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Advanced Valuation of Securities and Bond Trading

Trading Simulation
Section 1.0
The Requirements
Hypothetically invest:
( 1 ) £2,000,000 in an equity portfolio with only assets you have investigated in CW1, and
( 2 ) £2,000,000 in a separate fixed income portfolio.
All prices should be quoted in Bloomberg, Financial Times, or are obtained from other reliable
sources, which you must identify.
You must carry the necessary analysis and valuation of fixed income securities with an extensive
use of performance measures prior to a subsequent trade simulation.
Cash balances can be invested to earn LIBOR – 1%. Any borrowing will be at LIBOR + 1%.
Interest should be calculated daily and included in valuations. Allow for dividends and other
distributions. (i.e. Find the sterling 12 month LIBOR on the appropriate month and year from
Your entire well diversified equity and fixed income portfolios (portfolios I & II) originally
maintained in two Excel spreadsheets should be uploaded on Bloomberg using the function BBU
<GO>. They should be uploaded as two separate and distinctive portfolios. Each Excel spreadsheet
must include columns for the portfolio name, a security identifier, which can be a ticker, a CUSIP
number, it can also be a SEDOL and then a quantity which in this case is number of shares. In the case
of the fixed income portfolio include columns with the portfolio name, security identifier, which can
be the CUSIP or ticker, the position in each of whose names as well as the market price for each
instrument. The excel file(s) should be saved on a specific folder in “My Documents”, so that you
can access it from the Bloomberg portfolio uploader. You are expected to work with the excel file(s)
continually and should schedule the Bloomberg upload to be done as an automated process every day
at 9:00 A.M. You should access the portfolios through Bloomberg’s PORT <GO> function.
After the new portfolios are created (based on the excel spreadsheets), you should focus on (I)
characteristics using PORT<GO> function to analyze the core structure of your portfolio, including
valuation measures and other fundamentals for equity portfolios and interest rate sensitivity, cash
flow projections, and (II) performance by identifying the sources of your portfolio’s historical
performance on an absolute basis and relative to a benchmark through PORT’s performance and
attribution tools and subsequently focus on the following:
(1) equity trade simulation or evaluating the impact of a hypothetical trade by using the PORT’s
trade simulation capability to execute a hypothetical trade, to lower the risk of your portfolio.
Use the PORT function, and click on the tracking error tab, then identify what the initial tracking
error of the portfolio is, and to see what trades you can make to reduce that risk. Choose your
portfolio and compare that to the benchmark for your tracking analysis, and also choose how
you want to have the portfolio aggregated.
(2) fixed income trade simulation or evaluating the impact of a hypothetical trade by using the
PORT’s trade simulation capability to execute a hypothetical trade to get you the impact on your
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portfolio’s duration. From the PORT function, click on the Characteristics tab and then choose
your portfolio and the benchmark. Then choose how you want to have that portfolio aggregated
(i.e. market sector). Observe the OAD, or the effective duration as well as the yield on your
portfolio, as well as other metrics. Add a bond to the portfolio and see the impact on the overall
duration and run the Trade Simulation.
(3) optimize your equity portfolio by leveraging Bloomberg’s portfolio optimizer to reduce tracking
error on your portfolio by first looking at what the current tracking error of this portfolio is.
From the PORT function click on the Tracking Error tab, then choose the portfolio you’d like to
analyze, the benchmark that you want to compare that for tracking error analysis, and how you
want to have that portfolio aggregated. Use the optimizer to generate a list of trades to reduce
tracking error on this portfolio. From the top of the screen, you have Trade Simulation and
launch the optimizer; (a) choose the goal such as minimize active total risk, or tracking error, (b)
choose your investable universe, or the list of securities that the optimizer will look at when
trying to achieve that goal, (c) set constraints for the optimization.
(4) optimize your fixed income portfolio by leverage Bloomberg’s portfolio optimizer to increase
the yield on your portfolio without lengthening the duration. From the PORT function, click on
the characteristics tab, then choose your portfolio, and compare that versus a benchmark.
Decide how you want to have the portfolio aggregated (i.e. market sector). Set goal for the
optimization to increase the yield of the portfolio without increasing the duration. Click on the
Trade Simulation and launch the optimizer: (a) choose the goal for the optimization, rather than
minimizing active total risk, you should increase the yield or maximize yield to maturity, (b) select
the investable universe for the optimization, (c) set optimization constraints such as the amount
of turnover that you’d be willing to accept, further on set a constraint with regards to duration
because you don’t want to increase duration related to my current portfolio duration.
You should properly justify your choices, analysis and the valuations. It is important
that there are two optimized portfolios simulated in parallel. Set them to compete over a
period of three weeks with results observed and recorded daily. You should manage the two
simulated portfolios in a dynamic fashion, with transactions made at appropriate points in the
price evolution paths. You should investigate the effects of portfolio optimization through a
comparative portfolio pricing framework.
You should compute portfolio risk and return as part of advanced frameworks, which you
must clearly explain. Reflect and draw clear conclusions of such frameworks’ usefulness. You
should comment on the overall investment performance of your simulated portfolios Your
evaluation should include measures of performance and comparisons with appropriate
indices for the types of investment and sectors that you have chosen. Although the
portfolio observation is time-boxed, this does not mean that it has to be set up as a short
term investment. It might be set up as a short term, a medium or long term investment
portfolio, as neither minimizes or negates the positive effects of the theory that underpin
proper asset and capital allocations at an advanced level.
In your comments on the simulated trade and portfolio performance, you should explain what
you have learned from the exercise, and what if anything you might change if i) you did the
same thing again as an academic exercise, and ii) you were investing your own money. You
should explain to what extent you might expect professional security and portfolio analysts to
follow a strategy similar to the strategy that you adopted. You should clearly
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Identify the use of advanced valuation methods, techniques and tools used and include a
statement on your attitude to risk.
Section 2.0
Trade Simulation Report.
Section 2.0
The report
In the report, you should address all of the CW requirements, and you are expected to have
your own view of what is expected and how much weight to give any particular requirement
element, however you will need to plan your answers carefully, in order to provide a
focused answer to the questions, within the word-limit.
The report should show that you have developed your understanding of the relevant
materials in this module, therefore it is necessary that you, not only get correct numerical
answers, but also explain what is being calculated, how it is calculated, the underlying theory,
assumptions, the results at appropriate stages of the calculation, and interpretations of the
final answers.
You should justify relevant theories used, their relevance, where possible, demonstrate your
understanding of them, by using simple equations or diagrams, or some other illustrations
and in presenting your arguments, you should also comment on possible strengths,
weaknesses and limitations.
Graphs, tables, panels, and other illustrations, should NOT be copied from books in a
“wholesale” fashion, instead they but should be recreated with justified data selected on
appropriate and relevant ranges.
You should justify any conclusion you reach on the basis of evidence, cross-referenced to,
or quotation from, the course lecture notes, seminar material, textbooks, other course
readings, or any other reliable source you choose to use. A report without proper
referencing will not be acceptable.
You should make use of relevant articles, journals, white papers, books (which you
should clearly identify) in your research and relevant to the trading simulation to
support your work. You should also explain the trading strategy followed. Your strategy
statement should include a statement on your attitude to risk, your own “views”,
identifying the theoretical basis for your decisions.
In your trading simulations, you should make use of models and tools with advanced
features and should include measures of performance and comparisons with appropriate
indices. Justify the advanced features of the methodologies, models and techniques used and
their usefulness.
The length of the final paper should be 2500 to 3500 words, excluding exhibits, should be
referenced, and contain a list of the sources of (i) your evidence and (ii) the theory that
underpins your analysis and commentary. Failure to do so is unprofessional and
fraudulent, and will result in a failing grade for the report and possibly the
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The report should be submitted electronically via Moodle by the deadline specified on Moodle.
Detailed allocation of marks can be found in the rubrics of this assignment.
Plagiarism is a serious academic offence and you should ensure that you are aware of the rules,
regulations and penalties in regard to it on the CULC website.
A possible report structure (suggestive)
? Abstract
? Table of Contents
? Introduction
? Equity Portfolio 1
? Fixed Income Portfolio II
? Portfolio I & II Characteristics and Analysis
? Trade Simulation: Portfolio I & II
? Portfolio I & II Optimization & Performance
? Conclusion
? Reference List
? Appendix
Detailed allocation of marks can be found in the rubrics of this assignment.

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