Dubai Financial Markets Stocks: the Methods to Measure Risk - Research Paper Example

number Introduction There are many different ways and methods available to measure risk. In most financial publications, there is the common use of alpha, beta, standard deviation, Treynor, and shape ration methods (Hartman and Sprenger 37). Out of all these, standard deviation remains to be the best tool in understanding financial risks of a stock portfolio. The key idea is that when measuring the standard deviation one is able to measure the volatility of the stock. A more volatile stock is one where the stock’s returns have a higher variation from the stock’s average return (Dorfman 68). It is advisable to measure standard deviation of the stock portfolios returns rather than the range because the former gives a clear volatility measure. It is better to understand the pros and cons of risk in order to understand the importance of carrying out standard deviation on stock portfolios. It is common for people to try to avoid risk in all directions. This is because many people view risk from a negative perspective and prefer to avoid it through all means. However, this is not the game in the investment world. This is because risk is an attached factor that relates to performance directly. It can be either desirable or undesirable but again this is necessary for there to be any progress in the investment world (Blackburn par 9). In financial markets, risk can be either good or bad. It necessarily depends on doing the correct analysis and knowing when to invest (Dorfman 217). The important thing is to understand risk and its effect on stocks. This assists individuals in understanding and applying some financial tool such as standard deviation. In this case, standard deviation defines the probability of the spread in a series of data. Therefore, it becomes necessary and part of decision making when dealing with stocks. The essential stocks to be analyzed from Dubai Financial markets include stocks for Dubai Financial Market and stock for Emirates NBD Bank. These stocks are the best performing stocks on the Dubai Financial Market. The selection process involved going through the latest news articles and finding out the best performing securities in the market. Given that my company is a bank, I had to choose data that relates to the banking industry. I compared the performance and volatility of both institutions in the banking industry and the investment and financial institutions. The last criteria for choosing the stock are based on the companies’ data, which is widespread and diverse. It provides a good basis for testing financial data and calculations on stock. On the graphs provided, the stocks are labeled as stock A that represents stock data from Dubai Financial Markets and Stock B representing stock data from Emirates NBD. Stock A: Dubai Financial Market Stock B: Emirates NBD Graph showing the standard deviation and return of each stock. Daily Annualized standard deviations vs. Daily Actual standard deviations Actual returns vs. Annualized returns Graph The effect of the global financial crisis, which started on 15 September 2008 after Lehman Brothers’ crash On the September 15, 2008, the US experienced the largest bankruptcy filing in history. Lehman Brothers a firm with assets worth $639 billion and $619 billion in debt filed for chapter 11 bankruptcy protections making it the largest financial demise in history because of its assets (Anderson and Dash 13). The firm was doing well since its early years to the extent of withstanding some historical booms and busts. This included the 1930 Great depression, railroad bankruptcies, a capital shortage, and 2 world wars. The firm began to have problems after getting into leveraging business, which involved borrowing significant amounts of funds for its investment. Most of these funds were invested in the housing assets, which was an unstable market. The key cause of the collapse is related to the Aurora Loan Services and subprime lender BNC Mortgage (Bruno 40). The bankruptcy and collapse of the Lehman Brothers’ was the beginning of a disastrous financial crisis. One of the most affected industries was the money market. The independent money markets fund had to break down because of its association with the company as it held a commercial paper from Lehman Brothers. The depositors started to panic when they realized that the money market had to “break the buck” because of insufficient funds causing them to restrict redeeming shares at par. The stock markets panic spread over to the financial markets like wildfire. Things started falling apart in 2007 when the stock reached a record high of $86.18. This made Lehman to expand its market capitalization greatly closing in to $50 billion (Bruno 40). After the first quarter of 2007, things started falling apart after the housing market started showing cracks, evidently in the subprime mortgage, which went up to a seven-year high. The advantage rose to a high degree with the ratio of shareholders’ equity to the ratio of total assets standing at 13 in 2007. The large portfolio of mortgage securities increased its vulnerability to the worsening market conditions. Lehman’s shares fell more, down to 48% after the near collapse of the second leading benefactor of mortgage-backed securities - Bear Stearns (Blackburn par. 6). An issue of preferred stock raised hopes for the firm in April 2008 leading to the company raising $4 billion. Afterwards, the stock continued its decline making hedge fund managers to inquire the assessment of Lehman’s mortgage portfolio. In September, the stock fell to a low of 77%, after questions started trickling in to the CEO. The firm took drastic measures making it to start selling its assets and turning off the marketable real estate assets (Anderson and Dash 14). The collapse of Lehman has agitated worldwide financial markets over many weeks since the firm’s status was a key player in the U.S and international markets. One of the problems that caused financial crisis was under estimation of the risk factors in the market. This made Lehman’s corporation to invest in too many risky ventures. From the graphs highlighted on the two portfolios, the normal standard deviation shows a minimal risk than when taking an annualized standard deviation. Use of an annualized standard deviation could have saved the situation as it portrays a large area of potential risk. Therefore, the investors could have foreseen the dangers and necessary measures taken to maintain the securities. The following graphs indicate financial statistics on a monthly basis Graph showing the standard deviation and monthly return of each stock. Monthly Annualized standard deviations vs. Monthly actual standard deviations The monthly data is more reliable in showing the trend of the stocks as compared to the daily data. One can easily asses and analyze the monthly data and come up with conclusion in short periods. Dealing with stock markets requires spontaneity which means that decisions have to be made fast and the data has to be clear for this to be possible. Drawing the standard deviation and returns table are more accurate and consistent with the monthly financial data charts. On the other hand, the proxy standard deviation proves to be a more accurate measure of risk as its values spread to the extreme. From a quick glance at the analysis, one can be able to understand the risks involved in investing in the stocks by just looking at the monthly data. The annualized standard deviation is also more conscious of the risk area when compared to the daily standard deviation. Other tools that can be used to measure risk include the Bayesian Probability which is powerful tool assembled to assess stock portfolio risks (Hartman and Sprenger 216). The program generates computer programs and complex algorithms, which are used in financial markets across the globe. References Anderson, Jenny and Eric Dash . ""Struggling Lehman Plans to Lay Off 1,500"." The New Times 29 September 2008: 13-14. Newspaper. Blackburn , Robin. "Blackburn-The Subprime Crisis-New Left Review-March/April 2008". 29 April 2008. Web. 8 March 2013. Bruno, Joe Bel. ""Lehman shares slip on plans to auction off unit, consider sale of company"." The Seattle Times 10 September 2008: 40-41. Press. Dorfman, Mark S. Introduction to Risk Management and Insurance. New York: Prentice Hall, 1997. Hardcopy. Hartman, S. and J. Sprenger. ""Bayesian Epistemology"." Bernecker, S. and D. Ptritchard. Routledge Companion to Epistemology. New York: Routledge, 2011. 211-230. Document. Read More