The beta value for the Barclays security was determined to be 1.3317. This indicates that the Lloyds stock is more volatile than the overall market.
Why create a portfolio?
Creating a portfolio is a method used to decrease the overall risk of multiple investments. It is called diversifiable risk, as the number of stocks in a portfolio is increased; there is a decrease in the annual standard deviation, which is the measure of volatility of the portfolio. This can be observed in the data analysis carried out for this investigation; the individual standard deviations of the stocks are shown below:
Barclays Bank PLC = 5.64%
British Airways = 4.44%
General Motors = 6.51%
Honda Motor company = 3.56%
Lloyds Banking Group = 4.97%
The standard deviation of the five-stock portfolio was calculated to be 4.04%
There are some fundamental rules or “tricks of the trade” which involve investing into diversified stocks, for example not investing into too many stocks of the same industry e.g. investing into 5 banks stocks. This is important for the current financial climate in that all banks are currently suffering low share values, if a portfolio comprised of 5 banks, a vast loss would be observed in the returns. The investments made in this portfolio do follow this bad practice in that the portfolio contains 2 banks, 2 car manufacturers, but this was only done to demonstrate that for a successful portfolio, i.e. one with lower risk and possibly a good return, should not invest in this manner. As stocks are added to a portfolio the portfolios risk decreases however there remains an overall non-diversifiable risk which relates to the market risk. The excel file (5 Stock portfolio) shows the decrease in the standard deviation and the Variance of having multiple stocks in the portfolio. This does however have a fundamental requirement, if a stock is added to portfolio it will only reduce the overall risk if it is not positively correlated with portfolio, i.e. the daily returns don’t increase/decrease in lockstep (at the same time).
The is also the fact that small holding are essentially inefficient, as adding a security increases the reward and reduces the overall risk, assuming hat the new stock isn’t perfectly positively correlated with the portfolio.
Mean-Variance Portfolio / Efficient Frontier
The calculation of the risk i.e. standard deviation and variance of a multi-stock portfolio involves using the respective weights of each stock and the correlation between the individual stocks. This can be seen in the 5 Stock Portfolio excel file attached, firstly all possible mixes of stock investment weightings had to be determined with a minimum of 10% invested into each stock, for example 4 stocks could have just 10% invested into them and the 5th could have the remaining 60% invested. Then the correlation between the stocks individual returns had to be determined, over the previous 1 year of daily return values, this is shown below in the Correlation Matrix:
All the correlation values are less than 1, not including the values of stocks against themselves which always have a correlation value of 1. If the correlation values were higher than one it would indicate that the stocks are perfectly positively correlated, and it would not be advised to add them to the portfolio together as it would not result in a decrease of overall risk to the portfolio. Also there is no negative correlation, which means that there isn’t a stock that will increase in value when another decreases.
The table below shows the minimum and maximum standard deviations and variance depending on the ratios of investment.
The lowest expected return was for the following mix:
10% Barclays : 30% British Airways : 10% General Motors : 10% Honda : 40% Lloyds Group
The highest expected return was for the following mix:
10% Barclays : 20% British Airways : 40% General Motors : 40% Honda : 10% Lloyds Group
The following graph shows the efficient frontier of this portfolio:
The efficient frontier is the line along which the ratio of investment into individual stocks provides a minimum variance, i.e. a lower risk. The above graph shows such a line, this was not able to be done directly in Excel, and was drawn freehand. The minimum variance occurs at the point where the two lines meet.
As discussed previously the Beta value of a stock indicates it’s volatility against the entire market, this principle can also be applied to a portfolio, to measure its volatility. The graph below shows the linear regression of the 5-stock portfolio.
The beta value of the portfolio was determined to be 1.305, a value higher than 1 shows that that portfolio is more volatile than the overall market.
Future Portfolio Value (March 10 2009)
During the period from December 1st 2008 to March 10 2009, there were 6 US Federal Holiday / UK Bank Holidays where no trading occurred:
25/12/2008 – Christmas Day
26/12/2008 – Boxing Day
01/01/2009 – New Years Day
19/01/2009 – Martin Luther King Day
20/01/2009 – Inauguration Day
16/02/2009 – Presidents Day
There were also 28 days which accounted for weekends, therefore only 66 days of trading can occur over the 100 day period. The future value of this five stock portfolio has been determined to be
£78,556.00 which is a loss of £21,444.00 over 100 days. This however only includes 66 actual trading days, from December first to March 10 2009 is 100 days; however the markets close for bank holidays and do not trade on the weekends.
Bibliography
[1] BBC (2009). Weak Pound Hurts British Airways. Retrieved, January 30, 2009, from
http://news.bbc.co.uk/2/hi/business/7851738.stm.
[2] BBC (2009). Honda’s 4 Month Break Begins. Retrieved, February 01, 2009, from
http://news.bbc.co.uk/2/hi/business/7859863.stm.
[3] BBC (2009). General Motors to Cut 2000 Jobs. Retrieved, January 30, 2009 from
http://news.bbc.co.uk/2/hi/business/7852098.stm.
[4] Briggs Armstrong (2008). Yet Another GM Bail Out. Retrieved, January 23, 2009 from
http://mises.org/story/3202.
[5] Thomas. L Jr, (2009, January 26). Barclays to Write Down £8 Billion, but Asks for No Help. The New York Times, Page B1. Website version retrieved from:
http://www.nytimes.com/2009/01/27/business/worldbusiness/27barclays.html?partner=rss&emc=rss.
[6] Washington Correspondents, (2009). Lloyds Bank fined almost $500 Million. Retrieved January 30, 2009 from
http://www.news.com.au/perthnow/story/0,21598,24894995-5005520,00.html.
