Trading Case
CA0
Case
Objectives
CA0
is a stock trading exercise designed to introduce you to the problem of managing
the risk and return of your position.
Key
Concepts
Markowitz
diversification, efficient frontier; managing portfolio risk and return.
Case
Description
The environment
is based on the actual performance of 6 major US stocks between 1990 and 2001.
The companies are: American Express (AXP.N), DuPont (DD.N), Disney (DIS.N),
Dow Chemical (DOW.N), United Technologies (UTX.N), and General Electric (GE.N).
Closing monthly prices are provided over the period 1990 to 2001 adjusted for
stock splits and dividends. You can examine this file by first launching
the FTS Portfolio Returns Module from the Virtual Classroom home page. In
step 1 below you can download the spreadsheet containing the supporting price
history for trading case ca0. The latest closing prices on this file are:

AXP.N 
DD.N 
DIS.N 
DOW.N 
UTX.N 
GE.N 
Closing
Price 
32.91 
44.34 
20.47 
37.50 
60.20 
38.50 
Linking ca0.xls to the FTS Portfolio Management Module
Step 1: Click on the hypertext cao.xls to download the Excel spreadsheet. Launch the module FTS Portfolio Returns and Efficient Portfolios. Click on the button Find Excel Worksheets and select ca0.xls(Sheet1). Next enter 1 for Names are in Row, 2 for First Row with Data, 144 for Last Row with Data, B for First Column with Data and G for Last Column with Data. Keep both Interest Rates and Index Data unchecked and click on the button Initialize. Double click above the name AXP so that all stocks are selected (indicated by a Yes above their name) and finally click OK.
Observe that Step 1 has resulted in getting the price data into the portfolio module.
Step 2: Click on Data Analysis. This will let you compute risk and return statistics for the individual securities.
Step 3: Click on Portfolios this will let you form portfolios and consider the problem of managing return by diversifying risk. You can now verify the following risk and return estimates estimated from the historical price series is as follows. The average return realized from the historical price series is:
Name  AXP  DD  DIS  DOW  UTX  GE 
Average Return  0.01485  0.01113  0.00984  0.01018  0.01643  0.01636 
The covariance of realized returns
is:
AXP  0.00678  0.00226  0.00259  0.00258  0.00305  0.00262 
DD  0.00226  0.00509  0.00141  0.00327  0.00262  0.00191 
DIS  0.00259  0.00141  0.00654  0.00133  0.00304  0.00215 
DOW  0.00258  0.00327  0.00133  0.00592  0.00273  0.00131 
UTX  0.00305  0.00262  0.00304  0.00273  0.00626  0.00289 
GE  0.00262  0.00191  0.00215  0.00131  0.00289  0.00416 
In CA0 the realized end
of period price for the stocks will be drawn from the actual risk/return distribution. Your position at the end of the period will be marked
at the realized value, and this will determine your actual portfolio return, and
therefore your performance.
Using the Sheet Labeled CA0Worksheet
(Learning to work from portfolio weights to trading shares)
In the Portfolios subject of the FTS Portfolio Returns module, check Allow Short Sales and leave Risk Free Rate unchecked. Then click on the Plot Frontier button and the Plot Securities button (in that order). This will display the minimum variance frontier with short sales allowed. Now you can click anywhere on the minimum variance frontier to identify the portfolio weights associated the particular, target return/risk portfolio that you have selected. Alternatively, you can enter a target return directly in the text box beside Target.
Beside Weight you will see the portfolio weights for each security associated with the portfolio you constructed.
When you have identified a portfolio with the risk and return properties that you feel comfortable with then click on the Edit menu item and select Copy Weights. This copies the weights to the windows clipboard.
Give focus to Excel and select the second sheet titled CA0Worksheet. Click on cell c8 and then edit paste (or Ctrl V). This pastes the weights into Excel.
Hit
the F9 key to manually update if you do not have auto recalc turned on in Excel.
The
shares to be purchased or sold are now automatically computed for you.
Note it is up to each trader to determine what risk and return combination they are prepared to tolerate when trading in CA0. This is a personal decision.
Trading in CA0
In this economy,
you can trade the six stocks for one period, which corresponds to one month of
calendar time. There is also a
money market, but the interest rate is 100% and borrowing is not allowed. This means that if you have any money left over, you will
lose it at the end of the period (so you should try and be fully invested in the
stocks by the end of the period). Short
selling of stocks is allowed. All
trading is done at the closing prices of the stocks shown above.
At the end of the trading period, a new value for each of the stock will be realized, based on the historical distribution of the stock prices.
There
are two types of traders with the following initial endowment cash and shares:
Trader Data  Cash  AXP  DD  DIS  DOW  UTX  GE 
Type 1  100000  21000  25000  23000  38000  20000  31000 
Type 2  331490  11000  19000  80000  85000  20000  112000 
There
are (approximately) an equal number of type 1 and type 2 traders.
Over different market sessions your trader type can change.
Trading
Objective
The object is to
earn as much grade cash as possible by managing the risk and return of your
position.
The market is
open for one trading period. In
calendar time this is the beginning of a month.
At the end of the month your position is marked to the market value
associated with whatever value is realized for each stock.
The trading and the marking of your position is referred to as one trial.
Trading will continue over multiple independent trials where you start
with a fresh initial position at the beginning of each trial.
Your
grade cash in any trial is 0.0001 x market cash.
If you end up with negative wealth then you lose grade cash and if you
make money then you gain grade cash.
Trading
is conducted over a number of independent trials and a record of your cumulative
grade cash is maintained.
Trading
Support
Your trading support system is the FTS Portfolio Analysis Module combined with the ca0.xls worksheet. If you have not completed step 1 above then you should do so. This binds the module to the ca0 spreadsheet.
Objectives: You need to translate a point on the minimum variance frontier into a position that you trade towards in the FTS markets.
Step 1: Click on the Portfolios button and plot securities and plot frontier with short sales permitted. You will observe the yellow minimum variance frontier computed from the historical price data. The upper part of the minimum variance frontier is referred to as the efficient frontier. Click on this and you can observe that the portfolio weights corresponding to this point are automatically computed. Beside Target in the upper part of the screen you will see a number which is the average monthly return associated with this portfolio given the price history. Similarly, just below Risk Free Share you will see Volatility: and some number. This is the risk associated with the portfolio you have selected. Finally, from the Menu items select Edit, Copy weights.
Step 2: Give the focus to the CA0 spreadsheet and select the sheet labeled CA0Worksheet. You can paste the weights directly into Cell C8. After doing so you will see the target number of shares associated with the portfolio that you selected on the efficient part of the frontier. If this is your desired position then you can adjust your position to approximate this portfolio by trading in the FTS Markets. First, however, you may want to check the risk and return properties of your initial position.
Step 3: What does
my initial position look like in terms of risk and return? In the
CA0Worksheet you have the portfolio weights provided for both Type I and Type II
traders. Mark and copy the weights associated with your type. Give
the focus back to the Portfolio Module and click on the button Data
Analysis. From the drop down select Depicted Weights and then paste in the
weights using Edit Paste Weights. Finally, click on Plot Return
Histogram. This will display the risk and return properties associated
with your initial position.
Finally, for the purpose of the trading exercise it is your risk and return preferences that determine what portfolio you want to select.
© OS Financial Trading System 2001