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The differences or similarities in returns

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2. Find the adjusted monthly prices for the past year for both Novartis AG (NVS) and Pfizer (PFE). Assume you just inherited $3000. You plan to use half of your inheritance in Novartis AG and the other half in Pfizer. You purchase (go long) in Novartis and sell short Pfizer. Both transactions are done using margin where the initial margin is 50% and the maintenance margin is 30%. Using only monthly prices, determine if either strategy received a margin call and if so how much. What is the return on both investments? Explain the differences or similarities in returns.

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Solution Summary

Both the strategies performed well with respect to the margin call as there was no margin call for the strategies. The long only strategy had more risk, as the return on this portfolio ranged between -9.80% to 8.99%. As compared to that the return for the long-short strategy was narrower between -4.46% to 6.87%. Same trend is seen for another measure of risk i.e. standard deviation. The standard deviation for the long only strategy is higher at 5.92% as compared to that for long short strategy at 3.15%.
The total return on the long only portfolio was slightly higher at 4.85% as compared to that for long-short portfolio at 3.55%. The actual return on long-short portfolio would be much higher as the initial investment required in this portfolio would be almost zero. Thus, we can say that long only portfolio has higher risk but also provides slightly higher returns whereas long-short portfolio has slightly lower return but has significantly lower risk.

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