Examination the London Stock Market for Investment - Research Paper Example

Complete a Project Based On Your Choice of an Investment Portfolio Table of Contents Introduction 3 Investment Theory 4 Debt 5 Risk Involved In Debt 7 Equity 8 Risk Involved In Equity 9 Derivatives 10 Risk Involved In Derivatives 11 Cash 12 Risk Involved In Cash Market 13 Conclusion 14 References 16 Introduction Investment portfolio defines the set of different assets owned by an individual or an organization. Investment in financial products that include debt, equity, derivatives and cash is needed to be made in an effective manner. The aim of the portfolio investment is to earn profit in return of investment in financial assets. The return from financial asset is subject to expected risk and therefore, the investment has to be made with proper analysis. The aim of the paper is to analyse the London stock market in order to identify the most preferable financial asset for investment. In addition to this, it helps to identify the risk associated with each of the financial assets. Risk involved in portfolio investment is directly linked with the value. The willingness of an individual make investment or avoid risk is the most important factor for portfolio investment (Reilly & Brown, 2011). The investment portfolio has to be made in such a manner that maximum return can be earned from financial assets. The investment portfolio has been based from Monday 2nd March 2015 to Monday 6th April 2015. The major aim of investment in financial assets is to earn return and maximise profitability. Moreover, portfolio investment is considered to be the safest mean of earning income. The total amount fixed for portfolio investment is £100,000 (Reilly & Brown, 2011). The paper analyses current market trend and the risk involved with each of the financial assets that has the potential to prevent investments. Apart from risk other factors that have the potential to affect investment in financial assets include the amount invested and the expected length for which an individual holds different financial assets. The time horizon defines the time period between the investment in financial assets and receiving the return from it. The time length is considered to be the crucial factor in portfolio investment, because it directly affects the ability of investors to minimise the overall risk involved. The paper analyses the financial market according to the data of London stock exchange and identifies the assets from which the borrower can achieve maximum return with respect to the risk involved. Investment Theory Investment theory focuses on the process of decision making associated with selecting the appropriate financial assets for investment that in turn has the potential to maximise the overall return earned. Investment theory defines the relation between the risk involved in investment and overall return from the financial assets. Investment in financial assets is positively related to expected return. The increase in expected risk indicates higher return. The modern portfolio theory defines the relation between return on portfolio investment and risk. The Capital Assets Pricing model is used for pricing the financial assets and it is identified to be adopted by most of the industries. The model states expected return from portfolio investment is equal to risk involved in financial assets and premium (Peterson, 2012; Dow, 2009). Figure: Relation between Expected Return and Risk Source: (Dow, 2009) Debt The paper examines the London stock market for investigating the most profitable portfolio investment. The London stock exchange being one of the reputed exchanges is considered to be the global centre for the purpose of issuing different types of debt securities. The issuers of debt securities are given opportunity to trade in different markets including the regulated as well as professional regulated security markets. In the context of debt, market trading provides better opportunities to access Europe’s capital market. The value of debt securities determines the risks involve in investment and that in turn determines the willingness of the investors to invest in debt market. Investment in debt securities involves less risk as compared to that of equity investments. However, investment in debt market offers lower return as compared to other financial assets, but yet is likely to be preferable among the investors, as it involves consistent return over the period. In 2013, the value of debt securities was over £360 billion that has increased to £1.65 trillion in the present main market. Some of the debt based investments includes for instance government bonds, saving accounts, annuities and many other financial assets (London Stock Exchange plc, 2015; London Stock Exchange Group, 2012). The figure below represents the size of the UK bond market with respect to different financial resources available for investments. Figure: Size of Bond Market in the UK Source: (London Stock Exchange Group, 2012) The value of debt securities indicates the fact that London debt market is improving continuously that has the potential to increase investments. Moreover, there has been an increase in lending since 2013 and is expected to continue over the present year. The improvement in debt market can also be examined from the low bank margin with low rate of interests. Low rate of interest has enabled the borrowers to gain a competitive financial return on investments. Due to the stable position in different assets, a number of local as well as financial institutions are offering debts in term of financial assets. Moreover, the swap rate has been lowered and is expected to be at same level for 2015 (BNP Paribas Real Estate, 2015). The lower swap rate has enabled the borrowers to gain debt financing at favourable terms and to take the positive advantage of the position of debt market. The lower swap rate also signifies an increase in debt investment due to increased possibility of gaining more return. Improvement in debt market in the UK can also be identified from the change in lending to £19.6bn within six months of 2014 that has been £29.9bn in 2013. As a result of which, the financial institutions are more willing to invest in London properties. In addition to this, further improvements in repaying the loan capital and the issue of loan on the basis of interest have also influenced the debt market (BNP Paribas Real Estate, 2015). Risk Involved In Debt Investment in debt funds is influenced by the amount of risk involved. Some of the risk involved in debt investment includes credit, interest rates and many other factors that have the potential to affect the overall return from investments. Investment in debt funds are influenced by the rate of interest rates. The change in interest rate is likely to affect the price of bonds that in turn results to changes in investment pattern. The increasing rate of interest has a positive impact on funds with shorter maturity period. On the other hand, a fall in interest rates is likely to have a positive impact on the funds hold for a longer maturity period (OECD, 2002; Penza & Bansal, 2001). This indicates the fact that impact of interest rate on investment in debt funds is dependent on maturity period. The higher maturity of funds indicates that debt is more prone rate of interests. Higher duration of maturity involves more risks with respect to the fall in prices of bonds. The above analysis of London debt market indicates lower interest over the year that has enabled the borrower to earn more return on investments. Investment in debt market is subject to changes in economy and therefore, the amount fixed for the asset is £15,000. Therefore, investment in debt market is likely to be preferable by the investors due to lower rates of interests (BNP Paribas Real Estate, 2015). Equity Another form of portfolio investment includes equity investment that is purchasing shares of a company that are listed in London stock market. The shares are also known as equities and investing in them provides partial ownership to the respective investors. Buying a share of a business is also preferred by the individuals due to the probability of earning maximum return out of it with respect to the type of risk involved in investment. The companies issue shares in order to raise funds for further investments and to maximise profitability over the long run. The investors invest in shares with the aim to earn return out of it (London Stock Exchange Group plc, 2014). In equity trading, the value traded has increased to 8 per cent as compared to other financial markets. The economic condition of the nation is also likely to influence the decision of the potential investors in buying a company’s shares. The economic conditions have the potential to increase the interest rates and raise the yield of bonds. Gradual improvements in overall economic activities increase investment opportunities as well as the growth of GDP, which has the potential to develop equity friendly market. Therefore, it can be expected that equity investment is likely to be preferred by the investors with respect to the market activity. In the context of initial public offerings, the equity capital has raised from £18.0 billion in 2013 to £34.2 billion in 2014, as depicted in the figure below (London Stock Exchange Group plc, 2014). Figure: Equity Amount Source: (London Stock Exchange Group plc, 2014) Risk Involved In Equity Equity investments are also subjected to risk that in turn affects the return involved in it. However, the risk involved in equity investment has the potential to shift investment in bonds or fixed incomes. The degree of risk involved in equity investment is less in case of long duration as compared to shorter period. As the development of a company is dependent on growth of an economy, it is likely to act as a risk in terms of equity investments. The share prices are also subjected to the development of an economy and therefore, it is likely to affect the investment decisions. Economic development for instance the changes in interest rates, inflation rate as well as changes in government policies is likely to affect equity investments. The economic changes directly influence the price of equity that affects future investment decisions. The increase in inflation rate also affects the market, as it raises the premium risks involved in equity. The existing rate of currency also imposes restriction in equity investments. The service sector, manufacturing as well as many other industrial sectors are affected by changes in an economy that in turn affects the equity market (Mobius, 2007). From the above analysis of London stock exchange, it is clear that the equity market have shown sufficient growth in 2014 as compared to that of 2013. However, further examination of data presented in the above graphical representation revealed the fact that growth in equity market has been declining since 2010 to 2013. This also indicates poor economic condition of the UK that in turn has affected the equity market. The improvement in the equity market has the potential to raise investment in this asset and therefore, the amount fixed for the purpose is £15,000 (London Stock Exchange Group plc, 2014). Derivatives Investment in derivative market is dependent on other markets including currency as well as performance of the stock market. The type of derivative includes ‘future’, ‘forwards, ‘option’ and ‘swaps’ (Chui, n.d.). The London stock exchange offers new innovative products to the members firms with respect to the derivative market. Derivatives are different from other securities, because it has the potential to manage the risk involved in other financial assets. The investment in derivative is preferable, as it makes the future risk tradable. An investment in derivative market is preferable by the corporate business, as it protects the investors from the changes in price of raw materials as well as exchange rates and interest rates. The unexpected changes in price can be faced by increased investments in derivative markets. In the context of derivative market, Europe mainly covers the maximum of derivative market as compared to shares in bonds as well as equities (Deutsche Börse AG, n.d.). Figure: Comparison between Derivatives, Equity and Bond Markets Source: (Deutsche Börse AG, n.d.) Another use of derivative is investment that can be made in financial assets without holding or buying particular assets. As a result of which, the derivative market have shown growth with respect to investment in financial assets. Moreover, additional benefit involved in investing in derivative market is risk transfer that has raised its importance among the investors (Deutsche Börse AG, n.d.). Risk Involved In Derivatives Investment in derivative instruments also involves risk, but is considered as an alternative mean to participate in financial market. Some of the risk involved in the derivative market involves market risk that indicates any change in price is likely to affect the investment in derivative instruments. The amount fixed for investment in derivative market is £20,000, as it is the alternative form of investing and involves more risk than cash market. In addition to the market risk, other risk involved in investment includes operational risk that is mainly associated with different business operations. Credit risk also affects investment in derivative market (Sharpe, 2011). Cash Cash investment offers lower return on investment as compared to investment in other financial assets. In addition to low return, cash investment involves lower risk. Cash investment indicates direct investment to business enterprise and is not associated with borrowed sum of money. Considering the UK market, more than 82% of population hold cash saving products. The consumers’ saves for variety of purposes, but the selection of type of account is made by considering a number of factors including rate of interests, service providers and many other different features. The cash market is large and therefore, the investors are more willing to invest (Financial Conduct Authority, 2014). Figure: Different Type of Accounts Source: (Financial Conduct Authority, 2014) The above figure indicates the different types of cash saving products preferred for investment. The easy access account holds maximum balance as compared to fixed deposits and other types of accounts. The easy saving account is mostly preferred for investment, because of less restriction in terms of deposits as well as withdrawal of money. Moreover, the account offers different rates of interest and so, is likely to be preferred by the investors. The fixed term account is less preferred as compared to the easy access, as it involves fixed rate of interest and often the consumers face difficulties in accessing the account (Financial Conduct Authority, 2014). Figure Cash Saving Balances Over Time Source: (Financial Conduct Authority, 2014) The cash saving product are mainly offered by banking sector and other credit rating societies. The above figure indicates the cash balance over the years i.e. 2010-2013 that have remained in a stable position over a long period of time (Financial Conduct Authority, 2014). Risk Involved In Cash Market Investment in cash market is also subjected to risk that can affect the investment decision of the customers. The change in interest rate is likely to affect the investment in the cash market. The increase in bank interests is identified to be having a positive impact on cash investments. On the other hand, fall in the rate of interest reduces cash investments. From the above analysis of the UK cash market, it is clear that the customers are more willing to invest in the easy access account. The amount fixed for investment in cash is £50,000 as from the above analyse of cash market, it can be identified that the investors are more willing to invest in cash. Therefore, the change in interest rate is likely to reduce the number of account involved in easy access (Wormell, 2012). Financial Assets Amount for Investment Debt £15,000 Equity £15,000 Derivative £20,000 Cash £50,000 Conclusion From the above discussion, it can be comprehended that the London stock exchange market in order to identify the most suitable financial assets for investments uses different options. It has been recognised that the risk involved is likely to affect the investment decisions. The investment theory indicates the relation between risk and the return from investments. The financial assets that include debt, equity, derivatives and cash under separate headings in order to identify the risk involved in different assets. The risk involved in portfolio investment affects investors’ decision. From the above analysis, it can be concluded that investment in financial assets is subjected to risk and therefore, the selection of financial assets has to be made according to the risk involved in it. References BNP Paribas Real Estate, 2015. Real Estate for a Changing World. Investing In London 2015. [Online] Available at: http://www.realestate.bnpparibas.co.uk/upload/docs/application/pdf/2015-04/investing_in_london_guide_2015_-_bnp_paribas_real_estate_uk.pdf [Accessed May03, 2015]. Chui, M., No Date. Derivatives Markets, Products and Participants: An Overview. Introduction. [Online] Available at: http://www.bis.org/ifc/publ/ifcb35a.pdf [Accessed May03, 2015]. Dow, J. P., 2009. Modern Portfolio Theory. California State University. [Online] Available at: http://www.csun.edu/~jpd45767/303/13%20-%20Modern%20Portfolio%20Theory.pdf [Accessed May03, 2015]. Deutsche Börse AG, No Date. The Global Derivatives Market. An Introduction. [Online] Available at: http://www.math.nyu.edu/faculty/avellane/global_derivatives_market.pdf [Accessed May03, 2015]. Financial Conduct Authority, 2014. Cash Savings Market Study: Interim Report. Market Study. [Online] Available at: www.fca.org.uk/static/documents/market-studies/ms14-02-interim-report.pdf [Accessed May03, 2015]. London Stock Exchange Group, 2012. Debt Markets. London, The World’s Financial Centre. [Online] Available at: http://www.lseg.com/sites/default/files/content/documents/Listing%20Debt%20on%20London%20Stock%20Exchange.pdf [Accessed May03, 2015]. London Stock Exchange plc, 2015. Debt Securities. Our Markets for Debt. [Online] Available at: http://www.londonstockexchange.com/specialist-issuers/debts-bonds/our-markets-for-debt/our-markets-for-debt.htm [Accessed May03, 2015]. London Stock Exchange Group plc, 2014. Annual Report 2014. Delivering Growth. [Online] Available: http://www.lseg.com/sites/default/files/content/documents/LSEG%20Annual%20Report%20March%202014.pdf [Accessed May03, 2015]. Mobius, M., 2007. Equities: An Introduction to the Core Concepts. John Wiley & Sons. OECD, 2002. OECD Public Debt Markets Trends and Recent Structural Changes: Trends and Recent Structural Changes. OECD Publishing. Penza, P. & Bansal, V. K., 2001. Measuring Market Risk with Value at Risk. John Wiley & Sons. Peterson, S., 2012. Investment Theory and Risk Management, + Website. John Wiley & Sons. Reilly, F. & Brown, K., 2011. Investment Analysis and Portfolio Management. Cengage Learning. Sharpe, W.F., 2011. Investors and Markets: Portfolio Choices, Asset Prices, and Investment Advice: Portfolio Choices, Asset Prices, and Investment Advice. Princeton University Press. Wormell, J., 2012. The Gilt-Edgedl Market (RLE Banking and Finance). Routledge. Read More