FIN 435: Investment Simulation in DSE

Group 3

Section-2

Spring 2011

Faculty: Saif Rahman

Done by:

Zulkar Nayen Ahmed; ID# 0910633520

Gazi Musaeb Raffan; ID# 0910486520

Refayet Ahmed; ID: 081101530

MD Sabbir Hossain; ID 071770030

Imran Sayeed ; ID 081744030

Contents: Page

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Executive Summary…………………………………………………………………………………………………………3

Introduction……………………………………………………………………………………………………………………4

Objectives……………………………………………………………………………………………………………………..4

Analysis of recent market crash……………………………………………………………………………………..5

Industry Scene……………………………………………………………………………………………………………….7

Asset Allocation……………………………………………………………………………………………………….…….9

Economic Rationale………………………………………………………………………………………………….…..12

Trading Strategies and portfolio evaluation………………………………………………………………….14

Diversification………………………………………………………………………………………………………….……19

Portfolio Evaluation………………………………………………………………………………………………..…..…20

Lessons learned………………………………………………………………………………………………………………22

Executive Summary:

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The following report is based on a practical simulation on investment in the Dhaka Stock Exchange (DSE). The duration of the simulation was two months from 5rd February 2011 to 6th April 2011. The project started with an investment of TK 10,00,000 with certain constraints applicable during the investment horizon. The first portfolio selection was based on the individual stocks PE ratio and EPS which determined the return and the risk was determined by selecting a single stock from each of the major industries thus minimizing risk through diversification as well as macroeconomic factors. However, by the end of the first phase the portfolios performance was very poor and our equity was down to TK 7,64,876. Thus without any statistical analysis and investment decision based only on publicly available information selection was in semi-strong efficiency form of the market.

The second phase began on 5th March 2011 with a complete redesign of the original portfolio. Only stocks retained were Beximco, FuWang ceramics and Glaxosmith which made up 25% of the portfolio. They were retained due to positive returns and/or risk minimization while the others were sold off due to underperformance. The criteria for stock selection included positive expected return(mean), actual returns of previous stocks, utility and low or negative correlation and standard deviation with other stocks and the market. The second portfolio performed much better and the equity at the end of phase 2 was TK 11,45,035.

On Mar-26-2011 the third phase began and seven out of the nine stocks in the previous portfolio were carried forward with only three new additions. The decision to buy or sell was dictated by the statistics/calculation from the previous phases and ratios (Sharpe, Treynor, Jensens alpha) and beta with regression analysis as well as the previous performance of the stocks. Again the portfolio performed exceptionally well with an ending balance of TK 13,96,804. Thus by applying proper theories and concepts in three months the portfolio made a profit of almost 4 laks in two months which is quite extraordinary.

Introduction:Fin-435

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Bangladesh stock market is one of the smaller markets in the World and in fact Asia, and consists of two fully automated stock exchanges named Dhaka Stock Exchange (DSE) and Chittagong Stock Exchange (CSE). The Security and Exchange Commission (SEC) acts as its regulatory body by monitoring and implementing rules, regulations and policies with the ultimate goal of developing the capital market and adding more depth to it. In our simulation all investment activities were carried out in the DSE.

The paper is designed to act as a guidance on efficiently managing and maintaining a profitable and diversified portfolio of stocks by applying sound statistical analysis and financial theories. The simulation took place over a period of two months starting from 5rd February 2011 to 6th April 2011. The constraints of the simulation include a TK 1000000 limit on the initial capital to be invested and that no more than TK 100 000 to be allotted to a single stock, i.e. a maximum of 10% of the initial investment could be allocated to any particular stock. The total holding period was divided into three phases each lasting approximately three weeks. At the end of each phase the portfolio was modified based on its performance. At the end of the first phase the portfolio did perform poorly but following corrections soon recovered by the end of the second phase and in fact provided a healthy return by the end of the simulation. The Treynor ratio, Jensen's alpha, Utility, correlations, standard deviations and Betas as wells as macroeconomic factors were some of the analytical tools considered to evaluate the risk and returns of the portfolios.

Objectives:

Our primary objective in this simulation project was to get comprehensive and in depth idea about the workings and investment climate of the DSE. By looking into the intricate functions of the stock market we hoped to achieve a better understanding of how to effectively invest in the DSE. Our secondary objective however was to increase our portfolios wealth by using the proper analytical tool. Thus higher returns, rather than risk minimization through diversification, was the driving force behind our decision making. However, diversification did play an important role in influencing our portfolio selection. In our pursuit of maximizing wealth we did hope to apply theoretical knowledge into the practical world. We therefore attempted to generate an effective trading strategy based on theory and statistics that would dictate the purchase and selling decisions of the stocks in our portfolio. The ultimate goal is therefore to summarize the inner workings of the DSE and develop a trading strategy that would maximize the profit in this market.

What Went Wrong With The Dhaka Stock Exchange? (Stock-Market-Today, 2011)

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'There are financial markets located throughout the world. Some are larger than others and represent more of the global economy. However, many countries that have lagged behind the rest of the world economically have their own emerging markets. In Bangladesh, this is the case with their primary securities market being the Dhaka stock exchange. This market has recently seen a bubble collapse similar to the one experienced by US markets in 2009 and 2010. This has left many people wondering what went wrong with the Dhaka stock exchange.

The Crash of Dhaka Stock Exchange

What caused the crash in this market? A sharp increase on the demand side unsupported by fundamental analysis of the stocks being traded lead to incredibly exaggerated prices being paid for stocks that had an actual value of less than half the price per share.

Traders allowing emotions to guide them rather than study of fundamental market indicators created a market in which investors could not see anything but gains in value in the near future.

A large number of foreign investors entering the market for the purpose of taking as much profit as possible contributed a great deal to this problem. It was magnified when these foreign investors began selling off shares to take their profits and pull their money out of the market.

In the end, domestic mutual fund managers and foreign investors began to fear a market correction looming in the future and sold off as many shares as possible in order to hold their assets as cash until this correction took place.

All of the stocks showed extremely high P/E ratios. While a high ratio can be an indicator of healthy economic growth, Ratios reaching extremely high levels should have been a warning sign that stock prices were becoming exaggerated beyond reason'.

Recent shakeup

Dhaka stocks continued to dip for the fifth straight session, hitting 13 months' low Monday which prompted hundreds of angry investors to take to the street and demonstrate in front

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of the country's premier bourse, the Dhaka Stock Exchange (DSE).The news of buying shares by state-owned financial institutions failed to attract investors as DSE General Index (DGEN), the benchmark index of the market, ended at 5,203.08 points, shedding 4.76 per cent or 260.27 points, the lowest since January 24 of last year when DGEN was at 5,156.62 points.

The index lost more than 1,185 points or 17 per cent in the consecutive five trading sessions, and from its highest value of 8,918.51 as on December 5, 2010, it lost 44 per cent or 3,715 points. The day's total turnover stood at only Tk 4.89 billion in value terms, down by 2.4 per cent compared to the previous session. Nearly 85 per cent scripts lost in prices on the day as out of 252 issues traded, only 30 advanced, 213 declined and nine remained unchanged.

Meanwhile, the market opened with a negative note in the morning and fell by more than 180 points within fifteen minutes. It recovered some points in the mid-session, then fell steadily and finally closed at 260 points lower. The broader DSE All Shares Price Index (DSI) lost 215.76 points or 4.76 per cent to 4317.89. The DSE-20, including its blue chips index, dropped 4.69 per cent or 172.99 points to 3514.51. A total of 52.80 million shares changed hands against 54.91 million in the previous trading session. The number of trade deals stood at 121,467 which was 121,536 on Sunday. The total market capitalization came down to Tk 2413.07 billion against Tk 2,512.87 billion in the previous session.

Extreme confidence-loss among the small investors, liquidity crunch and inactivity of most of the big and institutional investors in the current volatile situation are the main reasons of the market fall, dealers said. The market lost across the board with most of the major sectors losing in big margin with telecommunication losing 6.61 per cent, non-banking financial institutions (NBFIs) 6.02 per cent, banks 4.94 per cent and pharmaceuticals 3.77 per cent.

Industry scene (BD Stocks, 2011) (Dhaka Stock Exchange, 2011):

The DS currently has a total 476 companies listed spread over 22 industries. The following is an analysis of some of the major industries and what it means for investors.

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Bank

Currently there are 30 banks listed in Dhaka Stock Exchange. Its PE ratio is 16.1 with an index point of 5164.2 and a contribution of .34%. The sector has shown positive growth trends over recent years and is one of the larger sectors in the DSE and can thus influence the market index. Although it has a lower PE ratio compared to other industries in the market its contribution is quite high.

Financial Institution

There are 21 financial institutions in Dhaka Stock Exchange with an average PE ratio of 30.9 and an index point of 3120. This sector also has strong weight and this influence over the index. The PE ratio is below 75 and is thus eligible for loan facilities (Mufazzal, 2009) so further growth of the industry can be expected.

Ceramic

5 ceramic companies are listed in Dhaka Stock Exchange. Its PE ratio is 121.7 and has an index point of 1316.8 and a contribution of 0.06%. Although the share of this industry is very low its high PE ratio means investors are expecting higher earnings growth in the future and thus prices of stocks are expected to rise.

Pharmaceuticals

In Dhaka Stock Exchange, the number of pharmaceutical companies listed is 20. The sectors PE ratio is 32.6 where it has an index point of 4574. Once again the sector has a healthy market share and also a relatively satisfactory PE ratio. Since the 90's this industry projected robust growth which has now stagnated.

Cement

With an index point of 2007.6, 7 cement companies are listed in Dhaka Stock Exchange. Its PE ratio is 30.7 when it has a contribution of 0.06%. Its market share in DSE is relatively low but its relative PE is satisfactory. Its PE ratio of 30.7 means the industry is also eligible for loan facilities and thus growth can be speculated.

Tannery

There are 5 companies of country’s tannery industry in Dhaka Stock Exchange. Its PE ratio is 18.2 when it has an index point of 4255.1 and no contribution. Thus it is one of the more poorer and less significant sectors in the market.

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Food and Allied

15 food and allied companies are currently enlisted in Dhaka Stock Exchange. Its PE ratio is 21.2 while it has an index point of 4809.8 and a contribution of -.01%. A relatively low market share, PE ratio and almost zero contribution define the Food and Allied industry. However on the positive side it does have a relatively higher index point.

Service and Real Estate

Dhaka Stock Exchange has 4 service and real estate companies. Its PE ratio is 59.7 when it has an index point of 9899.1 and a contribution of 0.05%. Although it has a relatively lower market share, the industry has one of the highest index points and a healthy PE ratio. This means the stock prices of companies in this industry can be speculated to increase in the future.

Fuel and Power

This industry has a PE ratio of 27.7 with an index point of 6866.8 and a contribution of .08%. Currently there are 11 fuel and power companies in Dhaka Stock Exchange. Again the PE ratio of the sector is relatively satisfactory and the sectors index point is also quite high. With ever increasing fuel prices the industry can certainly be expected to grow and its stock prices to increase.

Insurance

Insurance industry has 44 companies in Dhaka Stock Exchange. Its PE ratio is 42.3 when it has an index point of 8545.6 and a contribution of 17%. The insurance industry the largest market share in DSE compared to other industries and is thus a key influence on the market index. As a result it has one of the higher index points and also a healthy contribution. Its PE ratio is also above average compared to other industries implying investors are expecting higher earnings growth in the future.

Engineering

The country’s engineering industry has total 22 companies enlisted in Dhaka Stock Exchange. The industry has a PE ratio of 44.6, an index point of 6507.9 and no contribution. One again its relatively higher than average PE ratio suggests further expected growth of earnings.

Asset Allocation:

Phase 1 -

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The 1st portfolio consists of a total 11 stocks spread over eight different industries in the DSE. The criterion for choosing these stocks include their individual as well as industry P/E ratios and EPS which dictate the returns of the portfolio while an attempt was made to minimize the risk of the portfolio through diversification. In other words the expected returns of the portfolio was based on the P/E ratio and EPS and by investing in eight different industries risk minimization through diversification was achieved. At the same time no corporate bonds or treasury bills were chosen due to their relatively lower returns. As mentioned previously higher returns, rather than lower risk, was our main priority when choosing stocks and thus greater weights were given to the Fuel and Power, Bank and Cement industries specially after considering the macroeconomic factors. The following chart summarizes our asset allocation based on industry.

Miscellaneous10%

Ceramic5%

Insurance9%

Bank20%

Pharmaceuticals & Chemicals9%

Fuel and Power21%

Cement19%

Engineering7%

Asset Alocation

YCP

Phase 2 -

In the second portfolio except for FuWang Ceramics, Beximco and Glaxo Smith Kline, the rest of the eight stocks were sold off due to underperformance. However six new additions

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were made to the portfolio. As before no investments were made in Treasury bills or corporate bonds and the total equity of TK 7,64,876 was invested among nine companies spread over eight different industries. Care was taken to ensure an equitable distribution of capital so that no single industry or stock greatly dominates the portfolio thereby allowing for diversification. The criterion for buying or selling stocks in this 2nd phase include expected return(mean), actual returns of previous stocks, utility, correlation, variance as well as standard deviation as a measure of risk and return. The following chart summarizes our asset allocation based on industry:

Food and Allied14%

Insurance12%

Ceramic12%

Pharmaceuticals & Chemicals18%

Textile12%

Miscellaneous18%

Jute13%

Asset Allocation

YCP

Phase 3 -

The third portfolio consists of ten stocks divided among nine different industries which suggest adequate diversification. The equity available for investment was TK 11,44,258 and

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as before no investments were made in Treasury bills or corporate bonds. Because of the overall healthy performance of our 2nd portfolio, seven out of the nine stocks in the previous portfolio were carried forward with only three new additions. The portfolio is dominated by Bangas from the Fool and Allied industry mainly due to its high value appreciation since its original investment. The decision to buy or sell was dictated by the statistics/calculation from the previous phases as well as ratio(Sharpe, Treynor, Jensens alpha) and beta with regression analysis. The following chart summarizes our asset allocation based on industry:

Food and Allied19%

Insurance8%

Ceramic19%

Fuel and Power8%

Textile12%

Tannery Industries8%

Jute15%

Pharmaceuticals & Chemicals

7%

Miscellaneous6%

Asset Allocation

Mkt Lot

Economic Rationale:

Macroeconomic factors play a crucial role in influencing the stock market and factors such as Interest rate, Inflation, Government budget, Tax cuts, Exchange rate, International trade

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as well as Politics must be incorporated into the decision making process. The macroeconomic environment as well as steps taken by the SEC has important implications on stock market capitalization (which crossed USD 50 billion in August 2010) and affected our portfolio returns. These external factors account for the systematic risk in our portfolio and also causes the stock prices to fluctuate.

One of the major factors influencing our asset allocation in portfolio 1 was economic and external factors. We entered the market during the aftermath of its largest crash since 1996 and thus a bearish market. Our expectations thus included:

'Due to high rate deposit collection & liquidity crisis, less involvement in capital market, expected EPS of the Banks & Financial institutions much lower thus depress the prices. The index may face a good decrease further due to losing of major stakeholders (banks, financial) market capital' (Stock-Market-Today, 2011). These predictions are based on the fact that The Bangladesh bank dictated commercial banks not to invest more than 10% of their liabilities in the stock market, lowering the credit inflow and causing the overall index to go down.

The credit flow in the market decreased further when the SEC ordered merchant banks and stockbrokers not to lend to purchase equities with P/E ratio above 40. In spite of these factors commercial banks recorded a 30-95 percent growth in operating profit in the six months to June 30, 2010 which was the determining factor when choosing the two banks in our portfolio with price weight of 20%. The high growth rate prompted us to expect a positive growth in the prices of these stocks. The reigning high rates of inflation increased the cost of living and a shift of resources from investments to consumption. This leads to a fall in the demand for market instruments and subsequently leads to a reduction in the volume of stock traded. However recent trends show that by virtue of different government policies the inflation has been relatively brought under control. The capital gains tax cut to 5% by the Finance ministry also led us to expect a growth in the market index. The SEC also relaxed some of its rules and regulations after the market crash which compelled us to deduce a positive effect on the market after our initial investment. Coupled with the relative political stability the phase one portfolio consisted of all the major industries in the market. However the poor performance of our stocks in phase 1 can be attributed to time taken for these measures to take effect after the initial market crash.

By the time of our investment in the second portfolio some of the effects of the policies taken to rejuvenate the market were bearing fruit. Although the market was still bearish the factors that prompted us to choose the stocks in our second portfolio include the decision by Bangladesh Bank and SEC to allow merchant banks to provide 2:1 loans for investment in the stock market which would greatly increase the cash flow in the market thereby increasing the index. At the same time banks were ordered to reinvest their previous profits from the stock market back into the market. The ceramics and pharmaceutical industries are still subsidized and thus their performance was expected to be healthy. As a result they

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made up 30% and 26% of the portfolio in the second and third phase respectively. Again, since the overall index was predicted to increase due to the aforementioned factors the capital was distributed relatively evenly among the major industries. However in phase 2 more weight was given to statistical analysis rather than economic factors when building the portfolio.

During the duration of phase 2 the government announced a 5000 crore taka stimulus package for the stock market which caused the prices to further increase by the selection of our third portfolio. There was a hiccup during this period when rumors emerged that the stimulus package may not be put into effect and there was a sharp decline in the index. However this is soon rectified and the market picked up again. However it must be mentioned that the third portfolio consisted mostly of stocks brought forward from the previous portfolio due to their extraordinary performance and thus external factors played little role in the decision making process.

Trading Strategies:

1st Phase (05-02-2011:05-03-2011)

As a basic beginning of our investment in Bangladesh capital market we could not consider lots of factors in selecting our portfolio. The factors we considered in selecting stocks are like- Price Earnings ratio, Earning per Share, Previous 3 years net profit and also the company’s dividend policy. We also took into account the Macroeconomic policies adopted by the government in this period and also the changed decisions by the Security and Exchange Commission (SEC). Our first phase started from 5th of February 2011. The market had just started to recover from the biggest crash in the history of DSE and therefore choosing stocks in such a volatile market was not easy especially due to the fact that many people were clearing out their portfolio and exiting from the market, resulting in an erratic movement of share prices. Our main attention for stock selection was towards relatively low P/E ratio and high EPS. We also chose the best 1 or 2 stock(s) from each industry, and hence we have selected some stock which have a high P/E and low EPS, but it was selected just for the sake of diversification.

Beximco-This stock was chosen mainly for the sake of political backing. As we all know that Beximco group is run by the legendary Salman F. Rahman (SFR). As he is also backed by the

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present ruling government, it was an easy decision to choose his firm as it would surely perform well. Besides the political factor, its P/E ratio was sufficiently low and its EPS was quite high. Its dividend policy is very investor friendly with a 60% bonus share as dividend in 2009.

Fuwangcer- Although the best performer in the industry in terms of profit, its P/E was also the highest and so was its EPS and also the dividends which were bonus shares. Compared to other ceramic industries, it seemed like the most lucrative option for investment.

BGIC- The main reason we chose BGIC was because of its growth. Its net profit was gradually growing and also posted a healthy EPS and quite lower P/E ratio. Being one of the oldst insurance firms in Bangladesh, we also thought that its share price won’t be so volatile in the volatile market and we considered it as ablue chip company.

Citybank- Citybank was one of our most well thought investments in phase 1. It had just introduced the radical new American Express Cards, and was going through a very aggressive campaign, which we as investors liked very much. Secondly, its P/E ratio was very low (17) compared to its EPS (52). This led us to blindly pick citybank for our first phase.

Abbank- This was according to us one of the most undervalued bank. Its P/E ratio was amongst the lowest in our portfolio (11) and its EPS was among the highest (133). Thereby making it very easy for us to include Abbank in our portfolio for the 1st phase.

Glaxosmith- Despite mediocre P/E ratio and EPS, this stock was chosen on the basis of its extremely high profits, growth and dividend policy. The combination of the latter three made us believe that the company had the potential to do much better. Being a foreign pharmaceutical company, we also thought of its export possibilities and hence its inclusion in our portfolio.

Powergrid- Not many firms are listed in the fuel and power sector in the DSE. Of them , powergrid stood out with its stupendous net profits and impressive growth rates. It also had quite a reasonable P/E ratio and EPS in order to qualify to be in our portfolio.

Titasgas- Titasgas is one the highest profit making companies listed in DSE with stupendous growth rates in profits, moderate dividend payout ratio. This company therefore showed good prospect and unlike other companies, it didn’t lose much value as compared to other firms in the stock market crash.

Heidelberg Cement- Heidelberg was chosen mainly because of its high EPS and loe P/E ratio. This meant that the firm had good prospect. However it was severely overvalued and we think that it would have been much better if it hadn’t been included in our portfolio.

Aramit Cement- Being quite a small producer, Aramit cement posted good profits, and quite a healthy EPS, but a relatively high P/E ratio. It was found that the overall cement sector was kind of overpriced but this was the best of the worst and hence its inclusion.

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Deshbandhu Polymer – Being the youngest listed firm of all the stocks chosen in our portfolio, we thought that Deshbandhu might perform well, considering the fact that it is from the engineering sector and produces something that is in high demand. However, we failed to imagine that our portfolio would be for a very limited time and that it would take at laest a year for the market to realize its true worth. Therefore our selection of Deshbandhu despite its low P/E ratio and the lowest EPS was more like a blunder.

2nd Phase (03-03-2011:25-03-2011)

Since each stock in the portfolio is part of many stocks that make up the portfolio Treynor ratio gives us the best measure. The Treynor ratio measures the excess return of risk premium received compared to the amount of systematic risk taken. The portfolio in the second phase can be considered to be well diversified since each industry had roughly the same weight (around 10%) i.e. the TK 760000 was divided equally among the seven industries chosen. Since the Treynor measure should only be used with a well diversified portfolio (such as here) it will give us the best performance measure.

When selecting the second portfolio we used –Each stocks expected return, their variance, their standard deviation (risk). For the calculation of each of the aspects we choose their historical closing prices of 6 months. (Aug 2010-Jan 2011). The details of the calculation are shown in the appendix. We used daily return to find our expected return (annualized), variance and standard deviation. We chose stocks which had an annual expected return of atleast 50%, had a n annual standard standard deviation of less than 80%, however we had a risk averse index of 2. This meant that we were risk prone and chose stocks which would give us high return even if the rick was much high, (beta value is high). Correlation with the market was a major deciding factor and we tried to select stocks which were if not negatively correlated, but atleast highly uncorrelated against each other.

We chose several stocks which were very much correlated with the market and some which were not. This was done to diversify.

Provati Insurance - The main reason behind the selection of Provati Insurance was undoubtedly its huge expected annual return (201%), which was almost more than four times than that of the market. This stock was chosen keeping in mind that it had a standard deviation of 73% which was low and it had the highest beta (1.15). Being less risk averse, we decided to select it, and it also had a high utility.

Fuwang Ceramics – Other than correlation, it was chosen because of its high expected returns and low Beta. This meant that it lower risk as compared to the rest of the marklet and stocks and still gave us ahigh return. It also had quite a high utility level.

Glaxo Smith Kline – Selection of Glaxosmith in our phase 2 was one of our biggest mistakes. It already had a expected return which was negative and big. It had all the points for not

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making it to our portfolio , but still it was foolishly kept back and eventually we had to sell it off at a loss.

Saiham Textiles – Saihamtex had the highest standard dev in the market, but its expected return was so high that it simply couldn’t be left out. With an adjusted beat of 1.24, we decided to go on and take a leap of risk. Calculations also showed it give4 the highest utility. Hence, since all our criteria were verily fulfilled, it was included in our portfolio and given one of the highest weights.

Bangos – The stock Bangos was mainly chosen because of its very low Beta value. Although very insignificant, we included Bangos as a tool of risk aversion in our portfolio. Since this was the only stock for such a purpose in our portfolio, it was given the highest weight. It was also highly correlated witht the market and this was also another factor for choosing it.

Beximco – Our decision to hold back Beximco limited in phase 2, were much the same for which it was chosen in phase 1. Since its owner was one of the most influential man of DSE, we knew that it would give us positive returns, despite the fact that we calculaterd its expected returns to be negative, with even negative utility. Its standard deviation however was the lowest amongst all and this made us believe that its price would surely shoot back.

Sonali Aansh – Sonali aansh was selected despite having a medium expected return and moderate standard deviation, it was mainly bought for the sake of diversification and so it was given one of the highest weights.

Imam Button – Imambutton had the second highest expected return in our portfolio, and moderately low standard deviation as compared to the return. Having quite a high beta and a high utility value, it seemed like the perfect stock for us and so it was eventually selected. However, it was not given much weight, as it was indeed quite risky.

Sino Bangla – Sinobangla had quite a high expected return with a moderate standard deviation. Its utility was also very high and this gave us the perfect signal to incorporate it to our portfolio.

3rd Phase (24-03-2011:06-04-2011)

For the third phase, we used three new ratios along with all the knowledge of phase 2. Therefore for phase 3, the factors that we took into account were Correlation, Expected Return, Treynor Ratio, Jensen’s Alpha, Standard Deviation, Beta. Since each stock in the portfolio is part of many stocks that make up the portfolio, Treynor ratio gives us the best measure. The Treynor ratio measures the excess return of risk premium received compared to the amount of systematic risk taken. The Sharpe ratio was not taken into consideration as it works the best when the selected stock is

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the only risky assert in the portfolio. However in our case, all the stock were risky, and hence the Sharpe ratio was discarded. Following the success of phase 2, most of the stocks with our required level of treynor and alpha were heldback for pohase 3. However in the over heated DSE, finding an undervalued stock was harder than finding a needle in a haystack, so at the end we had to choose stocks which were the least overvalued or the slightest undertvalued.

Bangas – Bangas showed quite an impressive performance in phase 2. As it was included with the idea of risk minimization, it was included in phase 3 for the same reasons, even though its alpha and Treynor were not so promising.

Provati Insurance – Provati Insurance was one of our best performers in phase 2. In phase 3 calculations, it was seen that its treynor ratio was almost 5 times higher than the market and the Jensens Alpha was positive and large. This meant that it was very much undervalued and so there was a huge scope for some gains. Therefore provatins was held back in phase 3.

Fuwang Ceramics – Holding back Fuwang Ceramics for phase 3 was mainly because of its high performance in the phase 2. Despite the fact that its alpha and Treynor were not good enough to make it through our filter, we considered macroeconomic factors. Fuwangceramic is one of the largest ceramic gactories of Bangladesh, and its potential is infinite. Therefore it was included in the phase 3.

Titasgas Transmission and Distribution Company - Although Titasgas had a slight negative alpha, in the the current markets perspective, it was undervalued. Its Treynor may not also have been big, but the company had good fundamentals and that is why we decided to buy titasgas back to our portfolio as in pohase 1.

Saiham Textiles – Despite having the highest expected returns and quite a good treynor ratio, the alpha value for Saihamtex was positive. Which meant that it was still undervalued and there was opportunity to hold it back and earn more gains. It was therefore held back for phase 3 from phase 2.

Apex Adelchi Footwear – Among all the firms, Apex had one of the lowest negative alpha. This meant that it was slightly overvalued. However, since our entire market was overvalued, it made sense to buy a stock which was slightly overvalued.

Sonali Aansh – After the high performance of Sonali Aansh in phase 2, it was seen that it had a positive alpha value and a pretty good Treynor ratio as well. Considering the fact that Jute was now being highly backed by the government, we decided to hold it back in our portfolio for phase 3.

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Imam Button Industries – After showing tremendous performance in phase 2, imam button showed to have a high positive alpha value and quite a high value for the Treynor Ratio. This made imambutton an easy pick for the phase 3 , and to hold it back.

Sino Bangla – Sino bangle also showed impressive gains in the phase 2. This coupled with the positive alpha value and a good Treynor made us stick to sinobangla for the thirdphase as well.

Monno Ceramics – Monno Ceramics was a new inclusion in phase three. This was mainly because of its high alpha value and a above average Treynor value. It was also seen to be quite volatile, and since we were risk takers, we decided to include it in our portfolio.

Diversification

Our main aim in the selection of stocks in the portfolio was to diversify as much as possible. We tried to diversify based on activity, industry, correlation with the market, economic rationale, and systematic and non-systematic risk. Diversifying meant that our portfolio would be less prone to shocks in the market.

1st Phase (05-02-2011:05-03-2011)

Diversification in phase 1 was done mainly by choosing firms from different industries. This is why we chose the best one or two firm from each industry. The P/E ratio or EPS may have been higher in one firm than the other, but in order to diversify, we selected stocks of different industries even if their figures were not prominent enough.

For phase 1, we selected 10 stocks from a 7 industries. The main idea was to avoid the market shocks after the huge crash. Diversifying would make us less prone to volatile changes in the market and it would reduce our non-systematic risks. However, it was seen that for phase 1, almost all of the risk was systematic, as all the stocks plummeted along with the market. We then saw that no matter how perfectly diversified it was, the decline could never have been avoided, as the whole market went down by more than a thousand points. This also meant that there were almost

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no stock in the DSE which were negatively correlated with each other. However, we tried to diversify even among industries, such as we did not choose many firms from one industry even if they had a good prospect.

2nd Phase (03-03-2011:25-03-2011)

For diversification in the second phase, the main job was done with correlation. We primarily chose stocks which were very less correlated with the market and also stocks which were very little or negatively correlated among each other. The only negatively correlated stock we found with the market was fuwang ceramics. The correlation of the rest of the stocks ranged from 0.20-0.60, with the exception of Provati Insurance and Beximco ltd, which were highly correlated with the market. The range that we chose was very hard to find as all the stocks were in very close relation with that of the index, and hence finding stocks which were less correlated was very tough.

3rd Phase (24-03-2011:06-04-2011)

Diversification in phase 3 was done using the correlation and also a new factor, systematic and non-systematic risk was taken into consideration. However, in the 3rd phase, many stocks were held back from the 2nd phase, so diversification among those stocks were not so necessary. For selecting new stocks, it was almost of no use to take non-systematic risk into consideration as the non-systematic risk of almost all the firms were 0.99. This meant that again we had to stick to the correlation table. The correlation of the three new stocks that were added may not have had the lowest correlation but when compared with other stocks in the portfolio, it was a hot pick. Especially the selection of Apexadelchi from the Tannery sector was done mainly for diversification. Monnoceramic was also very less correlated with the other stocks in the market and hence it made an easy stand in our portfolio. However, its non-systematic risk was 1, but then again since all the stocks had a quite similar non-systematic risk and so this was not taken into account.

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Portfolio evaluation

Comparing the outcome or the performance of the three portfolios that we have formed with the market (DGEN) will help us to evaluate how well our decisions were.

Our first portfolio which was formed on the 5th February 2011 had an annual expected return of -1.01% and an annual standard deviation of 57.37%. Compared this to the market expected return of 49.22% and a standard deviation of 40.75%, clearly shows that our selection of stocks was not good. For our first portfolio we use the basic selection tool like P/E and EPS ratios to make our decision, turned out to be not so effective in outperforming the market. Our holding period return at 5th March 2011 was -23.51%, which was not so good. We also need to keep in mind that the stock exchange market at that time frame was going through a massive downturn; at the date when the portfolio was formed the DSE General Index had 7125.33 points which drastically fell to 5428.40 points by 5th March 2011 (Details in Appendix). This might be a reason for this below average outcome.

Our second portfolio which was formed on the 5th March 2011 had an annual expected return of 199.43% and an annual standard deviation of 86.26%. Compared this to the market expected return of 49.22% and a standard deviation of 40.75%, showed an excellent return from the portfolio. The portfolio’s standard deviation is bit high as compared to the market thus making the portfolio more risky to hold. For our second portfolio we did a detailed analysis of the market before selecting a stock. Our holding period return at 25th March 2011 was 14.50%, which is really impressive as compared to the first portfolio. On 5th march 2011 the DSE General Index had 5428.40 points which rose to 6340.91 points by 25th March 2011 (Details in Appendix); this might had been one of causes for this rise in return.

Our third portfolio which was formed on the 26th March 2011 had an annual expected return of 1348.14% and an annual standard deviation of 82.95%. Compared this to the market expected return of 49.22% and a standard deviation of 40.75%, showed a mind blowing expected return of 1348.14%, which is really impressive. As compared to the market the standard deviation of the portfolio was high; even though it has decreased form that of the second portfolio. At this stage we not only relied on the calculation but also closely observed the market to take the best out of it. Our holding period return at 6th April 2011 was 14.43%, which was a bit low as compared to the second portfolio. On 26th march 2011 the DSE General Index had 6164.82 points which rose to 6455.81 points by 6th April 2011 (Details in Appendix); this rise in DSE General Index may also have added to this holding period return of 14.43%.

Portfolios Beta Required Rate of Return (CAPM)

Utility

Portfolio 1 0.767 3.76% -0.339Portfolio 2 0.784 3.79% 1.250Portfolio 3 0.690 3.61% 1.745

Table: Portfolio Beta, Required Rate of Return and Utility

Comparing the Beta of the three portfolio, portfolio 2 (0.784) has the largest beta, next comes portfolio 1 (0.767) with a slightly lower beta than portfolio 2, but the lowest of all is portfolio 3 with

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a beta of 0.690. This shows that portfolio 1 and 2 are more volatile to changes in market than portfolio 3. The required of the three portfolio are almost similar, this because all three portfolio have similar bets. The required rate of return shows us the minimum return we expect from each portfolio. Except portfolio 1 the rest two has given us a return greater than the required rate of return. The greatest utility that we had was from portfolio 3 (1.745) next was portfolio 2 (1.250) and the lowest of all was portfolio 1 with a negative utility of 0.339.

Portfolios Sharpe Ratio Treynor Ratio Jenson’s Alpha Appraisal ratioPortfolio 1 -0.06 -0.04 -0.05 -0.24Portfolio 2 2.29 2.51 1.96 5.68Portfolio 3 2.91 3.49 2.40 7.08

Table: Sharpe, Treynor, Jenson’s Alpha, and Appraisal ratios for portfolios

For evaluating the performance of the three portfolios we used the following measures: 1) Sharpe Ratio 2) Treynor Ratio 3) Jenson’s Alpha 4) Appraisal ratio. From the table above we can see that portfolio 3 (2.91) has the largest Sharpe ratio, that is it has the largest risk premium per unit of risk, next is portfolio 2 (2.29) and lowest of all is portfolio 1 (-0.06). Portfolio 3 (3.49) also the largest Treynor ratio, that is it has the largest rick premium for each unit of systematic risk, next comes portfolio 2 (2.51) and finally the lowest is portfolio 1 (-0.04). Comparing the three portfolio Jensen’s alpha shows us that portfolio 3 (2.40) has the largest excess return over market return calculated by CAPM, next is portfolio 2 (1.96) and finally the lowest is portfolio 1 (-0.05). In context to the appraisal ratio: portfolio 3 (7.08) has the largest Alpha foe each unit of non-systematic risk, then comes portfolio 2 (5.68) and finally portfolio 1 (-0.24).

After comparing the three portfolios with the market and amongst each other we can clearly see and improvement as we proceeded further. Thus it clearly shows a gradual increase in our decisions making about choosing the right stock for the portfolio.

Lessons Learned:

Our purpose in this project was to generate a comprehensive idea about the workings and investment climate of the DSE and to achieve a better understanding of how to effectively invest in the DSE. Finishing the project, we were able to better understand the trading of stocks in stock market and to evaluate the stocks of different companies from different industries. We were able to apply our theoretical knowledge about investment and efficiency and even risk minimization into the real world and see our analysis bear fruit. The risk return tradeoff was more than established during the simulation but we also learned about risk minimization through diversification and It's advantages. The project taught us that by applying proper statistical and financial tools such as ratios (Sharpe, Treynor, Jensens alpha), beta with regression analysis, correlation and standard deviation analysis we the future behavior of the market in terms of stock prices can be anticipated. However we also realized that using data from a six month period was not sufficient in making accurate predictions about the market. By the end of the simulation we also realized that external factors and rumors play a major role in fluctuating the prices in DSE. As a result of this exercise we feel confident about investment and portfolio management in future.

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