Financial Planning and the Unsystematic Risk Statistics - Assignment Example

Financial Planning and the Unsystematic Risk Statistics Question 1 a) An efficient frontier refers to a system that comperes investment options through offering a description for each asset class or investment through math with the use of unsystematic risk statistics. This application is possible in the portfolios containing investment options. In the system, the line representing the efficient frontier offers the optimum combination of the risk and return while a single dot is a representation of a portfolio. b) The reason behind the manufacture of dry weather tyres in a country like UK is because they are suitable during summer. Therefore, during winter, people will prefer buying winter tyres and and when summer sets in, the demand for dry weather tyres will be high. c) i. The best asset for Gemma to choose is Rolls-Royce since it has the the highest monthly real return coefficients. This implies that they will guarantee a high interest as opposed to those with low return percentage. ii. The following outcomes show the optimal proportions of the shares in Gemma’s portfolio objectively to minimize risks. BskyB = 0.15/1.26 = 0.12*100 = 12% Glaxo = 0.12/1.26 = 0.095*100 = 9.5% Diageo = 0.37/1.26 = 0.29*100 = 29% Rolls-Royce = 0.40/1.26 = 0.32*100 = 32% Tesco = 0.22/1.26 = 0.17*100 = 17% d) i. The remaining shares that that can allow a high return of above 20% but a risk of less than 5% risk is: Rolls-royce 0.40 Diageo 0.37 ii. The share that can allow the minimum risk with the achievement of at least 20% return is: Rolls-royce 0.40 iii. Proportion in the new portfolio: = 0.12/(0.12+0.15+0.22+0.37+0.40) = 0.12/1.26 = 0.095% e). The objective of making an analysis of a company’s fundamentals is to find the intrinsic value of the stock as opposed to the value with which the stock trades at in the market. Therefore, in carrying out an analysis, if the intrinsic value happens to be more than the current share price, then it shows that the stock is worth much value than its price and it makes sense in buying a stock. However, if this is not the case, then using the stock-analysis strategy like in the case of Gemma is not useful. In addition, the stock-pricing strategy offers a lot of information in an intangible and unmeasurable manner. It is easy to find some aspects of the company that are quantifiable. Such aspects include profits and they are quite easy to find. However, it is quite difficult to measure the qualitative factors such as the competitive advantages of a company, company staff and the reputation of the company. Therefore, the aspects make the picking stocks a subjective and intuitive process thus not suitable in such a case. In addition, the human element evident in the forces moving the stock market, the stocks cannot do whatever one anticipates that they will do since there is a likelihood of having a change in emotions quite unpredictably. Therefore, when confidence turns into som fear, th stock market can be a bit risky and dangerous. Therefore, this also contributes to the decision by Gemma not to use the stock-pricing strategy. Question 2 a. i. In order to protect their portfolio of shares, Mark Brisley and Evie Petrikkou used the call and put options. The put option allowed them to sell assets at a given agrred on price while the call shows the right to buy shares at an agreed price (Taylor 2013). ii. For Mark Brisley and Evie Petrikkou to increase their income, they could sell shares lets say 100 that they bought at $50 which is a higher price for $200. If the stock goes down, then they would keep the money let the call expire. When the stock goes up lets say to $58, then they would keep the shares and have a gain of about $800 (Taylor 2013). b. If one makes a call option and then the stock happens to go up, then the person will keep the initial profit or investment and gain some amount on top as a profit. In this case, the person would have gained more profit between a given range. However, in such a case, it follows that the person will also losean extra amount per every share that he gains because each share should be sold at a higher price that will have been a call (Taylor 2013). From the scenario explained in the porevious paragraph, it is clear that if a person remains without any shares, then there is a possibility of having more losses per share. Therefore, the person may end up remaining without any shares. c. Option trading is very risky and baby boomers have to take caution while entering into the trading industry. One of the risks is the ability to make the correct market analysis. The market analysis will guide one into making a trade that will guarantee profits. Therefore, baby boomers more often than not just make a trade without proper consideration of the market trends or economy (Taylor 2013). The second mistake that baby boomers make is having emotional trades. This is very risky as it guarantees total failure in the trade. Instead of proper examination of the market trend, the baby boomers think about the returns that they can gain if they choose to make a particular trade as opposed to another. This trading is very risky an can lead to loss of even the initial investment thus frustrating the trader. d. The market of derivatives has its own negative effects. This results from the fact that sone of the existing financial items have their values relying on other securities. For instance, in the stock market, the price of buying and selling of currencies depend on each other. Thereofore, changes in one currency either positively or negatively will have the effect of creating a situation in which the system is unstable in terms of one currency relative to another. In such cases, then the systemic risks in option trading will increase because one cannot be certain of any changes at any given moment. This results in some instability that one has to analyze carefully before deciding to make a trade with low risks of getting a loss (Taylor 2013). Question 3 There are different investment approaches in business. The main approaches include active and passive investments that various business persons employ in their business dealings. They have different rates of returns and ultimately, there is an option that works best depending on various circumstances as opposed to the other. The performance indications refers to the means by which one can judge an objective as achieved or no. They are tied to goals and objectives measuring the degree of success in terms of goal achievement. The use of perfomance indicators and other investment approaches determine the performance of a company in terms of returns (Mazzucato et al. 2010). Performanc indicators refer to the measurable values that serve to demonstrate the effectiveness that a business process has in making a contribution to the attainment of fundametal business objectives. Through the monitoring of the correct key performance indicators, one can gain valuable insights into the performance of business. In addition, one cal also gain the strategic awareness that is suitable in making the correct decisions at the correct time. The performance indicators range from the sales to finance within a given company in the market. Passive investing is an investment strategy that involves limited activities of buying and selling. The passive investors always purchase investments with an intention of having long-term appreciation with limited maintenance. The investment strategy requires very detailed research, patience and a good portfolio. Unlike active investors, the passive investors buy securiies but do not actively attempt to benefit from the short term fluctuations in prices. They instead rely on their belief that long term investments are profitable (Mazzucato et al. 2010). On the other hand, active investing is a predominant strategy that tries to outperform the current market. The primary objective of active management is to beat a given benchmark and it involves active management of funds. The active managers constantly seek for information in order to help them to make viable invetment decisions that can guarantee business success. They use independent complex trading systems to implement investment ideas that they comeup with with a goal of outperforming the market (Mazzucato et al. 2010). Both active and passive management approaches have their own merits and demerits. In the use of active investment strategy, the primary advantage is that the active management can outperform the index as a result of their superior skills. They have the capability of making very informed investment decisions through their experiences. In addition, they have the ability, knowledge and insight suitable to identify opportunities capable of translating into superior performances. For instance, if they have a belief that the market can turn downwards, the active managers can take measures to increase their cash positions in order to reduce the impact of their portfolios (Mazzucato et al. 2010). On the other hand, one disadvantage that active investing has is that it is very costly. Therefore, it results to high operating expenses and fee. Having higher fee is an impedment in long term porformance. Thus, in an effort to beat the market, the active managers most likely have few securities with more concentrated portfolio. However, when the active managers have issues, they can underperform the market significantly. Passive management closely matches the existing performance of the index. Therefore, passive investing requires very little decision making by the respective managers. The managers try to make duplicates of the chosen index tracking it as effectively as possible. Thus, it results in low operating costs passed on to the investors in form of low fees. On the other hand, the investment manages passively cannot outperform the underlying index. In addition, the investor has to be satisfied with the performance oif the index. As such, the managers are not in a position to take action if they have a belief that the overal market will decline or the individual securities have to be sold (Mazzucato et al. 2010). Thus, from the above paragraphs, it is evident that active management is quite expensive than passive management because the active investors have the manadate to overcome numerous costs in order to match returns of average passively managed portfolios. In addition, the active management is far more risky than passive management. The reason is that active managers make attempts to choose securities that will outperform the existing market thus concetrate across relatively very few securities. Lastlt, the active managers do underperfom the active managers in all apects (Mazzucato et al. 2010). From the figures in the table 2 (Fund Performance Data), it is evident that the annual returns in the three years vary. There are may factors that may have a contribution to the varying rates of annual returns. However, one specific thing that is evident from the table, the starting return rates for the three companies, that is, Baillie Gifford, F & C and HSBC FTSE differ greatly. For instance, the first two companies using the active fund have their first year returns relatively low return rates as opposed to the thrid company using the passive return. Therefore, it follows that those using passive returns have quite a favourbale income. The data is not comprehensive though as it defeats logic. The performance of the companies using active investment is ultimately quite low averagely. Therefore, the main conclusion in such a case is that that is what mostly determines the performance of a company. The performance indicators that the company has laid down in order to ensure a favourable outcome support the whole in a bid to ensure success within the organization. The performance of the three companies is quire admirable. It is far above the negative returns though not very high. This shows that the risks are manageable but they are a threat to the three funds. Potentially, this forms the basis of having some quite excellent charges (Mazzucato et al. 2010). The data is a representation of a typical market scenario. It shows that the active investments so far have some excellent results. On the other hand, passive investment according to the data has also delivered awesome results. The main conclusion is that the two investment strategies have the potential od having very great perfromances under normal circumstances. However, there are times when each has its own outstanding performance. For instance, the active fund during the first year portrays a very high rate of return (23.2%), that no company has managed to achieve (Mazzucato et al. 2010). From the results, it is not that there is one fund that has the best results. Each of the two funds, both active and passive have their best and worst times in terms of return records. There are times when the active fund offers very excellent results while there are times when it also offers quite poor results that one caanot imagine. On the other hand, the passive investment has its times when it shows very high rate or return and this reduces drastically in other years. Therefore, each investment strategy highly depends of the input cooperant factors and management to enhance success (Mazzucato et al. 2010). In conclusion, a company can experience maximum performance using either passive or active investment strategies. What differs is the time that both will take to achieve the maximum returns. The two strategies have different levels of competency in terms of the rate of return and thus have effetive application depending on the mamagement strategies that one ca input to ensure ultimate success. Therefore, the business people should embrace both strategies for maximum benefit at all times since they seem to be a good combination in enhancing the success of any person earger to join the business world. References Mazzucato, M., Shipman, A., Trigg, A. and Lowe, J. (eds) (2010) Personal investment: Financial planning in an uncertain world, Basingstoke, Palgrave Macmillan/ Milton Keynes, The Open University. Taylor, C. (2013) ‘New baby boomer hobby: trading options’, Reuters, 9 July [Online]. Available at http://www.reuters.com/article/2013/07/09/us-options-boomers-idUSBRE9680U620130709 (Accessed 13 January 2014). Read More