Trading Case CA2

 

 

Case Objective

To understand the implications of CAPM for portfolio management

 

Key Concepts

Capital market line; market portfolio; betaís; diversification; efficient frontier.

 

Case Description

The case has 3 companies: Company 1, 2 and 3. (GE.N).†† You will start with an initial position in the three companies. You can trade (i.e., buy or sell) the stocks of these companies for one trading period.At the end of the trading period, you earn interest on cash at 12%.After interest is settled, one of 10 path of the economy is realized.Each path determines a value for each company, and your portfolio is market to market at these values.†† The set of paths and associated values is shown in the table below, where each possible path is equally likely.You are not allowed to borrow cash but can short sell stocks.If you shortsell a stock and donít cover your position, then you will have to pay the realized value at the end of the period.

 

Prices in this case are fixed, so you cannot bid or ask.†† The prices are:

 

Company

Price

Co. 1

28

Co. 2

26

Co. 3

25

 

 

Case Data

The possible paths for the economy, and the corresponding end-of-period realized values for the three companies are shown here.†† The average value is also shown.

 

Path

1

2

3

4

5

6

7

8

9

10

Average

Co. 1

5

5

5

24

25

30

32

68

75

75

34.4

Co. 2

4

5

10

21

66

65

65

20

20

20

29.6

Co. 3

55

55

49

22

22

20

10

10

10

10

26.3

 

Trading Objective

Your aim is to make as much money as you can which depends upon how well you trade relative to the prices discovered by the market.†† Each trial you earn grade cash that is cumulated across trials.Grade case in any trial equals 0.0001 x your closing balance of market cash.That is, 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.