Selling Short, Initial Margin Deposit - Assignment Example

 a) the above graph shows the trends of the prices of the shares over the period of time. The trends indicate that prices started to went up and crossed 2300p limit however, after that threshold level, they seem to dip down. Over all the trends are healthy and indicate confidence of investors in investing in the particular stock. b) selling short is one of the common phenomemon in current investment world as investors often tend to short sell the shares. Short selling is basically a process wherein investors sell those shares which they usually do not posses. This is done when the investor speculate that the value of the shares will decline in the future and he will take benefit from the fall of value. This strategy basically works in a very simple and straight forward manner as investor sells the shares which he or she does not posses. When the investors sells the shares, he actually does not possess it and the investor, at the time of settlement he will actually repurchase the same at the current price. Short sell therefore works on the basis of reciprocity wherein shares sold by the investors are purchased at a later date under short sell. Investor earns profit in this strategy on the assumption that on settlement date he will repurchase the shares. Any dividends paid during this period are paid to the original owner of the shares. Initial margin deposit is the deposit which brokers usually held with them in order to cover the initial losses incurring due to the reduction in the prices of shares. c) d) There will be no margin call as the initial margin will cover the loss or downfall in the value of shares. Thus from the available data set it is evident that there will be no margin call. e) f) buying shares on margin requires that the investors can buy the shares on the credit by pledging the same shares as collateral for the borrowing made. Margin trading is often done in order to take advantage of the leverage offered by the brokerage houses so that an investor can increase his exposure despie the fact that he or she may not have the required funds in cash to pay for the shares otherwise purchased in ready market. An investor have to pay a certain rate of mark-up on the funds borrowed therefore profit is paid after netting off the mark-up or cost of funds borrowed by the investor. An investor normlly take advantage of the margin financing in normal course of business. If shares purchased through margin finance cover the interest must cover remaining amount is the profitability of the investor. An investor will receive a margin call when the value of the shares hold in investors’ portfolio against margin borrowing fall below a particular threshold level. Normally brokerage houses require initial margin to be placed with them in order to cover the losses incurred as a result of the decline in the market value of the shares. Once the value fall below the margin level i.e. initial margin does not cover the drop in the value, the investor may get a margin call from the broker to either deposit new funds into the account or purchase or sell more securities in order to fulfill the gap that arise as a result of the decrease in the value. g) No. of Shares Price Maintaince Margin Total Margin Total 23000 2165.5 0.35 498,065.00 174,322.75 323,742.25 23000 755 0.35 173,650.00 174,322.75 -672.75 Investor will receive the margin call when the price of the share will go down between the level of 755p to 760p. Any price below that level will not result into getting a margin call because the maintaince margin will cover the decline in the value of the shares over the period of time. Q#2 a) Share/Index Expected Return Standard Deviation Correlation Covariance RRS 4.4% 0.13 0.36 0.005 BLT 3.1% 0.10 0.71   FTSE 0.3% 0.04 0.18   b) Share/Index Expected Return Standard Deviation Correlation Covariance Weight RRS 4.4% 0.13 0.36 0.005 70% BLT 3.1% 0.10 0.71   30% FTSE 0.3% 0.04 0.18     Optimal Risky Portfolio 0.008 Minimum Portfolio Variance 0.009 c) Standard Deviation Expected Return 0 100 10 90 20 80 30 70 40 60 50 50 60 40 70 30 80 20 90 10 100 0 d) Share/Index Expected Return Standard Deviation Correlation Covariance Weight RRS 4.4% 0.13 0.36 0.005 50% BLT 3.1% 0.13 0.71   50% FTSE 0.3% 0.04 0.18     Optimal Risky Portfolio 0.009 Minimum Porfolio Variance 0.009 If the above table is compared with the table in b it will be clear that the protfolio diversification affect does take place. The obvious benefit of the portfolio diversification is the reduction of the variance hence the overall risk is minimized. e) Non systematic risk is specific to the particular share and is based on the fundamentals of the share. As such this type of risk is considered as diversifiable with the help of the portfolio management. Systematic risk is however based on the market dynamics and is beyond the control of the investors to diversify it. Portfolio management helps to reduce or manage the systematic risk by combining risky assets together having relatively negative correlation. As such with the help of portfolio diversification an investor can reduce its exposure to the market through effective diversification. f) Sharpe ratio is a measure of excess returns over the standard deviation of the portfolio. It is measured as : Sp = E(Rp)- Rf / St, Dev. (Rp) Sharpe ratio is specially good measure in case when portfolio is not effectively diversified and provide a good measure of how the firm can actually measure the performance of the porfolio in relation to the market and also capture the risk associated with the stock. g) SUMMARY OUTPUT Regression Statistics Multiple R 0.044081862 R Square 0.001943211 Adjusted R Square -0.015879232 Standard Error 26.84288938 Observations 58 ANOVA   df SS MS F Significance F Regression 1 78.56175 78.56175 0.109032 0.742481 Residual 56 40350.28 720.5407 Total 57 40428.84         Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept -5.443740583 3.599398 -1.5124 0.136055 -12.6542 1.76672 -12.6542 1.76672 X Variable 1 -0.161728735 0.489791 -0.3302 0.742481 -1.1429 0.819441 -1.1429 0.819441 SUMMARY OUTPUT Regression Statistics Multiple R 0.045898 R Square 0.002107 Adjusted R Square -0.01571 Standard Error 8.859809 Observations 58 ANOVA   df SS MS F Significance F Regression 1 9.27974 9.27974 0.118219 0.732262 Residual 56 4395.788 78.49621 Total 57 4405.068         Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept -2.16245 1.188023 -1.82021 0.074073 -4.54234 0.21745 -4.54234 0.21745 X Variable 1 0.055584 0.161661 0.34383 0.732262 -0.26826 0.37943 -0.26826 0.37943 Q#3 Efficient market hypothesis is one of the most important theortical contributions made in the field of finance. The basic idea behind efficient market hypothesis is the availability of information and how it affects share prices. Efficient market hypothesis is therefore focused on the assumption that the financial markets are informationally efficient and any changes in the values of the shares readily absorb the changes that take place as a result of the available information. According to the efficient market hypothesis, there are three different forms of efficiency in financial markets. Three forms of efficiency are: Weak form of efficiency Weak form of efficiency outlines that the future behavior or future prices of the shares cannot be predicted with the help of observing past trends in the prices. As such past is not considered as the effective means of predicting the prices of the shares and any kind of technical analysis may not result into abnormal profits to be obtained by the investors. Semi-Strong Form of Efficiency This form of efficiency outline that share prices have already discounted the publically available information and as such any attempts to utilize publically available information may not result into any abnormal profits. As such any type of fundamental analysis will not result into profitability for the investors. Strong Form of efficiency This form of efficiency also outlines that any privately available information is also incorporated into the prices of the shares and as such any insider trading may not result into the abnormal profits for the investors. Accordingly this is the most desired efficiency level of the markets and financial markets are believed to be working in between semi-strong and strong form of efficiency in developed countries. Considering the above situation, the decline in the share of BP can be explained with the help of the efficient market hypothesis. The oil spill is considered as the publically available information regarding the future of BP as a viable entity because oil spill is considered as a negative signal by the market. This may be due to the various factors and according to the overall risk perceptions as well as appetite of the individual investors. Thus it can be sufficiently claimed that the decline in the share price is in line with the predictions made by the efficient market hypothesis which claims that share prices already incorporate the publically available information. The analysis made by the analysts as well as the behavior of the people in the market can also be related with the drop in the share price of the BP. This may be due to either the herd behavior wherein public tend to sell when everyone is selling and tend to buy when everyone is buying. Read More