Fortescue Metals Group PDF

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FIN222 ASSESSMENT Written Report

Table of Contents Question 1.........................................................................................................................................3 Question 2.............................................................................................................................................4 Question 3.............................................................................................................................................5 Question 4 (Referring to the Excel Work)..............................................................................................5 4.1. the beta of your portfolio...........................................................................................................5 4.2. Standard deviation of your portfolio...........................................................................................5 4.3. Standard deviation if there was no diversification benefit..........................................................6 4.4 Required Return of your portfolio................................................................................................6 4.5. Expected return of your portfolio using the annual average return............................................6 4.6......................................................................................................................................................7 Question 5.............................................................................................................................................8 Question 6.............................................................................................................................................8 References.............................................................................................................................................9

Question 1 For company 1 which is Fortescue Metals Group Ltd. (FMG), The company’s stock prices have been rising for the last five years with few drops in the stock prices. The most noticeable down period which is caused by unsystematic and systematic risk happened during the year 2017 and 2020, respectively (Fortescue Metals Group Ltd 2017). In 2017 the company had a downfall of their stock, which caused the underlying profit to fall from $1.2 billion to $1.1 billion. This was caused by an unsystematic risk (Creagh 2017). Unsystematic risk which is associated with a specific company this can be controlled with diversification (Investopedia, 2021). This was due to the CEO (Power) stepping down after 7 years, this resulted in a huge shift in management, Mr Power who was appointed during 2011 when a heavy debt made the company on brink of shutting down. Under the CEO’s management, they rose to be one of the highest producers of iron ore. About 8,500 people were working under Power, which has been relocated to new industries such as building and managing infrastructures (Ingram 2017). This resulted in the companies. To escalate the unsystematic risk, they decided to diversify and grow their portfolio by exploring minerals like Gold, Copper, and lithium instead of just focusing on iron ore. This also resulted from the stock price falling from $6.880 to $4.660 which is a 67.73% downfall in stock price (Ingram 2017). The market index price ASX200 responded strongly to the stock price during the downfall of 2017 and continue to respond toward the share price again. Whereas the systematic risk which caused the specific down period during 2020 was a decrease of price because the whole economy was affected during the Pandemic (COVID19). Systematic risk refers to the risk affects the entire market or the market segment. Systematic risk is reflected due to the impact of economic, geo-political and financial factors (Investopedia, 2021). As China is the biggest buyer of iron ore from Australia. The country's relationship with one of its primary sources has been affected due to the pandemic, and have been risking the

economic factor of the country, this makes the country buy iron ore from another country in turn, reducing the demand for iron, therefore reducing the profit Thus, the demand for iron ore went down as the supply went up, thus forcing the company to sell resulting in a downfall of prices. The stock for Fortescue Metals Group Ltd. dropped from 18.87 to 15.91 which is an 84.3% downfall in stock price. The company had a net profit of 3.2 billion during 2019 but was reduced by 740 million to 2.46 billion the following year (Reuters 2021). There was a major downfall in the share market from price ASX200 during 2020 mainly due to the pandemic (Mining technology 2021). Oversupply of iron ore resulted in the iron ore prices falling 1/3rd of its actual cost of 64.96$ a tonne. The relationship between share price and market index during 2020 is close, when the stock price plummets during 2020 the market index also drops down about the same (Share Prices & Charts Market Index 2020). In a conclusion, the decrease of price and Management shift had caused the share price of Fortescue Metals ltd to plunge and decrease its market shares as well as the profit margin.

Question 2

The correlation coefficient is used to measure the strength of the relationship between the relative movement s of two variables. Correlation Coefficient

FMG

0.272336219

Correlation between stocks

AZJ

0.493264146

0.114490177

If the correlation coefficient of FMG is positive this indicates the company has been earning profits during the last five years, in terms of the market index. but not a significant and very weak one since they are not close to one but rather close to 0. The correlation coefficient of AZJ is positive and more than that of the other stock, this indicates the company is earning profits better than the first stock in terms of the market index.

Since the company earn better profits as the prices rise the correlation between the two variable is highly positive. The correlation between stocks is the relationship between the variables. Since they are both positive, they move in Is the same direction by the same amount (Investopedia, 2021). Question 3

Beta is the measure of the volatility or systematic risk that affect the entire stock market across many industries. It is a stock's volatility concerning the market. Two Beta stocks are present here one is Fortescue Metals Group Ltd. (FMG) and the other being Aurizon Holdings Ltd. (AZJ). The betas for both stocks are given below. Betas

FMG

Once you

0.77078077 5

AZJ

0.690612352 get beta

from the stock it can be used to find which stock is more sensitive to the changes in economic conditions. Since a lower beta is less sensitive and a Higher beta is more sensitive to systematic risk. Therefore, AZJ would be less sensitive to the changes in economic conditions (Investopedia, 2021). Question 4 (Referring to the Excel Work) 4.1. the beta of your portfolio.

70% * Beta of FMG = 0.7 * 0.77078077 30% * Beta of AZJ = 0.3 * 0.69061235 (Weight * Beta) + (Weight *Beta) (0.7 * 0.77078077) + (0.3 * 0.69061235) Beta of the portfolio = 0.74673023 4.2. Standard deviation of your portfolio.

Standard deviation = (Weight2 * Std.dev2) + (Weight2* Std.dev 2) + 2 * W2 * W2 * COV1,2

Standard deviation = (70%2 * 0.12102) + (30%2 * 0.059872) + (2 * 70% * 30% * 0.0008) Variance = √0.1010 Standard deviation = 0.3178

4.3. Standard deviation if there was no diversification benefit Standard deviation = (Weight2 * Std.dev2) + (Weight2* Std.dev 2) + 2 * W2 * W2 * 1 Standard deviation = (70%2 * 0.12102) + (30%2 * 0.059872) + (2 * 70% * 30% * 1) Variance = √0.5207 Standard deviation = 0.721 4.4 Required Return of your portfolio.

The required rate of return for your Portfolio is. The required rate of Return = risk-free rate + beta (Return on market - Risk-free rate) Risk-free rate and return on market is 1.63% and 6% respectively as per RBA, the 10-year government bond rate on 1 March 2021 as a risk-free rate (Reserve Bank of Australia 2021). Required rate of Return = 1.63% + 0.74673023 (6% - 1.63%) Required Rate of Return = 0.0489571 or 4.8957%

4.5. Expected return of your portfolio using the annual average return.

Date

FMG.AX

SHL.AX

01/03/2017

-0.06033186

0.052136705

01/03/2018

-0.140873242

-0.045855685

01/03/2019

0.193818375

0.031825405

01/03/2020

-0.00793645

-0.101725597

01/03/2021

-0.170883517

0.023621931

Annual average for stock 1 (FMG) = [(1+r1) * (1 + r2) * (1 + r3) *(1 + r4) * (1 + r5)] (1/n) – 1 Annual average return of stock for Stock 1 (FMG) = [(1+-0.0603) * (1 + -0.1408) * (1 + 0.1938) *(1 + -0.0079) * (1 + -0.1708)] (1/5) – 1 Annual Average Return for Stock 1 = 0.9546- 1 = - 0.0454 or – 4.54% Annual average for stock 2 (AJZ) = [(1+r1) * (1 + r2) * (1 + r3) *(1 + r 4) * (1 + r5)] (1/n) – 1 (AJZ) = [(1+-0.5213) * (1 + -0.0458) * (1 + 0.0318) *(1 + -0.1017) * (1 + -0.0236)] (1/5) – 1 Annual average return for stock 2 (AZJ) = -0.1754 or -17.54% Expected return for portfolio W 1 * R1 + W2 * R2. = 70% * (-4.54%) + 30% * (-17.54%) = 0.7 * -0.0454 + 0.3 * - 0.1754 Expected return on portfolio = -0.0844 or -8.44% 4.6. To determine the portfolio is over or under priced you need the following figures which we acquired earlier. R1 = r2 + Beta (Rm – Rf) Expected return = Risk free rate + Beta (Market risk premium) Market risk premium = Expected rate – risk free rate = 1.63% + 0.7467 (4.8957% - 1.63%) = 0.0163 + 0.7467 (0.0489 – 0.0163) = 0.0406 or 4.06%

This portfolio is overvalued. Since the expected return on portfolio is -8.44% If the security is above the SML, it is undervalued, if it is below the SML, it is overvalued. Question 5 95% Prediction interval of S&P/ASX200 = Average ± (2 x standard deviation) = 0.0059 – (2 x 0.0428) or 0.0059 + (2 x 0.0428) = -7.97% and +9.15% Since the at confidence level 95% the stats being 0.01104,(refer the excel sheet 2 for the table) given a 95% confidence interval, the ASX200 fall between -7.97% and +9.15% throughout April 2021. Question 6 Beta from Excel

FMG.AX 0.770780775

AZJ.AX 0.690612352

Beta from Yahoo Finance FMG.AX 0.79 Source: Yahoo Finance

AZJ.AX 0.52

AZJ.AX https://au.finance.yahoo.com/quote/AZJ.AX?p=AZJ.AX FMG.AX https://au.finance.yahoo.com/quote/FMG.AX?p=FMG.AX&.tsrc=fin-srch

Some of the factors why beta differs from the calculation and website source is due to the capital structure of each firm and betas are not consistent. One of the major factors that make the beta from every source different is index choice since different sources use different index numbers such as ASX200, NASDAQ, SENSEX. Etc, they could affect the calculation of beta. One of the factors being the selection of period which they calculate beta, some of the websites calculates beta from the start year instead of the financial year which could cause a huge impact, the other period being the return time frame which could cause variation regarding daily, weekly, or monthly (Agrawal and Waggle, 2010).

References. 1. Admin 2021, How China is moving beyond Australia for its iron ore hunger, Miningtechnology.com, Mining Technology | Mining News and Views Updated Daily, viewed 6 May 2021, . 2. Agrawal, Pankaj and Doug Waggle, 2010, “The Dispersion of Betas on Financial Websites,” Journal of Investing, 19(1), 12-24.

3. AURIZON FPO (AZJ.AX) stock price, news, quote & history – Yahoo Finance 2021, @yahoofinanceau, viewed 6 May 2021, .

4. Beta 2021, Investopedia, viewed 6 May 2021, . 5. Creagh, B 2017, Fortescue aims to diversify beyond iron ore - Australian Mining, Australian Mining, viewed 6 May 2021, .

6. Creagh, B 2017, Power to step down as Fortescue CEO - Australian Mining, Australian Mining, viewed 6 May 2021, . 7. FORTESCUE FPO (FMG.AX) stock price, news, quote & history – Yahoo Finance 2021, @yahoofinanceau, viewed 6 May 2021, .

8. How does Beta reflect systematic risk? 2021, Investopedia, viewed 6 May 2021, . 9. Ingram, T 2017, Fortescue Metals Group chief executive Nev Power to step down in February, Australian Financial Review, Australian Financial Review, viewed 6 May 2021, . 10. Our Operations | Fortescue Metals Group Ltd 2020, Fmgl.com.au, viewed 6 May

2021, https://www.fmgl.com.au/about-fortescue/our-operations

11. Reserve Bank of Australia 2021, Reserve Bank of Australia, Reserve Bank of Australia, viewed 6 May 2021, .

12. S&P/ASX 200 (LIVE DATA): Share Prices & Charts - Market Index 2020, MarketIndex.com.au, Market Index, viewed 6 May 2021, . 13. Systematic Risk Definition 2021, Investopedia, viewed 6 May 2021, .

14. Unsystematic Risk 2021, Investopedia, viewed 6 May 2021, ....