INVESTMENT MANAGEMENT

3Investment Management

Question 1:

Geometric mean is considered to be a measure of change in wealth that is well suited for multiple set of periods. Over these multiple level of periods, the geometric mean is able to portray the compound rate of return while at the same makes sure to account for possible variances of these returns (Yang, 2014). On the contrary, arithmetic mean is used for the purpose of depicting the average rate of return while overlooking the fundamental aspect of compounding. For this reason, it is considered to be the most reliable measure of change of wealth for only single periods. Thus, I will go with the geometric mean since it allows for the compounding effect.

Question 3

The statement is true since any single mutual fund is made up of distinctive number of securities and currency, which are selected and included in alignment with the overall fund objectives (Haslem, 2015). Each and every mutual fund is highly diversified; which is a concept used for lowering their level of risk.

Question 4

Stocks are valued in accordance to whether or not they can result to dividends since investors use this ability of a company to establish its profitability (Williams & Miller, 2013). Companies usually make efforts to pay off dividends to existing stakeholders in order to attract even more investments in terms of stock purchases from potential investors.

Question 5

For most cases, growth stocks possess a higher P/E ratio since they are probably overpriced. Betermier, Calvet, and Sodini, P., (2015, p.1) notes that the P/E ratio uses past set of earnings hence resulting to a rather lower portrayal of the growth stock potentials. It is important to note that overconfidence amongst investors results to overpricing of stocks- an event related to positive news; and under price in the event of negative news.

Question 6

The car retailer acts a secondary market for the automotive manufacturer or owner who happens to be the primary market. It is important to note that the local retailer is dealer of cars because he is expected to sell the units once they have been received from the automaker or a subsidiary. It is worth to note that primary markets would always result to volatility in secondary counterparts since there is a challenge to correctly approximate the level of investor demand for new car units till numerous trading periods have already elapsed.

Question 7

The principle behind the dividend discount model lies in the net present values of a definite or indefinite set of cash flows for companies that pay out dividends at the end of operational periods (Lazzati & Menichini, 2015). This means that the intrinsic value of any given investment made is highly dependent on the immediate future net cash flows that is able to be produced. The net present values of cash flows concept relies on the time value for money, which notes that a dollar that can be received today is better than one that is to be received in a future period.

Question 8:

Dividend= $2.40

Closing Dividend= $ 40

Discount Rate= 10%

New Share= 2.40/ (1+0.1) + 40/ (1+0.1)4

= 2.18+27.32

Question 9

No. The success of these well-known investors does not invalidate the efficient market hypothesis at all. Efficient market hypothesis ascertains that since all information about the value of a company can be portrayed by its current stock price; it will be difficult to earn surplus profits that far much exceed the market on the basis of this information (Yalcin, 2016).

Question 10

According to Mallikarjunappa and Dsouza (2013, p.8) today, unlike in the past, the semi-strong form of efficient market means that most, if not all, public information is incorporated in the course of computing a company’s stock price. It thus means that in the past, the lack of company information that could be accessed through annual reports meant that both fundamental and technical analysis could be effectively used for purposes of attaining superior gains.

Question 11

The theory of limits to arbitrage opportunities ascertains that these chances cannot be quickly exploited by investors even in the event they understand how to go about it. The idea focuses on developing strategies that act to correct mispricing, which can be both risky and costly. According to Lamont (2005), the least likely limit to arbitrage in the case of 3Com/Palm case was the risk involved given that the whole idea resulted to overpricing of shares, which in turn resulted from both the concepts of overoptimistic investors and short sales constraints.

Question 12:

To technical analysts, the resistance level is manifested when the price of security moves above trending channel while support level is when it shifts below. They both form areas for which these analysts can purchase a stock of a given company.

Question 13

The illusion of knowledge in investment emanates from analysts set of opinions and reports. It is worth to note that not all pieces of information results to a true and complete representation of a given trading situation (Lambert, Bessière, & N’Goala, 2012). There have been recent failures and bankruptcies witnessed for numerous mortgage lenders that were once deemed very stable. Thus, it can be noted that aspects related to overconfidence and illusion of knowledge could result to assuming great risks and decision making that are obviously irrational in nature

Question 14

YTM is a form of internal rate of return for holding bonds till maturity.YTM is not same to coupon as the latter is affected on whether YTM is less, more or equal to.

Coupon rate= 0.1/ (1+0.08)2

Question 15

A young investor should ensure to have a substantial portion of equity in the portfolio since they have all the time to benefit from the high-risk investment. Unlike bonds, equity tends to have a significant chance of increasing in value in the future hence young investors should seek to hold at least 80% of their portfolio with equity to tap this potential (Brooks & Persand , 2003).

Question 16

Adding a high volatility investment to my portfolio would result to significant level of shortfall in the event that specific cash flows from the sale of securities in future date is conducted. Certainly, as a risk adverse investor adding high volatility investments would result to a possible broad distribution of final portfolio values.

Question 17

It is important to note that certain levels manifested while holding particular assets is distinctively unique to the asset. Investing in numerous assets class; the unsystematic portion of the overall risk can be done away with at little cost; on the contrary, systematic risks affect all forms of investments hence can be controlled by a costly reduction of overall expected gains.

Question 18

  1. It’s a systematic risk since it will affect all stock markets in general

  2. It is a nonsystematic and would thus only affect the price of X’s stock to change

  3. Non systematic risk since and would only affect X’s stock price

  4. Systematic risk and would affect the stock market at large. It is a country/political related risk.

Question 19

It means that all of the assets have similar risks for attaining a certain expected return level. To increase the return in this situation is through adding money-market securities since it improves on the risk-adjusted returns.

Question 20

The Sharpe ratio seeks to measure the number of surplus units of returns that a certain investor can gain in relation to the risk-free rate for each of the risk assumed (Guerard, Markowitz, & Xu, 2014). The Markowitz efficient frontier however, limits this capability.

Question 22

It is known as stock price insurance since it cushions the put option owner from losses in case where the held security declines in its immediate value (Barraclough, & Whaley, 2013). In fact, it seeks to reduce possible gains from owning certain security as well risk of losing money.

References List

Barraclough, K. & Whaley, R.E., 2013. Put Option Exercise and Short Stock Interest Arbitrage. Journal of Investment Management (JOIM), First Quarter.

Betermier, S., Calvet, L.E. & Sodini, P., 2015, Who are the value and growth investors? In Paris December 2014 Finance Meeting EUROFIDAI-AFFI Paper.

Brooks, C & Persand , G. 2003. «Volatility forecasting for risk management». Journal of Forecasting 22 (1): 1–22

Guerard, J.B., Markowitz, H. & Xu, G., 2014. The role of effective corporate decisions in the creation of efficient portfolios. IBM Journal of Research and Development, 58(4), pp.6-1.

Haslem, J.A., 2015. Mutual funds: risk and performance analysis for decision making. John A. Haslem, Mutual Funds: Risk and Performance for Decision Making.

Lazzati, N. & Menichini, A.A., 2015. A dynamic approach to the dividend discount model. Review of Pacific Basin Financial Markets and Policies, 18(03), p.1550018.

Lamont, OA. 2005. Short Sale Constraints and Overpricing. The National Bureau of Economic Research, Retrieved from http://www.nber.org/reporter/winter05/lamont.html

Lambert, J., Bessière, V. & N’Goala, G., 2012. Does expertise influence the impact of overconfidence on judgment, valuation and investment decision? Journal of economic psychology, 33(6), pp.1115-1128.

Mallikarjunappa, T. & Dsouza, J.J., 2013. A Study of Semi-Strong Form of Market Efficiency of Indian Stock Market. Amity Global Business Review, 8.

Williams, A. & Miller, M., 2013. Do Stocks with Dividends Outperform the Market during Recessions? Journal of Accounting and Finance, 13(1), p.58.

Yang, Z.H., 2014. Sharp bounds for Seiffert mean in terms of weighted power means of arithmetic mean and geometric mean. Math. Inequal. Appl, 17(2), pp.499-511.

Yalcin, K.C., 2016. Market rationality: Efficient market hypothesis versus market anomalies. European Journal of Economic and Political Studies, 3(2), pp.23-38.