Beta coefficient is a comparative measure of how the stock performs relative to the market as a whole. It is determined by plotting the stock’s and market’s returns at discrete intervals over a period of time and fitting (regressing) a line through the resulting data points. The slope of that line is the levered equity beta. When the slope of the line is 1.00, the returns of the stock are no more or less volatile than returns on the market. When the slope exceeds 1.00, the stock’s returns are more volatile than the market’s returns. The beta coefficient is a key component for the Capital Asset Pricing Model (CAPM), which describes the relationship between risk and expected return and that is used in the pricing of risky securities. The important types of stock beta used in financial analysis are historical beta, adjusted beta and fundamental beta. An historical betas are Continue reading
Investment Analysis
Investment Diversification
Diversification is the strategy of combining distinct asset classes in an investment portfolio in order to reduce overall portfolio risk. In other words, investment diversification is the process of selecting the asset mix so as to reduce the uncertainty in the return of an investment portfolio. Diversification helps to reduce investment risks because different investments may rise and fall independent of each other. The combinations of these assets will nullify the impact of fluctuation, thereby, reducing risk. Most financial assets are not held in isolation, rather they are held as parts of portfolios. Banks, pension funds, insurance companies, mutual funds, and other financial institutions are required to hold diversified portfolios. Even individual investors – at least those whose security holdings constitute a significant part of their total wealth – generally hold stock portfolios, not the stock of a single firm. Why is it so? An important reason is the lowering Continue reading
Risk-Return Trade off
Risk may be defined as the likelihood that the actual return from an investment will be less than the forecast return. Stated differently, it is the variability of return form an investment. Financial decisions incur different degree of risk. Your decision to invest your money in government bonds has less risk as interest rate is known and the risk of default is very less. On the other hand, you would incur more risk if you decide to invest your money in shares, as return is not certain. However, you can expect a lower return from government bond and higher from shares. Risk and expected return move in one behind another. The greater the risk, the greater the expected return. Financial decisions of a firm are guided by the risk-return trade off. These decisions are interrelated and jointly affect the market value of its shares by influencing return and risk of Continue reading
Sub Categories of Active Equity Management
Some of the major sub categories of the two major style of active equity management (top down and bottom up) are listed below; Growth managers: Growth managers can be classified as either top-down or bottom-up. The growth managers are either divided into large capitalization or small capitalization. The growth managers buy securities that are typically selling at relatively high P/E ratios, due to high earnings growth rate, with the expectation of continued high earnings growth. The portfolios are characterized by high P/E ratios, high returns, and relatively low dividend yields. Market timers: The market timer is typically a set category of top-down investment style and comes in many varieties. The basic assumption is that he can forecast the market i.e. when it will go up or down. In the sense he market timer is not too distant than the technical analyst. The portfolio is not fully invested in equities. Rather Continue reading
Naïve Diversification of Investment Portfolio
Portfolios may be diversified in a naïve manner, without really applying the principles of Markowitz diversification, which is discussed at length in the next paragraph. Naïve diversification, where securities are selected on a random basis only reduces the risk of a portfolio to a limited extent. When the securities included in such a portfolio number around ten to twelve, the portfolio risk decreases to the level of the systematic risk in the market. It may also be noted that beyond fifteen shares, there is no decrease in the total risk of a portfolio. Before discussing about portfolio diversification process, what the researches of investors and investment analysts have found is to be set out briefly. Firstly, they found that putting all eggs in one basket is bad and most risky. Secondly, there should be adequate diversification of investment into various securities as that will spread the risk and reduce it; Continue reading
Introduction to Financial Instruments
Often investors invest through financial assets or financial instruments or securities. Investments that represent debt, ownership of a business or a legal right to acquire a part of ownership interest in business are called securities. There are a number of financial instruments which are traded in the money market. The important financial instruments are Treasury Bills, Certificates of Deposits, Commercial Bills, Commercial Papers, etc. The money market instruments have maturity period upon one year. Money market instruments are highly liquid, short-term debt instruments which mature in less than 12 months, and normally pay continuously varying returns. These involve no or very little degree of risk. The money market instruments pay return to investors in the form of discount at the time of issue. On the other hand, Capital market has instruments of longer maturity period. These instruments are : Ownership Securities : Equity Shares, Preference Shares, and Cumulative Convertible Preference Continue reading