London Stock Market Financial Information Management - Research Paper Example

Financial Management Introduction This report aims to create a portfolio of ten companies, listed on the London Stock exchange Market. An attempt has been put forward to provide a more insight into the company shares and create a portfolio, which will fetch the maximum return at a moderate risk level. Portfolio Theory One crucial concept, which most investors must be aware of, is the trade off between risk and return of any financial asset. There is a positive relationship between the expected return of a financial asset and the risk associated with it. Higher the risk of a financial asset, higher the return would be expected for the same to compensate the associated risk. So if an investor is intended to fetch more return, he or she must be ready to take on more risk on the portfolio. The conception of ‘Modern Portfolio Theory’ is based on this risk return trade off. Capital Asset pricing Model (CAPM) is one of the most crucial theories in the securities market to calculate the price of the securities. As per CAPM model, the expected return is calculated as Expected Return = Risk Free Rate+ Beta * Risk Premium, Risk Premium is calculated as the difference between the market risk and the risk free rate. The Risk free rate is the minimum return, an investor can expect to fetch from any risk free investment (Wan, n.d.). Beta is known as the market risk of the portfolio. If the movement of a stock is higher than that of the stock market, the stock would have a beta more than one. Low beta stocks have low risk associated to them and hence they fetch lower return. Answer to the question no 1: Creating the Portfolio There are some 3000 companies listed on London Stock market. To pick ten stocks from them is a thorny task for the investors. While choosing on the ten stocks the investors need to be very clear about his or her risk appetite. It can not be denied that to fetch a higher return, one has to go through the risky stocks. While creating the below provided portfolio, it has been assumed that the investor wants to take moderate risk on his or her portfolio. (Source: Reuters, 2010) The prices are in British Pounds. The transaction cost has been calculated as, Transaction cost = 1.1% * Total of the share price amount (Invested). The investor has £ 10,000 to invest on the London Stock Market. In creating portfolios, diversification is a crucial factor. It is used to diversify the risk of the portfolio. Each of the stocks has some risk attached with it, which is expressed through ‘beta’ of that stock. While accumulating a number of stocks in a portfolio, one must ensure that risk is optimally diversified. If the beta of a stock is more than 1, this means that the return of the stock is, on an average, will move in the same direction as that of the market, but with a greater extent. If the beta is in between 0 and 1, that means the stock will move, on an average, in the same direction as that of the market, but with a lesser extent. If a beta is equal to 1, that means that the stock will move in the same direction as that of the market, and to a same extent. If a beta is equal to zero, that means that the return of the stock is indifferent to that of the market. If a beta is less than one, which means that the return of a stock will move in the opposite direction with that of the market. From the above discussion, it is quite apparent that one must consider the diversification of the risk factor, beta, while choosing on the stocks to be included in the portfolio. It is better to include stocks with positive and negative betas in the portfolio, so that the risk can be mitigated. However, right now, the UK stock market is showing upward momentum. In a rising market, it is suggested to hold more stocks with positive betas. However, as the investor has been assumed to be moderate risk taker, stocks with mush high positive beta have been avoided. At the same time two stocks with much low betas have been added to diversify the risk. The portfolio consists of five stocks with betas less than 1; this has been done to match up with the risk appetite of the investor. However, more weights have been given to the stocks with higher positive betas. The companies have been chosen from diversified industries. The names of the companies have been provided below with the industry names in the brackets. Aberdeen All Asia INV TST Plc ( Investment Trust) HMV Group Plc ( Retailer of Entertainment Products) Cable and Wireless Communications Plc (Telecommunication) BP Plc (Oil & Gas Company) WPP (Advertising and Communication) Marks & Spencer (Retail Chain) Cairn Energy ( Oil & Gas Exploration and Production ) Oxus Gold Plc (Mining and Gold Mining ) EBIQUITY (Data analysis and consultancies) Balfour Beatty (Engineering and Construction) The companies have been chosen from a wide range of industries to diversify the risk attached to each of the companies. Industries like telecommunication and retail chains are among those few industries, unaffected in the recent recession. Any investment portfolio aims to fetch the highest possible return at a minimal risk. The expected return for any stock can be expressed using the return on investment measurement. The stocks, chosen here, have positive high return on investments, which is significant for an investment. The portfolio consists of stocks with low to moderately high prices. Most of the high priced stocks have high earning per share. The portfolio has a balance of stocks with both the high and low prices. The transaction cost in UK market comprises of two major costs; brokerage and clearing. Brokerage amount is 0.6 % of the transaction amount. The clearing charges have been decided on 0.5 % of the transaction amount (A.H. International Limited, 2006). The calculations are shown in the above table. Apart from the current stock prices, the change in prices has also been taken into account. Almost all the stocks have seen positive changes in their prices. In this rising stock market scenario, it is preferable to choose the stocks with beta value of more than 1, as these stocks are supposed to out perform the market. This is why more weightages have been allotted to the stocks with higher beta values. Almost 54 % of the allocated money has been invested in those stocks in the expectation of high return from those. Stock of the companies like HMV Group Plc, which has a beta value of 0.34, have been added to act as defensive stocks in the portfolio to mitigate the risk associated with other stocks in that portfolio. Oxus Gold Plc has the highest beta value of 1.66. Any investor with high risk appetite may like to invest more in this stock as there are more signs of the market investment. However, as the investor has been assumed to have moderate risk appetite, much less weightage has been allocated to this stock. The market is assumed as the most diversified and efficient portfolio. Highest weightage has been assigned to the company, Aberdeen All Asia Inv Tst Plc, whose return is supposed to move in the same direction as of the market, and that too with almost to the same extent. Cable and wireless communication has been doing quite well, even in the time of recession; so the investor can increase some weightage to this particular stock. All the other stocks, too, have been doing quite well for the last few periods and have noticed high positive changes in their share prices. This is one of the reasons why these stocks have been added to this portfolio. Any investment portfolio needs cautious monitoring and active review of its stocks in it. The investors needs to incorporate necessary changes in the chosen stocks or in the allocate weightages of stocks. Right now as the market is still quite volatile, one can expect a faster change in the market scenario. In such a case, investors will be able to fetch maximum profit through active management of his or her security portfolio. Overall, certain points have been critical while choosing stocks for the creation of the portfolio. The stocks have been accumulated keeping the diversification of risk factor in mind. At the very first a wide range of industries have been chosen to lessen the concentration risk of the portfolio, which could happen if the whole portfolio would be based on the companies operating in one or two such industries. Some of these industries have been those industries, which can even were mostly unaffected by the recent recession. No doubt, surely this will mitigate the attached risk to the whole portfolio. As market is known as the most diversified and efficient portfolio, stocks with a beta value near 1 has been given preference; so that a large portion of the behaviour of the stocks can be expressed using the movement in the stock market. Combination of stocks with beta more and less than 1 has been an addition to the risk mitigation processes; even the addition of a stock with a beta of 0.34 aims to defend the portfolio in long run. To reduce the risk further, an investor can consider some assets with negative beta values for his or her investment portfolio. As the market is getting its upward momentum, stocks with positive betas have been chosen to create the portfolio. Another factor, crucial in this case, is the share prices. Higher the share price, higher is the earning per share attached to it. However, looking at the amount to be invested, a number of stocks with low prices have been included. The inclusion of the low priced stocks is supposed to accelerate the growth of the overall portfolio expected return. The weighted average beta of the portfolio has been calculated in the above table. Weighted Average Beta of the portfolio = ∑ (Betai * Weightage i), Where I =1, 2, 3….10. The Weighted average beta of the Portfolio has come around 1.06. The Portfolio has almost the same beta as that of the market. The return of this portfolio will move in the same direction and almost to the same extent as that of the market. Answer to the question no 2 The below mentioned discloses the portfolio value on 15th of February and 31st of March, 2009. (Source: Yahoo Finance, 2010) As 15th February was a Sunday, the previous day, on which market was open, has been taken. The closing price of 13th February can be assumed as the closing price on 15th February, as the market was close for 14th February (Saturday) and 15th February (Sunday). The total value of the portfolio was more in the February and March of 2009, than that in present time. On 13th February, the portfolio value has been accounted for 13,960.85 GBP with out any transaction cost. After deducting the transaction cost, it has been come down to a value of 13807.28 GBP. Post transaction cost, the portfolio value on the last day of March had been around 13855.94 GBP. These facts means that even in the recession, the portfolio has done pretty well due to its diversification effects. The share prices for certain stocks have seen a decline. However stocks like HMV Group Plc, Cable and Wireless Communications Plc, Cairn energy, Oxus Gold Plc and Balfour Beatty have seen high growth in their share prices. As a consequence, the overall value of the portfolio has seen a rise, even in the time of financial downturn. Almost half of the stocks have gone high, when the whole market has seen a downturn in the stock results. This ensures the liquidity of the investment portfolio. This has been achieved through proper diversification of portfolio with the accumulation of company stocks from various industries. Answer to the question no 3 Risk is inherent to all, be it life or be it finance. The crucial factor is how we fetch the best out of them, taking the minimum risk, possible. Investment is important to amplify the wealth, one has. However, when there is ‘one’s own money’ stuck in the market, people get more concerned and cautious in picking up the stocks for their portfolios. I will start investing in the stock market, shortly. So this assignment was an opportunity for me to look more into the interesting stocks to add in my real life portfolio. This feeling has really encouraged me to do more research on the stocks and their share price movements. London stock market is the home for some 3000 stocks. Picking up stocks from these huge stocks is really a difficult task to go through. It will not be much wrong if I say that it is simply not viable. That is why I took some 25 stocks from London stock exchange. Picking up stocks was not a random task; most of them were chosen looking at their share price movements. After picking up those 25 stocks, I carried out more research regarding the industries the companies are operating in, ROI, Beta value, share prices and the changes in those. I wanted to include stocks with both positive and negative betas in my portfolio. However, looking at the rising UK market, I discard the idea of including negative beta stocks. Instead in an analyst report, it was suggested to get hold of some highly positive beta stocks in the portfolio, as they have every chance to out perform the market. Out of the stocks, I picked up, some have very high positive betas of above 2, 3 etc. For an instance, Enterprise INNS (ETI.L) has a beta of 2.76. As a matter of fact, I do not have appetite for high risk; this is why, even in this case, I have assumed the same for the investor. So I avoided those stocks which have much high betas as those tend to be more risky stocks. Instead of this, I opted for moderately high positive beta stocks and to compensate the risk some low beta stocks were also included. Prices, expected return, and the changes in the share prices have been the other crucial factors while choosing the ten stocks for that portfolio. Overall, it was an amazing learning experience for me with lots of interesting research activities. Hopefully these activities will fetch some good returns for my real life portfolio. Conclusion This report has the room to go much more beyond the research activities, carried out here. Apart from the share prices and beta, investors must look at the companies’ financial statements, ROI, ROE, and EPS etc. It is crucial to know if the company has any rule for dividend payments. The industry performance is another factor which reveals a lot about the market environment, the company is operating in. Creating a portfolio demands cautious monitoring of the market conditions. An investor must reallocate its assets in accordance with the market movement. Reference A.H. International Ltd. 2006. Transaction Cost on Trading Securities. [Online]. Available at: http://www.ahintl.com/english/cost_e.html [Accessed on March 27, 2010]. Reuters. 2010. Overview. [Online]. Available at: http://www.reuters.com/finance/stocks/overview?symbol=BALF.L&exchange=XXCX [Accessed on March 27, 2010]. Wan, P., S. No Date. Modern Portfolio Theory. [Pdf]. Available at: http://www.ifa.com/Media/Images/PDF%20files/MPTTextbook.pdf [Accessed on March 27, 2010]. Yahoo Finance. 2010. Historical prices. [Online]. Available at: http://uk.finance.yahoo.com/q/hp?a=00&b=2&c=2009&d=01&e=7&f=2010&g=d&s=WPP.L [Accessed on March 27, 2010]. Bibliography Yahoo Finance. 2010. Price % Gainers. [Online]. Available at: http://uk.finance.yahoo.com/gainers?e=l [Accessed on March 27, 2010]. Read More