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A REPORT ON Event Study of Contract Win And Earnings release in Defense/Aerospace Industry

By Gaurav Kadian 07BS1431 METRICS4 ANALYTICS PRIVATE LIMITED

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A Report On

Event Study of Contract Win and Earnings release in Defense/Aerospace Industry

By Gaurav Kadian

A Report Submitted in Partial Fulfillment of the Requirements of MBA Program

Distribution List: Mr. Anjaneyulu Marempudi (Founder & CEO, Metrics4 Analytics) Mr. Rajeev Gupta (Director - Research & Analytics, Metrics4 Analytics) Mr. Sanjay Banka (Director - Research, Metrics4 Analytics) Dr. S.V. Seshaiah (Associate Dean, ICFAI Hyderabad)

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ABSTRACT

This study investigates quarterly earnings releases and contract win announcements of a firm to test for the existence of an information effect, the impact of an event on the announcing firms stock returns, and to estimate its magnitude also. This study investigates the affect of the event, contract win, on the stock returns of the concerned firm. Exhaustive list of all the financial parameters were considered for the purpose of analysis and the data was collected through online database and websites. For the purpose of this event study, impact of the event was considered on the firms stock returns and three variable, i.e. contract size, contract size as a percentage of market capital and new & follow up contracts, were studied. The three variables were studied to understand the variance in the stock returns for the contract win announcement. This study also investigates the impact of quarterly earnings releases for the Aerospace/Defense Products & Services industry on the firms stock returns. Study was conducted to analyze whether the year-over-year increase/decrease in the earnings had a more profound effect on the stock returns or the quarter-over-quarter increase/decrease in earnings had a more profound effect. For this event study, four years quarterly earnings releases data was analyzed from 2004 to 2008, and earning releases were studied for arriving at a conclusive results. For this study, hypothesis was developed and analyzed as to how the events might affect stock price volatility and various statistical methods were also used to draw conclusion regarding the trends from preceding and succeeding the event.

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Table of ContentsPage No. 1) Abstract......................................................................................................................... ......... 3 2) Objective................................................................................................................................ 5-6 3) Methodology .........................................................................................................................7-14 3.1) 3.2) Methodology for Contract Wins.....................................................7-11 Methodology for Earnings Release................................................12-14

4) Results and findings for Contract Wins...............................................................................15-20 4.1) 4.2) Results for Contract Wins..............................................................15-18 Finding for Contract Wins.............................................................19-20

5) Results and findings for Earnings Releases........................................................................ 21-23 5.1) 5.2) Results for Earnings Releases........................................................21-22 Findings for Earnings Releases......................................................23

9) Conclusion .............................................................................................................................24 11) References ........................................................................................................................25-26

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ObjectiveThe objective of the project was to analyze the impact of events on stock returns. To understand how stock returns are affected by different events in different manner. The main aim was to become more scientific about understanding the stock market and particular industry or even particular returns. All in all, the main objective was to become apt in various aspects of finance and to gain as much knowledge as possible to become a better student in this huge ocean of financial studies. The project was directed towards understanding the effect of Contract Win announcements on stock prices of companies belonging to Aerospace/Defense Industry. Further, the project was aimed to understand whether the year-over-year (YoY) quarterly earnings results comparison has more effect on stock prices, or quarter-over-quarter (QoQ) quarterly earnings results comparison. The main objective of this study was to investigate the effect of Contract win announcement by firms of the Aerospace/Defense Industry. Tests were carried out first to determine expected returns and then calculate abnormal returns for the event days, the event window (+/-4 days). After calculating abnormal returns, Z-values were arrived at to ascertain whether the Z-value shoe significant values or not. For the purpose of Earnings release, study was carried out to check which one had a more profound effect on stock returns (positive or negative), among the increase/decrease in quarterly earnings result, YoY, (i.e. increase/decrease in both Net income and Operating income for that quarter) from last year quarter, or the increase/decrease from sequential quarter, QoQ or preceding quarter.

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So, this study tries to find whether to take last year quarter results as a benchmark for comparing the current quarter results, or one should take sequential quarter, last quarter for comparing current quarter results. Same method was used for arriving at abnormal returns for the earnings event study also. Four year quarterly results, from 2004 to 2008, for more than 20 firms of Aerospace/Defense industry, were studied and further segregated into two categories. The first category was taken as the case when the quarterly results in which earnings results increased from last year quarter ( YoY Up), but current quarter earnings decreased when compared with the results of preceding quarter or last quarter (QoQ Down).

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Methodology

The event study methodology is used to investigate the effect of an event on a specific dependant variable. The dependent variable in the study is the stock price daily returns of the company. The study analyzes the changes in stock price daily returns over and above the normal returns of the stock, over a period of time (event window). The event study methodology seeks to determine whether there is an abnormal stock price effect associated with the event Contract wins and Earnings releases, and infer the significance of the event. Index or reference chosen is Standard & Poor 500 Composite Index (S&P500). S&P500 index is a broad measure of the US equity market, which reflects the performance of the 500 largest quoted companies in the US. The index had market capitalization of $11.94 trillion on March 31, 2008. The index has on aggregate given a return of 15.45% since 2003 and portrays 9.70% per annum as risk.

Methodology for Contract Win As discussed earlier, to do a basic single event study analysis, one has to firstly decide on few criterias, example: Period of data to be studied. Estimation window. Event window. Model to be applied and procedure. Hypothesis to be tested. Tests to be carried out.7

Period of data to be studied The period of event study is of one year, from 2007 to 2008. One year data is studied as the data is readily available in the database of Metrics4, along with the trade date and contract size. And as the data for this period was covered for more than twenty firms of Aerospace/Defense Product & Services Industry, the numbers of data points were 133.

Event window The event window is the time span in which all relevant information needed to assess outcomes linked to the event being examined. The event window can be from day t x day to t + y and is of length y + x + 1 days. For this event study analysis +4 to -4 is the event window. Estimation window The estimation window, also called pre-event period, is usually a time span before the event period. The estimation period is the period where you measure the normal relationship between the stock of interest and the variables in your model. One should have a 50 observation estimation period. However, anything more than a 100 observations should be sufficient. Most researchers choose anywhere from 200 to 250 observations, where approximately 250 daily observations is one calendar year. For this study 120 days pre-event period was taken as estimation window. Model to be applied Market model or single index model was chosen for this event study. The market model says that the return on a stock depends on the return on the market portfolio (S&P 500) and the extent of the security's responsiveness as measured by beta (calculated in the regression analysis). The return also depends on conditions that are unique to the firm. The market model can be graphed as a line fitted to a plot of asset returns against returns on the market portfolio.

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The procedure for Market Model was applied as follows:

Step 1: Firstly calculated the stock returns for the stock closing price and S&P 500 Index values for the estimation window., which is 120 days prior to event window of +4/-4 days. Table below gives an example how step 1 is carried out

Event window 4.00 3.00 2.00 1.00 0.00 -1.00 -2.00 -3.00 -4.00

Date 39511.00 39510.00 39507.00 39506.00 39505.00 39504.00 39503.00 39500.00 39346.00

Stock Closing 22.65 22.85 21.65 22.65 23.28 23.41 22.74 22.95 23.02

S&

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