Investment Analysis Definition - Assignment Example

Answers Name of the student Name of the Institution Date of submission Q1. Explain each of them Mix- The total asset mix of a given investment portfolio determines its overall return this is prompted by the fact that each asset contains risk return tradeoff. Holding period- The higher the holding period the higher the return on the investment Business risk – the more riskier the business the higher the return Political environments with unstable political environment give a more risky and low return compared with stable political environment Q2. Explain the purpose and function of a capital market? Capital market helps in providing alternative source of long term finance for companies and investment which assist in spreading stresses on the financial institution. It further helps in providing equity capital and infrastructure development and capital which has long term benefit to the socio-economic. Capital markets give Alternative Avenue for investment opportunities that help in encouraging thriving culture on the entrepreneurs resulting in increased domestic savings and investment ratio which is very important for industrialization in an economy. Q3. Clarify in detail the distinctiveness that determines the quality of a capital market? Capital market can be said to be the one for relatively long term financial instruments, it should have both primary markets and secondary markets. It is characterized by public issuance which involves the sales of bonds to the general public, when companies issues security to the general public through an investment bank, privileged subscription where the options available for members only. Lastly, private placements where the sale of a complete subject of unregistered securities (normally bonds) directly to one purchaser or a group of purchasers and financial intermediaries is done, that shows the presence of standby arrangements. It further indicates the financial intermediaries’ own securities flow to the savings sector. Q4. Primary and secondary markets A primary market can be defined as a market for securities are buying and selling for the first time that is a “new issues” market while secondary market can be defined as a market for existing (used) securities rather than new issues. Q5. Explain the specific factors that contribute to an efficient market? Factors that affect market efficiencies include time frame of price adjustments, transaction costs and the cost of acquiring information, market value verses intrinsic value among other factors. Q6. Efficient market hypothesis Overall efficient market hypothesis states that it is not possible to hit the market due to the fact that stock market competence causes obtainable share prices to always incorporate and reflect all relevant information. The other three are first; strong form of EMH which states that market is competent if all information pertinent to the value of share, whether or not generally available to existing or potential investors, is quick and accurately reflected in the market place. Second one is the semi strong form of EMH which is slightly less rigorous form, the EMH states that market is efficient if all relevant publicly obtainable information is quickly reflected in the market place while the third and last one is the weak form of EMH which confines itself to just one subset of public information, namely historical information about share process itself. It states that new information must by definition be unrelated to the previous information otherwise it would not be new information. Q7. Explain each with example liquidity Liquidity: the common ration that determines company liquidity includes current ratio, Quick ratio and Operating cash flow. It determines the firm’s ability to pay off its short term debts and obligations. In most cases the higher the ratio the better. In order to measure firms operating performance ratios to use include fixed asset turn over which is calculated as Another ratio is sales. Revenue per employee which measure productivity of every employee, it is calculated as follows The ratio that determines the company riskiness includes asset coverage ratio, capitalization ratio, and equity multiplier among others. The ratio that measure a company growth potential includes return on equity and DuPont system, it is given by G = RR * ROE Where: RR = retention rate = % of total net income reinvested in the company or, RR = 1 - (dividend declared / net income) ROE = return on equity = net income / total equity On the external liquidity, market Liquidity is the ability to buy or sell an asset quickly with little price change from a prior transaction assuming no new information. External market liquidity is a source of risk to investors. The most important factor of external market liquidity is the dollar value of shares traded, it can be estimated from the total market value of outstanding securities, and it will be affected by the number of security owners and numerous buyers and sellers provide liquidity. Q8. The DuPont analysis It helps in showing that both the net profit margin and asset turnover reduces, two negative signs for company and the only reason ROE stayed the same was a large increase in leverage. The three step DuPont calculation is given as follows Q9. Risk Aversion Risk aversion is when an investor selects investments which are less risky with expectation that investment with high risk must be accompanied with high returns. Risk aversion is simply avoiding riskier investments. Q10. Explain the basic assumptions behind the Markowitz portfolio theory? The assumptions include; Investors normally estimates risk based on the variability of expected returns Investors normally base their decisions mostly on expected return on risk Investors normally maximize one time expected utility and their curves explain diminishing marginal utility of wealth. Q11. Risk can be defined as uncertainty of future outcomes or the probability of an adverse outcome. Some alternative measures of risk in investment include the measure of variance and the standard deviation, the covariance and correlation. Q12 What is the major assumption of the capital asset pricing model? Explain each assumption The CAPM assumes that security markets are usually perfectly competitive with many small investors and the investors are price takers. Secondly, it assumes that markets are frictionless and there are no transaction costs or taxes in the market. Thirdly, investors are myopic in nature since all have similar holing period and lastly, investments are usually limited to publicly traded assets with unlimited borrowing and lending at the risk free rate Q13. What is a risk-free asset and what are its risk-return characteristics? An asset which has some specific characteristics returns like the treasuries bills are usually considered as risk free assts since they are normally backed by their respective governments. They are normally backed by the government and their prices are close to market interest rates. Q14. Define portfolio management. How do we measure diversification for an individual portfolio? This is the process of managing more than one portfolio which includes identifying, prioritizing, authorizing controlling and programming related work to achieve specific objectives. The diversification of portfolio in its management helps in reducing risk in the business which results into success of the business. Q15. What is systematic and unsystematic risk? How they affect the business? Explain. Systematic risk can be defined as a risk which is inherent to the entire market or an entire market segment. It affects overall market’s performance. It is also called undiversifiable risk or market volatility or market risk. Unsystematic risk on the other hand is risk which affect only specific investment portfolio and the investor is capable of avoiding it. It does not affect the entire market but they are risk, which are inherent to specific investment portfolio. Q16. How does the goal of a passive equity portfolio manager differ from the goal of an active manager? Explain Passive portfolio manager have long term by and hold strategy, they normally have track an index overtime, design and match market performance. The active portfolio management portfolio usually attempts to outperform a passive benchmark portfolio on a risk-adjusted basis Attempt to duplicate the presentation of a directory, may slightly underperform the aim index due to fees and commission and Strong underlying principle for this approach Read More