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An Investment operation is one which, upon through analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative Investment Objectives Safety Regularity of income Capital gain Tax savings Liquidity Speculation Some speculation is necessary and unavoidable for in many common stock situations there are substantial possibilities of both profit and loss, and the risk therein must be assumed by someone. Speculation is unintelligent when Speculating when you are thinking you are investing Speculating when you lack proper knowledge and skill for it Risking more money than you can afford to lose. Speculation beneficial on two levels For untested new companies to raise capital Risk is exchanged but never eliminated every time a stock is bought or sold (buyer has primary risk of prices going down and seller has a residual risk the chances of prices going up) Investment Decision An Investment is a commitment of funds for a period of time to derive a rate of return that would compensate the investor for the time during which the funds are invested, for the expected rate of inflation during the investment horizon and for the uncertainty involved. If estimated intrinsic value of the security is more than prevailing market price --- Buy or hold the security
E(Rp) = S wi E(Ri)
i =1
Where:
E[Rp] = the expected return on the portfolio n = the number of stocks in the portfolio wi = the proportion of the portfolio invested in stock i E[Ri] = the expected return on stock i
Diversification
Investing in two assets with an imperfect correlation between assets or a correlation coefficient of anything less than +1 will diversify our investment portfolio. We can benefit from the positives of diversification by holding both the assets, instead of just one. As the number of assets increase, the standard deviation of the rate of return of that portfolio reduces effectively narrowing down the range in which the average rate of return would fall As the number of assets increase, the standard deviation of the rate of return of that portfolio reduces effectively narrowing down the range in which the average rate of return would fall.
Efficient Frontier
A set of optimal portfolios that offers the highest expected return for a defined level of risk or the lowest risk for a given level of expected return. Portfolios that lie below the efficient frontier are sub-optimal, because they do not provide enough return for the level of risk. Portfolios that cluster to the right of the efficient frontier are also sub-optimal, because they have a higher level of risk for the defined rate of return.
Prof. Harry Markowitz published his doctoral thesis Portfolio Selection in 1952, marking the beginning of what is known as MPT. He demonstrated that for every level of risk it is possible to construct an investment portfolio that, mathematically, delivers the maximum investment return.
A given point on an indifference curve represents a combination of risk and return that yields the same level of utility as any other point on that curve. Indifference curves that are to the northwest of any other curve represent higher levels of utility. A portfolio with a greater level of risk for the same return (i.e., moving in the eastern direction) makes this individual worse off. Portfolios with higher returns for similar levels of risk (i.e., moving in the northern direction) makes this individual better off.
Risk Aversion
Risk aversion refers to the behavior of investor of preferring less risk to more risk Risk averse investors Prefers lower to higher risk for a given level of expected return Accept high risk investment only if expected return are greater
Systematic risk : This is non-diversifiable risk that refers to the portion of a stocks risk that is attributable to factors that affect all stocks to some degree. These risks are out of external and uncontrollable factors, arising out of the market, nature of the industry and the state of economy thus it cannot be reduced by diversification. The risk factors that affect the entire market are systematic risk . For ex. Economic news, natural disaster, oil prices or interest rates etc
Unsystematic risk : These are company unique risk or diversifiable risk are all terms that refer to that portion of a stocks risk that is attributable to factors specific to that one stock. Thus this risk can be offset by investing in stocks that do not share that factor. Example include : Lawsuit outcomes/filing; Regulatory rulings; Issues with management team/labour relations ; New product launch/R&D breakthrough OR Systematic Risk Market Risk changes in the market condition (demand and supply cycle) Interest Rate Risk Changes in interest rates as it affects the borrowing cost Purchasing Power Risk changes in the inflation rate leads to rise in cost of production, lowers margin, rise in wages etc. Countries credit rating GDP Unsystematic Risk Business Risk relates to variability of the business, sales, income and profit. Financial Risk relates to the method of financing adopted by the company, high leverage leading to short term liquidity problems etc. Default or insolvency Risk - delay of default of the payment. Asset specific risk liability law suit against company, new product announcement, companies credit rating etc.
Beta
Beta is the measure of market risk (systematic risk) It is a relative measure of volatility that is determined by comparing the return on a share to the return on stock market as a whole. The greater the volatility, the more risky the share and the higher the Beta What does the beta tells A beta of 1 implies the asset has same systematic risk as the overall market (will be expected to generate returns equal to the market) A beta < 1 implies the less systematic risk than market risk. Portfolio with low beta will not lose as much value as the market average (in bearish conditions) and losses will be considerably lower than for a portfolio with a high beta. A beta > 1 implies that more systematic risk than market. In the rising market, the stock would rise faster than the market average, ie outperform the market.
Trend Lines
There are three basic kinds of trends: An Up trend where prices are generally increasing. A Down trend where prices are generally decreasing. A Trading Range.
Momentum Oscillators
Momentum oscillators are reduces the problem of sharp changes in market sentiments that are out of ordinary. They are constructed using price data but they are calculated so that they either oscillate between a high and low. (0 to 100) Technicians look for convergence or divergence between oscillators and price. Convergence is when oscillators moves in the same manner as the security. Whereas divergence is when the oscillators moves differently from the security. Oscillators alert traders to overbought or oversold conditions
Candlestick chart
The candlestick can be created using the data of high, low, open and closing prices for each time period that you want to display. The hollow or filled portion is called the body. The thin lines above and below the body represents the high and low range and called shadows Japanese candlesticks offer a quick picture into the psychology of short term trading, studying the effect, not the cause. Applying the candlesticks means that for short term, an investor can make confident decisions about buying, selling or holding an investment.
Wealth Management
Wealth management defined as an all inclusive service to optimize, protect and manage the financial goal of an individual, household, or corporate. It ensures an enduring and committed relationship for a long tenure by taking care of the entire client needs. It is a comprehensive model, which can offer guidance on investment management, tax planning, asset protection, cash flow management, debt management, retirement solution and real estate investment. Wealth manager looks after the financial well-being of his client. His efforts are devoted to assisting clients to achieve life goals through the proper management of their financial resources. On the other hand Investment Management is the art of selecting investments such as stocks, bonds, and derivatives and combining them in a way that compliments a clients specific risk-to-reward requirements
Greedy clients (short term result oriented) Goal Setting understand and prioritizing clients goals Hidden goals (clearly defined and quantified unexpected risks and corresponding cost issues critical to the return generating process) Time-bound goals (clear understanding of a clients time frame) Intermediate goals (consciously anticipated, are finite in time) Lifetime (retirement) goals Consumption-oriented goals (sufficient wealth to fund a current level of annual living expenses) Goal Prioritization many financial goals for specific consumption at specific times. Assist their clients in setting priorities among goals.
Time Dimension - classify mid-term, short-term and long term goals, prepare time schedule Data Gathering help the wealth manager to understand the clients needs and allocate his assets accordingly. Personal Interview Personal Data Existing portfolio, including existing loans Expected returns and their tax impact Post-retirement assumptions Questionnaire A standardized/customized questionnaire may be used including questions on behavioral psychology, finance and investment theory or decision science. Personality Test (on risk profile) Indirect questions (to validate the direct answers) Direct and numerical questions (questions related to portfolio design) Model Portfolios (select own allocation from a variety of choices) Constraints - Their will be some constraints which will limit clients ability to achieve the stated goals. Time Horizon Liquidity Marketability Risk Risk Profile Age Value of pre-owned assets Types of pre-owned assets Financial responsibilities Income-earning capacity Tax planning
Investment Strategies 1. Value Investing Advocate of this strategy Warren buffet / Fisher Russell Identify undervalued asset (dirt cheap) Will outperform in future Based on fundamental analysis take time for market to recognize the undervalued asset 2. Dividend investing strategy Company generating cash cash flows Not borrowing and paying out dividend & leveraging up the balance sheet Cash dividend or other way of payment 3. Contrarian Investing Whenever everyone is buying you should offload/sell When everyone is selling you should buy Based on behavioral finance / market sentiments 4. Momentum Investing Identify a trend invest in to trend expect trend will persist Most primitive of all investing strategies Doing some technical analysis short term investing Intermediate (big institutional investors) 5. Passive Investing Market is efficient buy and hold for long term Indexing replicate particular index well diversified portfolio not high return (market return) Up purchase down short sell 6. Active Investing Do some kind of analysis and choose specifically and intentionally 7. defensive investing strategy When micro economic downturn the stocks out perform the market (these stocks are called defensive stock) food, pharmaceuticals, Identify business cycle 8. Market Timing Use of entry and exit point Time the market to enter your position Buy at or close to bottom / sell at or close to top Use mostly technical analysis Use behavioral finance / study of market sentiments 9. Buy and hold strategy Combination of active, market timing, defensive, value investing, dividend, contrarian strategies Equals to long term investing strategy