Financial Instruments Available for Investments - Coursework Example

Financial investment Introduction Investment forms a basic need in ensuring that an individual obtains returns for the capital heholds. Investments are undertaken for various reasons such as profit making, wealth maximization as well as to allow for growth. The options that are available for individuals to invest as well as save have been on an upward trend due to various reasons such as increased availability of capital, increased knowledge and also better security of investments. Despite the increased availability of investment options, these options may as well as be easily grouped into the three basic categories which are safety of the investment, its income and also ability to grow. Before undertaking a specific investment opportunity, an investor is required to objectively as well as comprehensively understand and evaluate himself in order to select the best investment opportunity which meets his profile and abilities as well. In order to understand one’s abilities and choice of investment opportunity, it is important to consider one’s risk profile. This involves considering aspects such as individual tolerance to risk which also includes the level of comfort by an individual when it comes to lose of money for investment or even the amount of investment returns in terms of variation. Most investors tend to seek investment for purposes of capital growth as well as building of their individual wealth for a specific period of time and protection against inflation. It as a result of the above factors that resulted to this study settling for exchange traded fund (ETF). This choice was made mainly in a bid to find an investment option, which allows for wealth building and increased capacity of profit generation specifically in the stock markets. An analysis of individual portfolio, involving different aspects such as one’s character, his or her lifestyle, the available time horizons and the investor personal objectives contributes to choice of investment. All these individual factors heavily rely on the nature of investment opportunity in question. The duty of selecting the most appropriate as well as optimum investment opportunity basing on ETF or rather the funds for investment to select from tends to be very tricky and challenging as well, but the following aspects help in understanding oneself; Character: As an individual, the reason behind weariness in investing in the stock market may mainly be attributed to fluctuations of prices in the stock markets. This has the capacity of completely wiping out an individual’s investment. The basic character for a viable investment opportunity would be considered by looking at the investment’s intrinsic value. The idea here is that the investment opportunity is purchased at a purchase price that is supposed to be lower in value compared to the actual intrinsic value which in the course of purchasing guarantees automatic profits for the parties involved. Question on how long the investment will be kept shall be important in helping to select any venture. For a long term investment opportunity, factors to be considered will include the specific expenses that are related to the investment opportunity for instance the cost of repair and maintenance and taxes as well. It is as a result of this that the investor is supposed to bear in mind that the choice of investment opportunity should be one that provides income that is greater than the sum of the entire expenses. It as a result of this cost benefit analysis that the choice of ETF was reached. The location of the investment is another important factor for consideration since it is part of the basic characteristics of any given investment opportunity. It helps in evaluation of the feasibility of the investment and its profitability. ETF offers quite steady and growing income along with a positive outcome in terms of returns. Another important aspect that is considered in the analysis is lifestyle. As an individual, most of the funds are directed towards good sound and enjoyable lifestyle. Majority of these savings are spent on the purchase of ETF stocks. Time horizons are also another factor to be considered. Investment serves as the most ideal means of wealth preservation and also growth of wealth. The higher the amount the investment the mores the costs involved and taxes included. The knowledge on time horizon will be enabling the first time investor to be able to assess the success for any given time during the life of the business. Time horizon focuses on the goal of the investment at a specified period during the life of the business. All these factors are important for evaluation purposes so that one is not a victim if significant losses due to collapsed investment opportunity which is often a result of poor choice of investment. In this study as stated earlier, the main area of discussion shall be ETR in order to be able to use it as a foundation of for successful investment opportunities. Financial instruments available for investments There are many financial instruments which are available for an investor to undertake and they depend on the characteristics of the investor himself in terms of his tolerance for risk as well as his ability to diversify. Some of the main instruments include the following: Equity shares: - Ownership of equity shares in a company gives an investor a chance to be able to take part and also share in the general performance of the business as well as participation in the profit sharing. This is through the sharing of dividends as well as growth of capital. The basic trait of equity shares, which mostly come in form of individual shares as well as stock markets, is their volatility. These shares tend to be highly volatile especially for those market shares which are for a short term period. The volatility of shares varies from one group of shares to another depending on various factors such as the size as well as nature of the business and the industry with which it operates which contributes to the firm’s liquidity and also price for its stock. The investors who are planning to take up shares of any given firm are obliged to have a proper understanding of the company which they are investing in. This is because the portfolios of shares tend to be more vulnerable to considerable losses in the event that the company lacks any form of diversity. This may be the tendency to heavily rely on the particular stocks that are from a single company, country or even an industry as well. It is worth noting that when it comes to shares, apart from the initial cost which the investor pays in order to be able to acquire the shares, the investor shall not be subjected to any additional costs as well as financial obligations and liabilities. Other than this, the investor needs to understand that when dealing with shares, over time on a good performing company, the value of the equity shares may increase in value. This may not be the case in case the company is underperforming whereby the value of the shares tends to reduce significantly. This therefore implies that there is the risk potential of an investor in a company shares being able to lose part of or the entire amount of investment. Exchange traded funds (ETF): - These are mainly investment products which give the investor a chance to be able to undertake an investment in not one but rather a diversified range of shares which come in the form of one single investment instrument. The main task of an instrument is simply to be able to track down the individual shares by different companies which are part of the market index that have been selected. The ETF then helps in undertaking the investment opportunity in two ways; either investment in the entire shares of the company or investment in only part of the shares that act as a sample to represent the entire block of shares from the selected index. How well an ETF performs is quite an important as well as a useful tool in the evaluation and analysis of the performance of the market index which the ETF has been based on. The main characteristic of an ETF is that it tends to be very liquid as compared to other normal funds. They can also be traded in a similar way just like other normal shares. ETF have also the volatile nature like shares particularly in the short term period and this level of volatility varies from one ETF to another basing on factors such as the specific nature and also size of the companies involved and the liquidity price for the stocks in question. Just like the case for equity shares, the potential investors for ETF are required to have a sound understanding of the company with which they are purchasing the ETF. Under ETF also the investor is not subjected to any additional cost other than the initial cost of investment which he uses in the acquisition of the ETFs, and their value could either increase or decrease leading to gains or losses on the investment. Bonds: - This refers to a specific debt instrument whereby the individual or party which issues it commits or promises to repay the principal holder of the bond as per the underlying terms and conditions that have been provided by the bond. Bonds as much as they differ from shares, they also have the tendency to vary significantly in terms of their prices. They may also be subjected to the case of default as well as non-payment of any interest or even principal amount by the specific lender. Unlike shares as well as ETFs, bonds tend to stand out in terms of risk since they are very safe. On a general scale, bonds which are issued by the government as the principal tend to be less risky as compared to other form of bonds such as corporate bonds. In bonds, there is the rating of different kinds of bonds in order to provide the investor with an indication of the probability of the issuer defaulting in repayment. This is based on a number of factors such as evaluation as well as analysis of the financial condition of the specific issuer as well as his profit potential. Warrants: - This refers to a right for an investor to be able to subscribe for shares, loan stock for a specific company, debentures as well as government securities in a limited time frame. This right is to exercise against the party that is issuing the specified securities. Warranties have the unique characteristic of involving significant amount of gearing; this therefore implies that any slight movement or shift in the price of the specific asset which may either be favorable to the investor or adverse will lead to higher margins of movement in price of the specified warrant. This also implies that the warrants are very volatile and as such if the performance of the warrant is below the anticipated standards, the investor could lose his entire investment including the commission as well as transaction costs that have been incurred on the warrant. Warrants come in two forms, a call warrant and a put warrant. A call warrant is designated to a specified number of shares in a company which could be obtained through purchase from the party issuing them at a definite price on a given date or a certain specified time frame. On the other hand a put warrant is aimed at a specific amount of shares which could be resold back to the specific issuer of the warrant for a certain specified price on a stated period or date. Portfolio of Funds and ETF Mutual funds for investment and ETFs are composed of stocks of different kinds. Traditionally, the notion was to simply establish an investment in diversified stock baskets through as single step. This is not the case in the present markets as an investor is required to personally select the stocks to invest in which was not the case in the past as it was left to be the task of mutual funds. Presently however, this has been made easy by ETFs. This is because ETFs have provided investors with the opportunity to develop low-cost as well as diversified portfolio in an easy way. The EFTs can be easily traded through sale and purchase by selected professional traders. This implies that the ETF value may be updated on a continuous basis after every second on a continuous basis all year round thereby providing the investors with an opportunity to be able to know their standing as well the right time for them to pull out. ETFs offer individual investors with the opportunity to own proportionate number of shares which are in form of portfolio stock or other securities such as bonds. To add on this, ETFs provide the investors with the option of purchasing shares in a wide range of shares which are at very competitive prices. Most of the ETFs strive to attain an equal return on investment as that provided by the market index for instance NASDAQ. Basing on the latest data provided from Dow Jones market index, there is an estimated growth of ETFs by 30% in the year 2014 to at an estimated 1.8 trillion dollars’ worth of assets. Asset Allocation In terms of allocation of assets for the ETFs, the selected vehicles are a combination of stocks, cash as well as bonds. This form of diversification will be important in offsetting the potential volatility in terms of losses from a single form of investment. It will also ensure that an investor is able to take advantage of the various strengths in a large number of assets when they are allowed to work together. Role of Financial Markets in the public and private sector Financial markets are avenues where all the financial instruments are traded and exchanged on a continuous basis. The roles of financial markets can be categorized into three basic functions as follows: a.) Price discovery: - Financial markets help in the discovery of prices. This means that the markets help in determining the prices of the assets that are traded through the buying and selling transactions of financial instruments by the traders. The players in the financial markets help in determining the required rate of return on the funds that have been invested. b.) Liquidity: - Financial markets provide the investors with an opportunity to be able to sell off their financial instrument. This is because the markets provide a specific measure on the ability of selling a given asset at its fair value in any given time. In the absence of liquidity, it would mean that the investor would have to remain with his financial instrument and wait until the suitable conditions for resell arise before he sells it or pay off the contractual obligation. c.) Reduction of transaction costs: -Financial markets reduce the total costs which the investors would have been charged if they would trade independently. Financial markets serve a major role in helping as well as improving the economic growth of a state. This is achieved through mobilization of the savings from the market in order to focus and channel these funds to productive investments as well as facilitating capital returns. Financial markets facilitate investment for both human as well as human capital. The markets are responsible for channeling of the savings directed to uses that are more productive through collection of information that is related to investment opportunities. This therefore means that through creation of efficient as well as sound mechanisms that allow transactions on a long term basis, the markets are able to provide the investors with a wide range of wealth generation opportunities for the private sector as well as the government. Relationship between macro-economic forces and financial markets Macroeconomic forces have a strong relationship with financial markets in the sense that the stock prices are dependent on the macroeconomic variables. It is important to note that the stock prices respond immediately to any changes or variations in the macroeconomic variables such that an increase in the supply of money tends to reduce the stock prices. This therefore means that it is important to ensure that there is stability in the macroeconomic variables in order to ensure that the stock prices are stable and as a result ensure that investors gain from the amounts invested in the stock prices. Risk and reward of investment possibilities This is often referred to as the risk/return trade off. It is related to establishing a balance between the amount of investment one can undertake and the amount of associated risk that the investment comes along with. It is important for the investor to be able to quantitatively as well as objectively determine and decide the exact amount of risk which he is able to take while at the same time being able to remain in a comfortable position with his investment. Risk can be viewed in terms of the chance that the expected returns by an investor could differ with the actual returns from a given investment. It can be determined or measured through the use of standard deviation. It is important to note that the level of risk goes hand in hand with the amount and cost of investment such that low risks are associated with low returning investments whereas investments that generate considerable higher amounts of investment have a higher level of risk. In the country presently, the risk free rate of return or the returns that an investor is able to obtain at a zero level of risk is 6%. This therefore, means that an individual is able earn 6% worth of returns at virtually no amount of risk. The investment that provides this zero risk level is government securities such as treasury bills and bonds. It is as a result of this risk and return trade off that the choice of investment was ETFs which involved different securities that can be analyzed as provided in the table in the appendix section. Conclusion As an investor, one must be able to understand his risk profile so as to be able to match this with the kind of investment to undertake. In order to cut down on risks, an investor must ensure that he or she uses more than one security to avoid being at risk of losing all the investment in case the single investment collapses. This therefore makes exchange traded funds the reliable choice as it is better placed to benefit the investor as a vehicle of investment compared to other options. References Ang, A., & Liu, J. (2007). Risk, return and dividends. Cambridge, Mass.: National Bureau of Economic Research. Atkinson, H. J., & Green, D. (2007). The new investment frontier III a guide to exchange traded funds for Canadians (3rd ed.). Toronto: Insomniac Press. Berman, B. M. (2009). From assets to profits: competing for IP value & return. Hoboken, N.J.: John Wiley & Sons. Engle, R. F., & Ferstenberg, R. (2006). Execution risk. Cambridge, Mass.: National Bureau of Economic Research. Frush, S. P. (2012). The strategic ETF investor: how to make money with exchange traded funds. New York: McGraw-Hill. Hehn, E. (2005). Exchange traded funds structure, regulation, and application of a new fund class. Berlin: Springer-Verlag. Lerman, D. (2011). Exchange traded funds and e-mini stock index futures. New York: John Wiley & Sons. Lofton, T. (2007). Getting started in exchange traded funds (EFTs). Hoboken, N.J.: Wiley. Lydon, T. (2010). The ETF trend following playbook: profiting from trends in bull or bear markets with exchange traded funds. Upper Saddle River, N.J.: FT Press. Lydon, T. (2010). Exchange traded funds the nuts and bolts. Upper Saddle River, N.J.: FTPress Delivers. Poterba, J. M., & Shoven, J. B. (2012). Exchange traded funds: a new investment option for taxable investors. Cambridge, MA.: National Bureau of Economic Research. Samadian, S. (2005). Risk management in emerging markets. Houndmills, Basingstoke, Hampshire: Palgrave Macmillan. Stevenson, D. (2012). The Financial times guide to exchange traded funds and index funds how to use tracker funds in your investment portfolio (2nd ed.). Harlow, England: Pearson. Lofton, T. (2007). Getting started in exchange traded funds (EFTs). Hoboken, N.J.: Wiley. Wiandt, J., & McClatchy, W. (2011). Exchange traded funds. New York: Wiley. Appendices Asset portfolio Allocation ETF Ticker YTD NAV YTD Return Amount invested 25% Dow Jones IYW 0.54 1.14 $10,000 15% Russell 2000 index IWN 1.39 -0.48 $5,000 10% Vanguard MSCI VGK 5.22 -14.14 $2,500 10% MSCI EAFE Index EFA 3.32 $2,500 15% Barclays IEI 8.10 7.99 $10,000 15% Vanguard short term govt. bond VSGB 1.49 1.42 $10,000 5% Lyxor ETF Euro cash LYCSH:SW 0.71 - $5,000 5% iShares Gold Trust 14.39 15.64 $5,000 Net Asset value 34.38% Market 34.48% Index 37.21% Total Return 18.80 Price earning 17.73 Price earing of B 4.28 Return on equity 11.81% Market capitalization $1.32 Billion Dividend Growth Rate for 5 years=47.58% Total expense ratio = 0.47% Read More