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Course Project Fi 567

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Course Project FI 567 | 12/12/2010 |

Keller Graduate School of Management
Professor
Alan Meyers

Executive Summary
The course project was a hypothetical project involving the investment of approximately $1.5 million dollars split into the following four categories 10 stocks picked from the Dow Jones Industrial Average, A section on hedging options to protect against a significant price drop, Several bonds ranging in maturity of 2 to 5 years, and a risk free investment in a money market account. The anticipated outlook of the market was for the next 18 to 24 months was bullish but there were concerns about possible price drops.
The investment in the 10 equities positions were chosen based on their current dividend yield and price to earnings ratio. The stocks are listed on sheet two of the attached spread sheet. The bonds are U.S. treasuries with maturity dates for the next 2 to 5 years. The investment in the money market account is a risk free investment at Nationwide bank of Columbus, Ohio.
The average Rate of return for the equities position is approximately 4% annually. The same rate of return is expected after the cost of the hedging positions is taken into account for the entire 2 year anticipated holding period. The bonds range in return from 0.68% to 2.07%. The risk free money market account at nationwide has an annual rate of return of 1.14%.
The anticipated return for the entire portfolio is estimated to be about $33,937.20 or about 2% per year overall.

Hedging Strategy
For this project I looked at several different hedging strategies. The first strategy was an overall one covering all of the stocks in our portfolio plus the other 20 in the Dow Jones Industrial average. This was accomplished by a straddle for 15 contracts on an Exchange Traded Fund by the symbol of DIA which is a fund that mimics the Dow Industrials. For this strategy we buy 15 contracts of DIA Jan13 115 calls. This is a call option for January 2013 for a strike price of $115 per share, each contract is for 100 shares. For a call the person who sells the call they have the obligation to sell the listed stock to the us for the agreed upon strike price, which in this case is $115 per share times the 100 shares for each contract. The other side of the straddle we Bought 15 contracts of DIA Jan13 115 puts in this case we have the option to sell 100 shares of the listed stock at the agreed upon strike price which is also $115. With this strategy we are looking for the market to either remain stable or if there is a significant increase or decrease we will be able to profit from it. For this to be profitable the break even points are as follows. For the calls we need the price of DIA to rise above $115 per share in order to recover the $15,225 premium we received, any rise above $125.15 per share leads to a profit. For the puts we need the price of DIA to fall to less than $99.10 per share. If the market remains neutral we will have spent a total of $39,075 for the insurance. We also bought some puts on AT&T and Pfizer to protect our initial cost and guarantee a slight profit from each share if the price falls. There was the sale of some calls on General Electric and Intel to generate some income now to help offset the costs of the insurance. As long as the price of GE and intel remain stable we will keep the premium paid. We will start to lose money on them if the prices rise above the following point purchase price plus the premium received for the call. We could also lose money of the stock price drops to zero. (Kolb & Overdahl, 2007)
For an explination of all calculations and stock purchases please see sheet 2 and 3 of the attached spreadsheet.

Conclusion
Based on the projected returns we are looking to make an overall return of invest of 2% per year. Since we are bullish on all of our stock positions for the 2 year mark this is not a bad investment to be in. The combinations of the risk free money market return of 1.14% (Bankrate.com)and the returns on the bonds will help offset and expenses we incurred to purchase the options strategies we employed to cover our equities positions. The anticipated dividend returns will also help offset any potential losses from the insurance hedges we employed.
All bond and stock prices are based on the closing of the markets on Friday December 10, 2010. (Bloomberg) (Sharebuilder.com)

Works Cited
Bankrate.com. (n.d.). Retrieved December 12, 2010, from http://www.bankrate.com/funnel/savings/savings-results.aspx?local=false&prods=37
Bloomberg. (n.d.). Retrieved December 12, 2010, from http://www.bloomberg.com/markets/rates-bonds/government-bonds/us/
Kolb, R. W., & Overdahl, J. A. (2007). Futures, Options, And Swaps. Malden, MA: Blackwell Publishing.
Sharebuilder.com. (n.d.). Retrieved December 12, 2010, from www.sharbuilder.com

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