Risk ManagementBAFI3192

Semester 3, 2015

An Luong-s
Huong Giang-s
Duy Tran-s
Lelio Adriano-s3479961

Contents
Semester 3, 2015.................................................................................................... 0
I. Introduction:......................................................................................................... 1
I.

Trading strategy:............................................................................................... 1

1.

Market assessment:.......................................................................................... 1

a.

Selection Process:............................................................................................. 1

b.

Portfolio establishment:.................................................................................... 1

2.

Trading Process................................................................................................. 3

II.

Risk Control Plans............................................................................................. 4

III.

Reflection:...................................................................................................... 7

Investopedia,2015/ http://www.investopedia.com/terms/f/futuresexchange.asp
APPENDIX:............................................................................................................... 8

I. Introduction:
The Global Crisis, which gravely affected many of the worlds economies, including
the United States of America, has been the central topic of the past decade. Due to
this crisis the US stock market has faced challenges such as fluctuating prices and
investors and industries have to bear its risks whilst attaining positive returns in
order to generate profit. It is thus vital for individuals to understand how this crisis
influences their lives as economically influenced entities. As such, the following
report analyzes this premise from a simulated standpoint. This brought us to this
trading game where we had a chance to experience the portfolio and risk
management processes that trading activities entail. In this particular assignment,
we will describe the way we bought and sold stocks and what we gained or lost from
such trades in four stages. In the first stage, we shall describe the initial trading
strategy, comprised of the market assessment and the portfolio establishment.
Secondly, we shall outline the trading process and its outcomes. Thirdly, we shall
explain the risk control plan and, finally, in the fourth stage, we shall propound our
reflections.

I.

Trading strategy:

1. Market assessment:
The investment process was carried out in a simulated platform of the worlds two
largest stock exchanges, namely the National Association of Securities Dealers Automated
Quotation System (NASDAQ) and the New York Stock Exchange (NYSE). Corporations are able to
rapidly raise funds by issuing shares as there are frequent large volumes of activities and various traders
in the markets. As long as companies gain returns, there are opportunities for investors to generate private
wealth by participating in the investment process. Nevertheless, stock exchanges with such massive
trading scales are highly correlated with not only the US but also the worlds financial and economic
matters. Therefore, it can be exceptionally challenging to predict the fluctuations of stock prices.

a. Selection Process:
Technical Analysis is a portfolio evaluation and selection process whereby stocks are
screened with the help of graphical and numerical records pertaining to particular
stocks prices. Through extensive research we extrapolated price movements of the
stocks that would be most likely to generate profits and ultimately structured our
portfolio in the following way:

b. Portfolio establishment:
Please refer to image 1 and Image 2 below. As part of the composition of this
assignment we participated in a simulation of the New York Stock Exchange. The
aim of such an activity was to systematically trade stocks and to track the overall
process undergone between November and December. Initially, as seen in table 1
and image 1 below, we invested predominantly in stocks from Apple and Amazon
with 62.87% and 25.71% respectively. The 3 rd and 4th stocks, Facebook and Nike,
accounted for 6.69% and 2.32% respectively. At the close of the exchanging period,

HPQ was second to Amazon, which covered 37.45% of the stock whilst HPQ covered
27.43%. Google and itbit Inc. accounted for merely 9.72%.

Figure 1: Major Portfolio Weights at beginning of trading period from A.1 in the
Appendix.

Figure 2: Major Portfolio Weights at end of trading period from A.2 in the Appendix.

2. Trading Process
Please refer to A.3 in the Appendix. In the beginning, our group had
$25,000,000 to trade in the game (Risk Management on
MarketWatch.com). We traded from November 16 th to December 11th
using a 4-stage trading process:
a.
Firstly, we settled 126 transactions to buy and sell 16 different stocks to
-

certify our prediction about the markets profitability. These stocks were
divided into the following 3 types:
i) Blue Chip Stocks: Amazon, henceforth AMZN; Apple, AAPL and
Microsoft, MSFT. These belonged to the consistently best performing
stocks which were stable and least risky.
ii) Volatile Stocks: Facebook, henceforth FB; E I Du Pont and De Nemours
and Co, DD; Manitowoc Company Incorporated, MTW; Nike, NKE and
Twitter, TWTR. These were stocks whose prices frequently fluctuated and
so rendered them risky.
iii) Potentially Profitable Stocks: These stocks were those which we
believed would generate positive returns in the future but which we were
uncertain about.

However, we erroneously predicted the rise in the value of the

stocks of AMZN and GMCR, which generated a loss of $30,963.79
and $2820 respectively. Nevertheless, the other stocks rose as
expected, especially AAPL, with an absolute profit of $ 441,298.94,
making a total profit of $439,264.05 during this period. We
retained these stocks to review our technical analysis.
b.

Secondly, when we felt familiar with the market, we placed a

number of potentially profitable stocks on a watch list and
automatically placed an order to buy them at a low price and to sell
them at a high price. With this strategy we accumulated
$1,188,421.38, most profits being from AMZN, $699,255.43;
AAPL, $269,901.87 and TWTR, $101,050.00. Furthermore, we
predicted that AAPL would increase, so we held a large number of
its stocks and estimated increased profits. Counterintuitively, loss
ensued due to a sudden deduction of FB stocks, leading to a loss of
$126,451.04.

c. Thirdly, the portfolios value dropped because of abrupt price shifts. The
loss was predominantly due to a deduction in AAPLs price, which fell from
$ 118.7 to $ 114.64, causing a loss of $408,137.84. Moreover, we traded

HPQ (Bought or sold?) stocks, which were potentially profitable due to its
volatility. In the beginning of this stage, HPQ helped us make a profit of up
to $310,055.6 after about 30 transactions, so we decided to buy large
volume of HPQ stocks in late trading on the 1 st December expecting to
earn profits greater than the next day. However, on the 2 nd December,
HPQ s stock price suddenly cascaded from $ 12.75 down to $ 12.11 and
halted at $ 11.87. After that, we settled a large number of transactions of
HPQ to reduce loss; this allowed us to reduce losses from $ 1,068,072.06
to $ 401,269.3 at the end of this period. Similarly, the price of AAPL
suddenly dropped leading us to not expect future rises in this stock; hence
we sold out to avoid further losses. However, due to AMZNs $
127,186.75 profit, DDs growth of $ 101,120.00 and GOOGs
accumulation of $206,987.38, overall we lost approximately 1% of our
wealth compared with the initial capital $ 140,693.27.
d. Finally, we closely monitored the market to avoid losses; we believed that
this was seminal to the avoidance of risks faced in earlier stages. After
watching the market carefully we focused on AMZN, AAPL, DD, FIT, GOOG,
HPE, and HPQ. We closely monitored watch lists and bought a large
amount of stocks at a very low price and sold at very high prices. Our
profit in this period was mainly from transacting DD, $ 1,635,710.00;
HPQ, $ 941,803.11 and HPE, $ 181,450.00. However, contrary to our
expectations, the stock prices of AAPL, AMZN, and FIT declined further,
causing a loss. In summary, at this stage we overcame losses and earned
$2,024,455.46, while still holding a large amount of AMZN and HPQ.

Overall return and capital gains

II.

Risk Control Plans

In lieu of the risks that we were exposed to we employed the following strategy:
a. Diversification:
Diversification is a technique that helps investors reduce risks by allocating
investments into different financial instruments for the purpose of maximizing
returns.
The stocks were traded in different industries:
- AMZN: Technology and Online Shopping.
- AAPL: Electronic Devices.
- FB: Social Network Services.
- GOOG: Internet Technology and Production.
- HPQ: Information Technology.

- DD: Engineering and Science.

We believed that when the budget was divided between different sectors, if
one sector was devalued because of one event or news, the rest of the sector
would not be affected.
b. Trading Blue Chip Stocks:
Trading these stocks can control price fluctuations better by the continuous
growth of the stock. The large companies use very strict control measures to
ensure the wealth of their shareholders.
c. Short Selling to Cut Loss:
When stocks suddenly plummeted, short selling helped investors limit losses.
The amount of money recovered could be used to purchase other profitable
stocks.
For example, when the price of HPQ suddenly deducted from $12.75 to
$12.10 we decided to sell 90% of its stocks. This reduced greater losses when
prices fell to $11.87. We used the amount of money recovered to purchase
stocks in potentially profitable stocks such as DD and GOOG.
d. Setting Extremes for Purchase and Sale Prices:
We tracked the movements of the prices of a few stocks in the short term and
long term, to place an order to purchase at a desired high price, and placing
orders to sell when they reached a specific lower price.
Some typical transactions:
- DD: Buying 317,500 stocks at price of $66.70 and Selling at a price of
$71.85, earning a profit of $1,635,710.
- HPQ: Buying 660,000 stocks at a price of $12.15 and selling at a price of
$12.33, earning a profit of $52,760.
e. Futures Contracts:

A futures contract is a contractual agreement, created on a futures exchange, agreed

upon to buy or sell a particular commodity or financial instrument at a pre-determined
price in the future. Futures contracts detail the quality and quantity of the underlying
asset; they are standardized to facilitate trading on a futures exchange. Some futures
contracts may call for physical delivery of the asset, while others are settled in cash
(investopedia.com, 2015).
We used futures contracts to minimize portfolios risk to unfavorable
actions in the stock exchange game.
In order to hedge using futures, our group could enter the S&P 500 September
futures contracts at $671.19 on 1st Dec 2015 (investing.com). The size of the
contract is 617.19*10,000 = $6,117,190.00.
- We could see that the portfolio was in the long position, so we needed to
enter a short futures hedge.
- Our performance would have incurred a loss if the S&P 500 index had gone
down. But the loss would have been offset when we closed out our position.

 On December 4th 2015, Amazons share price was $671.53; our groups
expectation was that the price would continue rising due to the coming Christmas
sale. As a result, we chose to take long futures contracts to buy AMZN shares.
Futures Outcomes (illustrated in Figure 4 below):
1. We bought AMZN shares by entering futures contracts expecting price
increases to $706.68 for 3 months.
2. During this time, if the price had reached $800, we would close out the long
futures contract by selling an equal number of contracts with the same expiry
date, making a profit of $93.32 per contract.
3. If the price declined to $620, we closed out by buying an equal number of
contracts with the same expiry date, making a loss of $86.68 per contract.

f. Option contract:
Market prices are constantly changing and as such, sellers who predict price rises
or falls, can enter into an options contract. This is a legal entitlement or claim but not an
obligation that the buyer has over the seller of a security or other financial asset. It has a price
established in advance, called the strike price and can be exercised on or before a deadline, the
exercise date, depending on the contracts conditions. It is granted to the buyer by the seller. The
result is that both the buyer and the seller can transact at a price that is in their favours i.e. at a
lower price than that prevailing in the market, for the buyer, if the price rises, and at a higher
price than that prevailing in the market, for the seller, if the price falls. Option contracts are
profitable if investors correctly predict the direction the stocks price will move in on the
expiration date.
On December 1st 2015 our total costs were $1,828,787.8 when we purchased 144,340 HP shares at
$12.67 per share. Fearing that the shares price would decrease in the future, we decided to buy

72,170 put options with a strike price of $12.00 per share. The put premium was $0.8 for each option
and the expiration date was December 10 th 2015. Thus, the break-even point of this option contract
was $11.2. Hence, the following outcomes were possible:

If the current price is from $0 to $11.2, the option will be exercised to make a large profit of the
difference between the current and the break-even price.

If the current price is equal to the strike price ($11.2), the option may be exercised to gain the put
premium but not the profit earned.

If the current price is between $11.2 and $12, part of the premium could be recovered when the
option contract is exercised.

If the current price equals to $12, either exercising the option or not would not make a difference
because of a loss of prepaid premium.

If the current price is higher than $12, the option should not be exercised because we will have
made a loss of 0.8 per share.

Figure 5 below depicts the option contract of HP shares and all the circumstances that we may face when
it is exercised.
Profit
If $11.2> Current Price profit
is made

Break
Even

Strike Price:
Current Price in

If $12.00< Current Price Loss is

made.

If $11.2< Current
Price<$12.00 only premium is
gained
Premium: $0.80

Los

III.

Reflection:

Our assignment entails trading activities in a virtual stock market on

marketwatch.com. This is a very enticing and enriching activity because we have
been able to apply the theory learned in the classroom, as well as practical skills in
the process of buying and selling shares. We also believe that we have the highest

accumulated volume of transactions over the entire period amongst the participants
in the game. In the field of share trading, we realized that risk management is a
very important tool because when employed shrewdly it minimizes the risk of loss
and enhances return. Over this period, we had to use methods such as technical
analysis of the potential ordinary shares thus creating a feasible portfolio; skills in
handling the risks etc. In this game, the ranking reflects part of our ability, of
course, with a little luck, but also boosts our confidence. The last thing we learned
with this game was a snippet of what it means to create a simple transaction
process, but in reality we know that it is not like that. Moreover, we did not have any
real capital at play in the actual stock transaction so good risk management was our
teams linchpin.

APPENDIX:
TOTAL
STOCKS
PROFIT/LO
Table 1:
TOTAL COST
REVENUE
HOLDING
SS
$129,807,55 $130,248,85
$441,298.
AAPL
6.94
5.88
$0.00
94
$53,085,955. $53,054,991.
($30,963.
AMZN
64
85
$0.00
79)
$13,822,490. $13,835,140.
$12,650.0
FB
00
00
$0.00
0
$4,789,972.5 $4,793,511.4
NKE
0
0
$0.00
$3,538.90
A.1: Weights of Portfolio at Beginning of Trading Period derived

Table 2
AMZN
HPQ
GOOG
FIT

Weight
62.86505
7%
25.70922
4%
6.694153
%
2.319756
%
from A.4

A.2: Weights of Portfolio at End of Trading Period derived from A.7

TOTAL
STOCKS
PROFIT/LOS
TOTAL COST
REVENUE
HOLDING
S
Weight
$109,565,735 $83,090,911 $26,431,728.
($43,096. 37.44954
.57
.01
40
16)
%
$80,261,836. $81,203,639
$941,803. 27.43347
36
.47
$0.00
11
%
$37,696,288.
$7,500,000.
$30,201,578.
12.88458
80
00
80
$5,290.00
%
$28,423,440. $28,220,109
($203,331 9.71512
10
.03
$0.00
.07)
%

A.3: Portfolio Trading Process and outcomes.

A.4: Portfolio at beginning of trading

period.

A.5: Portfolio at 2nd quarter of trading

period.

A.6: Portfolio at 3rd quarter of trading

period.

A.7: Portfolio at end of trading

period.

References:

Investopedia,2015/ http://www.investopedia.com/terms/f/futuresexchange.asp