Question

Question 1. Suppose you are an investment consultant. You have produced below analysis of the key financial ratios of 5 companies.

	Zoom Video Communications, Inc. (ZM)	Merck & Co., Inc. (MRK)	Starbucks Corporation (SBUX)	Caterpillar Inc. (CAT)	Alibaba Group Holding Limited
Standard deviation	19.56	4.71	6.10	7.55	9.15
Variance	361.48	21.76	36.58	56.02	82.22
Skewness	0.21	-0.63	-0.01	-0.55	-0.12
Kurtosis	-1.26	0.65	0.91	0.13	-0.13
Jensen's Alpha	15.18	0.67	0.23	0.98	1.38
Beta	-1.4	0.4	0.8	1.0	1.3
R-squared	0.19	0.13	0.28	0.34	0.36

You are required:

Please advise your client which of these companies he/she needs to invest as the first choice choice. Which company he/she must not invest. Clearly explain your client the reasoning behind your advice. You must make use of analysis results presented in the above table to justify your andive. ( 25 marks)

Question 2.

You are a financial consultant. Your curious client, who started to learn finance, has asked you to explain why Zoom Video has a negative beta in the above table. Explain using fundamental factors that determine company beta.

Question 3. What does Jensen’s alpha tell you. If you were to select a company just based on Jensen’s alphs which company would you invest and which company would you avoid?

Question 4. Your friend has suggested you to invest $150,000 US Dollars into one of the below projects with future cash you can earn listed in the below table. Suppose that the discount rate 15% per year. Which investment project you will invest if you must select only one project (hint: use Net Present Value estimation method)

Year	Costmetics shop	Hair Salon	Gym
1	35,000	90,000	10,000
2	35,000	70,000	10,000
3	35,000	20,000	10,000
4	35,000		10,000
5	35,000		10,000
6	35,000		180,000
total cash	210,000	180,000	230,000

Answer 1

Answer 1 - Client should invest in Merck & co. as the company has lowest standard deviation (risk) and beta with sufficient amount of jensen's alpha and kurtosis. This shows that company is less risky and will be able to outperform the return on the market. While client shouldn't invest in Zoom Video Communication because oh high standard deviation and negative beta which suggests that company will move in the opposite direction of the stock market which is not a good thing while considering an investment option.

Answer 2 - The company beta's depends upon the standard deviation of company's stock, standard deviation of market and correlation between them. Since, standard deviation of company's stock and market can not be negative. so the reason of negative beta is the negative correlation between them. The negative beta suggests that company will move in the opposite direction of the stock market. If stock market rises, company's stock will go down and vice versa.

Answer 3 - Jensen's alpha tells us whether company will be able to get enough return considering the beta. If the value is positive, then the portfolio is earning excess returns and vice versa.
If we consider only Jensen's alpha in the given information, then we will select Zoom Video Communications because of the highest Jensen's alpha value. It shows that company will earn excess return as compared to the market return.

Answer 4 -

Year	Costmetics shop	Hair Salon	Gym
1	35,000	90,000	10,000
2	35,000	70,000	10,000
3	35,000	20,000	10,000
4	35,000		10,000
5	35,000		10,000
6	35,000		180,000
total cash	210,000	180,000	230,000
Rate	15%
Net Present Value	$132,456.89	$144,341.25	$111,340.52
Cash Invested	-150,000	-150,000	-150,000
Net loss	($17,543.11)	($5,658.75)	($38,659.48)

The loss is minimum in Hair Salon business ($5.658.75). Thus, friend should invest in Hair Salon business only.

Note - NPV = Cash1/(1+Rate) + Cash2/(1+Rate)^2 + ........+ CashN/(1+Rate)^N - Initial Cash Invested