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
Investment Analysis
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
Random Walk Theory
History of Random Walk Theory The term ‘Random Walk’ was popularized by the 1973 book, “A Random Walk Down Wall Street”, by Burton Malkiel, Professor of Economics and Finance at Princeton University. Burton G. Malkiel, did a test where his students were given a hypothetical stock that was initially worth fifty dollars. The closing stock price for each day was determined by a coin flip. If the result was heads the price would close a half point higher, and subsequently if the result was tails, it would close a half point lower. Each time there was a fifty-fifty chance of the price closing higher or lower than the previous day. There were cycles or trends determined from the tests. Malkiel then took the results in a chart and graph form to a chartist (a person who “seeks to predict future movements by seeking to interpret past patterns on the assumption Continue reading
Duration and Portfolio Immunization
Portfolio Duration Duration is a significant measurement of how sensitivity the change in price of a bond in the change of interest rate. It is broadly linked to the length of time before the bond is mature. Duration assists investors during the investment decision making process by expressing the relation between interest rate and price variables of the bond. Therefore, duration is useful measurement for investors because it protects investment from interest rate risk. When the duration of bond is lower that means investors can obtain the cash earlier and reinvest it at prevailing interest rate. As a result, the lower the duration of a bond, the lesser sensitive changes in the interest rate. Majority of investors are familiar with maturity which is the point of time when investors get back the principal of bond. However, duration is defined as the length of time before the maturity of the bond. Continue reading
Diversification of Risk in Portfolio Management
Average investors are risk averse. Therefore, they will be ready to invest into securities under the presumption of an adequate compensation for risk taking. The compensation for the risk taken should be in the form of minimal rate of return for the invested financial assets, and the rate is named the required rate of return. It has two components: Delayed consumption compensation (investors could have purchased goods and services with the assets they are to invest) and Risk acceptance compensation. Diversification is used to stabilize the potential return, and thus increase the value of the investment. Diversification stands for he investment of capital into several different securities or projects, all together called the portfolio. Each security or project entails certain risk; however, the only thing that matters to the investors who diversify their investments is the total risk (portfolio risk) and the portfolio return. There are two types of risks Continue reading