Answer To: End assessment Submission guidance You must ensure that you have: This is a single assessment,...
Shakeel answered on Feb 26 2021
The pharmaceutical industry is one of the leading industries of UK that contributed around £34 billion to the UK economy as on June 2015. Around 73,000 people are employed in this Industry in around 545 companies. World’s top 20 firms have presence in the UK itself. Pharma Industry spent a significant amount of £3.9 billion on research and development as on 2007. In 2017, the total revenue generated by the Industry is £42 billion that has growth rate of 5% over previous year’s revenue and expected to grow with the same pace. Glaxo Smithkline, Pfizer, Novartis, AstraZeneca, Hoffmann-La Rocha are some of the leading pharmaceutical companies in the Industry.
Glaxo Smithkline (GSK) is UK based multinational pharmaceutical company that was established in 2005 and as on 2015; it is world’s seventh largest pharma company. Its shares are listed on London Stock Exchange and also a constituent of FTSE 100. With the market capitalization of $81 billion, it is fourth largest company on stock exchange. Some of the key financial statistics of GSK is on Dec 2019 are as follows –
Return on Assets
Return on Equity
Beta of stock
Long term debt and Common equity are two major source of financing of GSK. As on Dec 2012, the long term debt to equity ratio is 4.36 that are quite high. Pfizer, Merck and Amgen are the major competitors and their sources of finances are also long term debt and equity. However, the Debt to equity ratio of Pfize, Merck and Amgen as on Dec 2019 are 0.52, 0.74 and 2.79 respectively. Therefore, in comparison to competitors the Debt equity ratio of GSK is highest and thus, high risk of solvency.
The mean monthly return on GSK and FTSE 100 are 0.6613% 0.6657% respectively. The Standard deviation of monthly returns on GSK and FTSE 100 are 0.0468 and 0.0365 respectively. Therefore, the monthly return on market is higher than GSK while the average risk on market is lower than GSK.
Sharpe ratio is defined as the excess return on the portfolio or stock over the total risk. It is a performance measure over some benchmark. Thus, Sharpe ratio is mathematically defined as
Sharpe ratio = (Rp – Rf) / σ
Where, Rp is the average return on portfolio
Rf is the risk free rate of return and
σ is the total risk of portfolio.
The Sharpe ratio of GSK and FTSE 100 over the time are given in the following graph –
The graph shows that Sharpe ratio of FTSE 100 fluctuates more than GSK. In most of the time, the FTSE 100 performs better than GSK.
The correlation coefficient provides very important information regarding the degree of mutual association of any two stocks. It shows how the return on one stock is varied with the return on other stock. If Correlation coefficient is 1 or -1, both the stocks are perfectly correlated and if it is zero, both the stocks are completely uncorrelated. Therefore, the correlation coefficient lies between -1 and 1.
The correlation coefficient between GSK and FTSE 100 is -0.15. The figure is negative and low. It shows that for 1% increase in the return on FTSE 100, the return on GSK falls by 0.15% and vice versa. Thus, GSK can better be used to diversify the portfolio’s risk if such portfolio is constructed including both FTSE 100 and GSK. In the time of recession when the market may give negative return, GSK may prove to be a better investment avenue that will give positive yield to investors. Thus, GSK stock may acts as a cushion in adverse situation.
Portfolio is basket of different securities that provides an average return over moderate risk. Since it is a basket of securities of different asset class, the loss if occur on single or few assets, it is compensated by gain one other assets. Therefore, risk of huge loss is generally not occurred selection and an average return with moderate risk is generated. However, it is also very crucial to form an efficient portfolio where the one can gain the maximum return over minimum risk.
The risk and return on the portfolio is defined as -
Return on the portfolio = W1R1 +W2R2
Risk of the portfolio = Sqrt[(W1*σ1)2 + (W2*σ2)2 + 2*W1*W2*ρ* σ1* σ2]
Where, W1 and W2 are weight of the securities 1 and 2 in the portfolio
R1 and R2 are the returns on the securities R1 and R2 respectively
σ1 and σ2 are the risk of securities 1 and 2 respectively.
ρ is the correlation coefficient between returns on securities 1 and 2.
Now, For Client A
Client A wants a portfolio of the stock and the market such that for every pound invested in the stock, there is a pound invested in the market.
Therefore, the proportion of stock and market in the portfolio is1:1. It means portfolio is equally weighted. So weight of stock and market in portfolio would be 0.50 and 0.50.
Therefore the average monthly return on portfolio = 0.5*0.006613 + 0.5*0.006557
= 0.006585 i.e. 0.6585%
The risk of the portfolio = Sqrt [(0.5*0.0468)2 + (0.5*0.0365)2 + 2*0.5*0.5* (-0.15)*0.0468*0.0365]
= Sqrt [0.000547 + 0.000333 – 0.000128]
= Sqrt [0.000752] = 0.0274
Therefore, the risk and return on the portfolio would be 0.0274 and 0.6585% respectively.
For client B
Client B wants a portfolio where for every pound invested in the stock, there is 25 pence invested in the market. Therefore, the proportion of stock and market in the portfolio is4:1. It means the weight of stock and market in portfolio would be 0.80 and 0.20.
Therefore the average monthly return on portfolio = 0.8*0.006613 + 0.2*0.006557
= 0.006602 i.e. 0.6602%
The risk of the portfolio = Sqrt [(0.8*0.0468)2 + (0.2*0.0365)2 + 2*0.8*0.2* (-0.15)*0.0468*0.0365]
= Sqrt [0.001402 + 0.000053 – 0.000082]
= Sqrt [0.001373] = 0.0370
Therefore, the risk and return on the portfolio would be 0.0370 and 0.6602% respectively.
Portfolio for client A is more preferred than portfolio of client B. It is due to the reason...