StudentShare
Contact Us
Sign In / Sign Up for FREE
Search
Go to advanced search...
Free

Investing and Financial Markets - Essay Example

Cite this document
Summary
The profile of the individual is that he is productively employed with a good regular salary, and therefore does not require his…
Download full paper File format: .doc, available for editing
GRAB THE BEST PAPER91.1% of users find it useful
Investing and Financial Markets
Read Text Preview

Extract of sample "Investing and Financial Markets"

Personal Investment The aim of the portfolio The portfolio developed for this study is a long-term personal retirement savings account for the subject, a young individual in his late twenties. The profile of the individual is that he is productively employed with a good regular salary, and therefore does not require his portfolio at present to provide income for his subsistence. The subject has the capacity to borrow ₤1,000,000 from the bank at an interest rate of 2% p.a. for the purpose of setting up the retirement savings. There is no term specified within which the borrowed money is supposed to be returned, but there is the commitment to return it with the promised interest rate. The portfolio was required to contain up to 9 items, specified here as stocks (five at most) and funds, with the excess money being invested in the money market, representing the risk-free rate of return. Stocks are equity instruments which are prone to greater risk than investment funds, depending on the nature of the underlying company upon which ownership the stocks are constituted. Mutual funds are considered of lower risk because they are comprised of different component investments and managed by a professional fund manager, with a higher level of knowledge of the workings of the markets, as well as information superior to that available to lay investors. The investment portfolio should suit the risk and return profile of the subject investor (Kaptan, 2001). In this case, it is assumed that the subject investor is young and a strong earner. The fact that the funds he is investing is borrowed indicates that he does not have savings of his own for this purpose, therefore he has not been working for a long time by which these savings would have been earned. Also, the fact that he had been granted a sizeable loan for the long-term indicates that the bank or creditor has undertaken the necessary investigation to ascertain that the subject could pay this loan. This means that the subject investor has a long investment horizon, further supporting the contention that he still faced a long productive career. As a result the investment portfolio was designed according to the profile of the subject. A slightly higher risk is tolerated by the subject, for which reason a full 70% of the portfolio funds was allocated to equity investments which are considered higher-risk than other investments. Mutual and index funds were allocated approximately 20% of the portfolio, and the remaining 10% was placed in the money market. More senior investors who must realize income from their portfolios would normally place their funds more heavily in the money market because of its low risk and regular returns quickly convertible to cash. In the case of the subject, however, only 10% is placed in money market because the aim of the portfolio is strong growth and asset value appreciation, rather than cash income on a regular basis. Portfolio Selection Thus, the aim of the portfolio is to realize a rate of return which exceeds the 2% risk-free rate, which is assumed to be equal to the interest rate. In the choice of issues, the risk should be sought to be minimized by diversification of investments. According to the Markowitz Portfolio Theory, also known as the Modern Portfolio Theory (MPT), risk is quantifiable and may be represented by the variance of the rate of return of a particular investment (Mangram, 2013). MPT makes the following assumptions with respect to investor behaviour: (1) Each investment alternative is considered by investors as conveyed by a probability distribution of the expected returns in the course of an investment horizon or holding period; (2) Investors would tend to aim for maximum one-period expected utility, and their utility curve demonstrates a diminishing marginal utility of wealth; (3) The risk of the portfolio is estimated by investors on the basis of the variability of expected returns; (4) Decisions made by investors are solely based on the expected return and risk, for which reason the utility curves reflect the workings and interaction of expected return and the expected standard deviation or variance of returns only. (5) Investors would naturally tend to prefer high return to lower returns, given a specific risk level. Conversely, given a particular expected rate of return, investors would also prefer to shoulder less risk rather than more risk. Thus, the risk investors are willing to assume depends upon the possible return that could be realized, and vice versa (Reilly, et al., 2012, p. 182). In the preceding principles, what Markowitz requires is for the choice, and periodic adjustments, in investments to be made in accordance with the goal of maximizing gains but only if risks are tolerable, or to take on added risk only if it justifies the added likely returns and if does not irresponsibly expose the investor to risk he or she cannot transcend. In the choice of issues to include in the portfolio designed here, it was important to assess the global economic prospects in light particularly of the weaknesses in the various national economies and, particularly, in the UK where the FTSE stocks and index-related funds are linked. Five stocks and their industry sectors were identified for the portfolio, namely Associated British Foods (food producers), Barclays PLC (financial), Reckitt Benckiser Group PLC (household goods and home construction), Next PLC (general retailers), and Balfour Beatty PLC (construction and construction materials). Four exchange traded funds (ETFs) were also identified, namely: DBX FTSE China 1C, ETFX 100 Lever GBP, Oxford Technology Venture Capital Trust PLC, and Emerging Markets (EM) Standard (Large+Mid Cap). These are shown in the table following. Asset Selection ‘Associated British Foods PLC’; ‘Balfour Beatty PLC’; ‘Barclays PLC’; ‘Next PLC’; and ‘Reckitt Benckiser Group PLC’ Historical Prices. Yahoo! Finance UK & Ireland, 2013 In the case of the chosen stocks, while returns tend to vary and exhibit high volatility during economic shocks, stocks offer the advantage of being predictable to the degree that the underlying company has a tangible business that may be analysed. The sectors chosen were selected because in a weak but recovering economy, they are forecasted to become the more defensive industries. This means that demand for goods and services along these areas remain strong, despite possible increases in price or reduction in buyers’ discretionary income (Fabozzi, 1999). Several issues were chosen depending upon the fundamentals of the issue. To narrow down the choices and decide which among the different stocks would reduce risk, the means and standard deviations were derived. The standard deviation indicates the variability of returns over time, for which reason they are taken to be a measure of risk. The greater the variability means the greater the probability that the expected returns may not be realized. As an added measure of risk, the coefficient of variation (CV) was included. This measure is the quotient of the standard deviation divided by the mean. Portfolio In the foregoing table, the issues which exhibited the highest risks as indicated by the standard deviation are Next, Reckitt Benckiser Group, and Associated British Foods, in order of decreasing risk. However, it should be noted that the mean returns on the stocks are also considerably larger than the other stocks with lower risks, thus the coefficient of variation would prove useful in common-sizing the risks. Based on the CV, the risk of Next is still comparatively high at 0.445, but is lower than Oxford Technology Venture Capital Trust (0.587) and Emerging Markets (0.522). By comparison, Reckitt has a much lower risk as denoted by a CV of only 0.180, followed by ABF with a CV of 0.307. In the following correlational matrix, each issue was correlated with the other issues using Pearson product moment correlation, and their correlational coefficients are indicated in the table below. When the correlation is positive, this means that the prices of the issues correspondingly move together in the same direction, proportionately to the coefficient’s size. If the correlation is negative, it means that the prices move in opposite direction (as one goes high, the other goes low). Correlations closer to zero mean that the price movements of the issues do not affect each other (Miles & Shevlin, 2001). Correlational matrix From the matrix above, there are evidently strong positive correlations among ABF, Next and Reckitt, highlighted with yellow. The correlation coefficients are above the 0.90 level which means that there is a near perfect correlation among the three. It should be recalled that these were the issues with the highest mean returns. Relatively strong positive correlation are also manifested by ETFX 100 Lever GBP, with symbol LUK2.L, Oxford Technology, and Reckitt. On the other hand, Emerging Markets (EM) shows relatively strong negative correlation. EM would be a useful issue that would reduce the possible risks if lead stocks Reckitt, ABF and Next would fall because EM would then be going up. Correlations with FTSE ABF.L -0.2773 BARC.L 0.5102 RB.L -0.2747 NXT.L -0.3770 BBY.L 0.2254 XX25.L -0.2488 LUK2.L -0.0206 OXT.L 0.2640 EM 0.5182 From their historic correlations with the FTSE, it appears that if the FTSE were expected to rise, then good issues to have would be Barclay and EM, as they have a higher than 0.50 coefficient Calculated beta of the stocks Issue Beta ABF.L 0.0037 BARC.L 0.0035 RB.L -0.0022 NXT.L 0.0084 BBY.L 0.0024 XX25.L -0.0004 LUK2.L -0.0043 OXT.L 0.0159 EM 0.0085 The beta of the stocks are calculated from the Capital Asset Pricing Model (CAPM) developed by Markowitz, from the formula: The beta coefficient is also a measure of risk, because it indicates the degree to which the stock or issue price reacts to changes in the index (in this case, the FTSE) which represents the broader market. The betas show that there are sufficient issues with positive as well as negative betas, therefore the risk of the portfolio is sufficiently minimized by diversification. References ‘Associated British Foods PLC’ 2013 Historical Prices. Yahoo! Finance UK & Ireland. Retrieved 24 March 2013 from http://uk.finance.yahoo.com/q/hp?s=ABF.L&b=1&a=02&c=2008&e=1&d=02&f=2013&g=m ‘Balfour Beatty PLC’ 2013 Historical Prices. Yahoo! Finance UK & Ireland. Retrieved 24 March 2013 from http://uk.finance.yahoo.com/q/hp?s=BBY.L ‘Barclays PLC’ 2013 Historical Prices. Yahoo! Finance UK & Ireland. Retrieved 24 March 2013 from http://uk.finance.yahoo.com/q/hp?s=BARC.L ‘Next PLC’ 2013 Historical Prices. Yahoo! Finance UK & Ireland. Retrieved 24 March 2013 from http://uk.finance.yahoo.com/q/hp?s=NXT.L ‘Reckitt Benckiser Group PLC’ 2013 Historical Prices. Yahoo! Finance UK & Ireland. Retrieved 24 March 2013 from http://uk.finance.yahoo.com/q/hp?s=RB.L Fabozzi, F J 1999 Investment Management. Prentice Hall Kaptan, S S 2001 Investment Management. New Delhi: Sarup & Sons Mangram, M E 2013 ‘A Simplified Perspective of the Markowitz Portfolio Theory.’ Global Journal of Business Research (GJBR). 7(1): 59-70 Miles, J & Shevlin, M 2001 Applying Regression and Correlation: A Guide for Students and Researchers. London: Sage Publications Reilly, F K; Brown, K C 2012 Investment Analysis & Portfolio Management, 10th edition. Mason, OH: South-Western Cengage Learning Appendices Read More
Cite this document
  • APA
  • MLA
  • CHICAGO
(Investing and Financial Markets Essay Example | Topics and Well Written Essays - 1500 words, n.d.)
Investing and Financial Markets Essay Example | Topics and Well Written Essays - 1500 words. https://studentshare.org/finance-accounting/1798731-investing-and-financial-markets
(Investing and Financial Markets Essay Example | Topics and Well Written Essays - 1500 Words)
Investing and Financial Markets Essay Example | Topics and Well Written Essays - 1500 Words. https://studentshare.org/finance-accounting/1798731-investing-and-financial-markets.
“Investing and Financial Markets Essay Example | Topics and Well Written Essays - 1500 Words”. https://studentshare.org/finance-accounting/1798731-investing-and-financial-markets.
  • Cited: 0 times

CHECK THESE SAMPLES OF Investing and Financial Markets

Investing in the International Financial Market - Bermuda Offshore Product and Legal Implications

The paper "Investing in the International Financial Market - Bermuda Offshore Product and Legal Implications" finds out the different types of financial markets, determines the role of financial markets, as well as the legal implications of using financial markets.... financial markets are the kinds of markets in which people trade commodities and securities at a valuable cost.... There are different types of financial markets that are used for marketing internationally....
62 Pages (15500 words) Dissertation

Amazons Business Model and the Operational Strategies

This essay evaluates Amazon's business model and the operational strategies that underlie it they greatly resemble those of its key competitor Barnes & Noble.... Amazon.... om uses pure play strategy as it conducts the sales of its products and services to its customers entirely via the Internet....
4 Pages (1000 words) Coursework

Earnings per Share, Dividend, and Current Year Performance of Volkswagen and Mercedes-Benz

The Volkswagen company employs 400,000 people to produce about 30,000 vehicles each day and markets its vehicle in 153 countries.... The astounding company results are attributed to its investment in new products, manufacturing operations in the emerging markets like China.... The company plans to invest heavily in developing markets simultaneously consolidating its position in developed regions such as Europe and the Americas.... The revenues from the developed markets were down substantially which were partially offset by the reasonably good performance of emerging markets....
9 Pages (2250 words) Case Study

Operating, Investing and Financing of a Firm Abroad

Details of firm's operating, investing and financing activities are given below: Operating Activities Firm has been able to generate profit from its continuing business and has shown that its operating activities have been affected by reversal of its provisions.... Details of firm's operating, investing and financing activities are given below: Operating Activities Firm has been able to generate profit from its continuing business and has shown that its operating activities have been affected by reversal of its provisions....
3 Pages (750 words) Essay

A Critical Analysis of Bermudas Offshore Product and Legal Implications

In financial markets, two forms of markets namely general and specialized markets may be identified.... In the opinion of McCormick (2010), “general markets involve the trading of commodities and securities of different kinds to different people whiles the specialized market involves the trading of a particular type of commodity.... Investing in the International financial Market: A Critical Analysis of Bermuda's Offshore Product and Legal Implications CHAPTER ONE 1....
43 Pages (10750 words) Dissertation

EUROPEAN FINANCIAL CRISIS AND FINANCIAL MARKETS

This paper analyzes the impact of the Euro zone debt crises on the financial markets.... This paper analyzes the impact of the Euro zone debt crises on the financial markets.... Equity markets and the Euro zone Financial Crises: Farlow (2013) denotes that another term used to refer to the equity market is the stock market.... Equity markets are a very volatile segment of an economy, and companies can use this type of a market to raise capital for their expansion and growth....
6 Pages (1500 words) Essay

Market Failure

This paper "Market Failure" discusses the stock markets that are not for the chicken-hearted.... markets had to face a huge downturn, with a loss of 770 points in a single day.... These market fluctuations in the US exerted a profound influence on world markets.... Once the US market tumbled the markets around the world followed suit.... Some Asian markets even lost 40% (China)while others lost almost 60% (India) in a matter of months....
6 Pages (1500 words) Case Study

Analysis of Distressed Financing

There may be many internal as well as external factors that may cause a company to declare bankruptcy and opt for restructuring as a way to fight bankruptcy.... The economic downturns in the recent few years have caused the liquidation of a number of companies across the globe.... In.... ... ...
12 Pages (3000 words) Research Paper
sponsored ads
We use cookies to create the best experience for you. Keep on browsing if you are OK with that, or find out how to manage cookies.
Contact Us