Investment Market and Principles

Ali Marhoon Al Fuliti

ID: 1620433
Gulf College

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Table of Contents

Task-1
Introduction………………………………………………………………………………………..3
Investment Markets………………………………………………………………………………..4
Investment Management and Banking Process…………………………………………………...5
General Recommendations for the Composition of an Investment Portfolio……………………..7
Conclusion………………………………………………………………………………………...8

Task-2
Introduction………………………………………………………………………………………..8
Equity Markets…………………………………………………………………………………….8
Difference between Speculation and Investor………………………………………………….....9
Equity Market Forms…………………………………………………………………………….10
Conclusion……………………………………………………………………………………….12
References………………………………………………………………………………………..12

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Task-1

Introduction
Investment (which he called “enterprise”): “the activity of forecasting the prospective yield on
the asset over its whole life … assuming that the existing state of affairs will continue
indefinitely.”

Investment strategies are changing day by day. New policies are being adopted by the
institutions to make their investors happy and to have a regular income. It is difficult for a
financial institution to survive in today's market without implementing proper planning and
strategies. Investment institutions provide various options for investors. An investor would
expect the institution to keep up with its words and to provide them a problem-free investment
return. The basic investment objectives are the safety of the funds, income from the invested
amount and the growth of their investment. (Cuthbertson and Nitzsche, 2008). The company
must follow such objectives to satisfy the investors and this would increase the number of
investors. The committee must decide on including options that will fulfill these objectives.

The safety of the investment is the major criterion of any investment company. The company can
decide on including any other benefits that would enable them to continue their investment in
this company. They should provide options to withdraw their money according to the financial
requirement of their children's education. The investor will also expect an income from the
investment. The institution must provide an investment environment based on the current
financial market. (Blake, 2000).The government decides the rate of interest and other options
that must be followed by the institutions. The institution can have flexible options for withdrawal
that would increase the number of investors. By including these features the company will be
able to satisfy the investors. (Jones, 2003).

Investment Markets

Asset Allocation

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Asset allocation is creating different ways to maintain the assets using the asset classes. Asset
allocation will help in optimizing the investment and its performance. Since the assets will be
allocated to different classes, the risk of investment is considerably low. (Gibson, 2000).The
financial market will certainly be fluctuating and asset allocation will protect the investors from
the risk. This is possible since each asset class will have risk at different levels (Rutterford and
Davidson, 2007).

The asset allocation is based on basic strategic and tactical methods. Most of the investment
companies allocate their assets according to their types of assets. The assets may be cash, stocks
and equity bonds. The company's assets are diversified as bonds, stocks, and cash. Hence the
company must allocate its assets according to the market situation. Based on the current situation
the company must allocate their assets according to certain strategies.

Principles of Portfolio Management

The company must select a portfolio management strategy according to the company’s financial
status. If the company needs to be improved, then the strategy must be selected to suit the
improvement. There are various principles to manage the portfolio of a company. The company
must follow these principles so that the company’s financial status will improve. The company
must implement a process to control the market volatility. The committee should satisfy the
requirements of the investor.

It must make use of flexible options for management. The company has to decide on strategies
that will minimize the risk and fulfill the objectives of the investors. Asset allocation is one of
the important principles of portfolio management. Thus the company must realize the importance
of allocating their assets. These principles must be followed by the company to ensure proper
investment returns and this, in turn, will increase the number of investors.

Bond Valuation and Bond Portfolio Management

These bonds are purchased by the government or the public. When a company requires money,
they can borrow through selling bonds to the public or the government. The rates of interest of
such bonds are generally fixed. Since the rate of interest is fixed, the bonds will serve the

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company for a long time. Bond portfolio management strategies should be implemented by the
company to improve the company's financial status. The various bond portfolio management
strategies are passive, active management strategy and matched funding strategy (Brentani,
2004).

Equity Portfolio Management

In equity portfolio management the equity issues and bonds that have the common criteria are
selected and a portfolio is built. The investors must invest in companies with a good reputation
so that the invested amount is safe. The committee members must decide on their equity bonds
and their value. Since equity bonds and shares are an important aspect of the company's financial
status. They should make sure the equity bonds are in the safe hands and the people holding
these bonds must not sell it. The company's assets are in the form of equity bonds that are
divided among the government and the corporate in the U.K.

Investment Banking & Management Process

Investment banking has no features like traditional banking. Investment banks are involved in
public and private market transactions for investors, companies, and governments. Investment
Management advises and assists its clients in issuing debt and equity securities, mergers,
acquisitions, diversification, etc. Investment Manager’s services are acquired when a company
needs to raise funds in the financial markets usually through the issuance of new securities.
Investment Management usually performs three tasks: first, they assist the companies in
designing the securities which have features that are most appropriate for a certain market;
second, they buy these securities and third, they resell them to the investors. (Fabozzi, 2008)

Investment Management raises capital for their client companies through underwriting in which
it purchases a whole block of new securities and resells them to investors. In this way, the
income earned is the difference of the amount given to purchase the new block of shares and the
amount received by the investors. Apart from Merger & Acquisition (M&A) advisory services, a
bank's other integral and core function nowadays is Investment Management in which the bank
manages the investments of clients. Security services are also an important feature for investment
banks which include prime brokerage, financing, and securities lending.

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Regardless of the activity undertaken by the investment bank, it needs to focus on its portfolio
construction and management which will be done according to the portfolio strategy of the
investment bank. This means the bank needs to make investments that ensure successful trading
that could be done by making risk management a top priority. This would mean that if a
company incurs a loss of one of its investments, it should earn a profit of over 11% on another to
make it even. In this way, the company needs to construct a portfolio of investments which
ensures a favorable position for the company. (Fabozzi, 2008).

Performance Measurement
Every company will measure its performance to know the growth rate of the company. It helps in
knowing whether the predefined programs are following the schedule. The parameters are
defined and the company’s growth is measured using those parameters. The committee members
must ensure that the company’s performance is measured at regular intervals. This will enable
the company to grow at a faster rate. (Armstrong 2000).

The drawbacks and the disadvantages can be known and this, in turn, will lead the company to a
better position. Performance is measured for various reasons. It will help in evaluating the
company's bonds and its values in the financial market. Another reason is to control the
unnecessary expenses that incur in the company. The budget of the company's expenses can be
derived if the performance is measured. By doing this, the necessary money for each expense can
be allotted and it will reduce the hidden costs.

The major reason for measuring performance is to improve the organization. This company can
certainly improve if they measure their performance in terms of asset allocation. The institution
can decide on how much funds to be allocated for each investor.

Risk Measurement and Risk Management

Risk Measurement

Any financial institution is prone to risk than any other company. The state of such financial
institutions purely depends on the financial market and its fluctuations. The rate of risk involved

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in these companies is comparatively more. The company must use any one of the risk
measurement techniques or systems to keep the company free from any sudden risk. The
company's major risk is the decline in the value of shares and bonds. Risk measurement systems
can be used to predict and measure the risk involved in each activity that occurs in financial
institutions (Gallati, 2003).

Risk Management

Once the risks are identified, the company should move on to the next step of managing those
risks. The risks are assessed according to the company's policies. They assess the reason for risk
and the way to resolve the issue. The risks are prioritized according to the severance of the risk
(Gallati, 2003). If the risk is more severe, then steps are taken immediately to improve the
situation and to solve the problem. Then they are monitored regularly to ensure that they do not
happen again. In this stage, the probability of such risks can be identified. This will help in
maintaining a system so that the company can avoid such risks in the future.

General Recommendations for the Composition of an Investment Portfolio

An investment portfolio should be constructed following the investment objective (timings,

return, and needs) and the risk appetite of the investor. Hence, there is no specific formula for the
most appropriate investment portfolio. However, a few guidelines that should be considered are:

- The investments should include more of income-generating investments rather than

capital gain generating investments as they are riskier.

- There should be a larger portion of investment made in money market instruments and
debts as they are safer than equity instruments if the market gets unpredictable.

- There should always be a balance between high-risk investments and low-risk

investments. For example, if there is an estimated loss of 5% in a high-risk investment,
there should be a supporting low-risk investment that will generate a fixed 10% gain.

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Conclusion

Investment decision making is not an easy job, as the people involved in the decision-making
process have to calculate the previous income statements of the company or business in an
addition to evaluating all the accounts reports and statistical details of the profit and loss of the
company. The investment analysis plays a very important role as a precautionary step in
decision-making as there appear to be risks in returns, which would be acting as a major
drawback in the financial conditions of a business or a company.

Task-2

Introduction

Equity markets remain likely as the more competitive, inexpensive and highly liquid source of
capital funds for publicly-traded corporations all across the globe. What with the many and diverse
interests of investors trading on publicly-held corporate securities and accepting the risk factor of
holding shares of stock; in exchange for the potential of capital gains, earnings per share growth
and dividends at the end of the year.

Technology has had much influence on the way equity markets and their exchange functions are
structured today. Physical trading on the exchange floor traditionally carried out by brokers and
market makers, or specialists in an order-driven market are driving towards obsolescence and
being outmoded by electronic and online trading systems. As this developed, the structure of
organized exchanges and the trading policies imposed by regulatory bodies continue to influence
the turnover of physical shares, price formation of equities and trading costs, while generally
exerting pressure on the behavior of market participants and the overall competitiveness of
securities markets.

Equity Market

Equity refers to trading stock in the stock market where investors buy them and thus provide
funding to the company. When these components combine, it forms the cost structure of a company
(Besley, 2011). The cost of equity is a company's shareholders' rate of return on their investment
in the equity of the company (Pratt, 2010). The formula used in computing cost of equity is;

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 Ke = D1÷P0 + g

Computing the cost of equity is the most difficult method. This is because even though the stock
price can be obtained easily, it is difficult to estimate the correct amount of dividend and the
earnings growth rate of the company. To avoid this, the company needs to get the current price of
equity, the correct number of dividends expected and the correct rate of growth in dividends
(Besley, 2011).

It is necessary to undertake investment in equity more systematically. While undertaking the

investment in equity markets, it is necessary to take into consideration the concept of timing. The
concept of investment and timing are interrelated to each other. For evaluating capital
expenditure projects or investment decisions, it is necessary to consider the fundamental
concepts of equity investments and timing strategy.

Difference between Speculation and Investor

Speculation: "the activity of forecasting the psychology of the market … attaching hopes to a
favorable change in the conventional basis of valuation."

In our Occam's Razor model, the combination of initial dividend yield and prospective 10-year
earnings growth—the two investment fundamentals—is the analog for the Keynesian concept of
enterprise—the estimated yield of the asset over its lifetime. The change in price-earnings ratios
is the analog for speculation—a change in the basis of valuation, or a barometer of investor
sentiment. Investors pay more for earnings when their expectations are high, and less when they
lose faith in the future. When stocks are priced at a multiple of 21 times earnings (or higher), the
mood is exuberance.

As demonstrated, investment, or enterprise, has prevailed over-speculation in the long run. In the
eight virtually consecutive decades from 1926 through 1997, the nominal initial dividend yield
has averaged 4.5 percent, and earnings growth has averaged 4.2 percent. Speculation cannot feed
on itself forever. Periods in which speculation has enhanced returns have been followed by
periods in which speculation has diminished returns. No matter how compelling—or even
predominant—the impact of speculation on return is in the short run, expecting it to repeat itself

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leads our expectations down the wrong road. Speculation is the wrong thing to remember as we
peer into the future to consider things yet to come.

The point of this analytical exercise is pragmatic. If there are favorable odds of making
reasonably accurate long-term projections of investment returns, and if fundamental returns—
earnings and dividends—are the dominant force in shaping the long-term returns that actually
transpire, would not a strategy focused on those fundamental factors be more likely to be
successful than a strategy of speculation for the investor with a long-term time horizon?

Short-term investment strategies—which effectively ignore dividend yield and earnings growth,
both of which are virtually inconsequential in weeks or months—have almost nothing to do with
investment. But they have a lot to do with speculation; that is, simply guessing at the price that
other investors might be willing to pay for a diversified portfolio of stocks or bonds at some
future time when we are willing to sell.

Speculation is typically the only reason for the sometimes astonishing daily, weekly, or monthly
swings we witness. But speculation can also play a major role in longer-term periods. The
speculative element outweighed, by a wide margin, each of the fundamental elements, and came
close to matching their combined contribution. (Bakshi, 2001 14)

Equity Market Forms

One of the most common forms of equity financing is venture capital. Venture capital is seldom
chosen by small businesses because they believed that it is provided only for large and high-tech
companies producing millions of dollars in profit. Many companies will grant us loans if we
provide reasonable prospects (‘Business Financing Alternatives', 2005).

Venture Capital

Venture capital is also referred to as equity financing because it addresses the financing needs of
a firm in exchange for a stake in the firm in question. This form of equity financing is often
pursued by firms, which cannot seek financing from other traditional financing modes like those
sourced through the banks and public markets (Mclaney and Atrill, 2006).

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A similar form of equity financing is a private investment partnership. It is a deal with one or
more individuals to provide funding for the business. They act as passive partners who provide
funds and expect a substantial return of the investment. The return is usually less than those of
the venture capital (‘Small Business Financing', 2005).

The venture capital process involves three stages: fund-raising, investing and exiting (Gompers
and Lerner, 1999). At the fund-raising stage the venture capitalists, as general partners, raise funds
from investors - institutional investors such as pension funds and endowments, individuals,
governments, or corporations. The purpose of contracting is to bring the parties together into
limited partnerships for intended venture capital projects. Studies along this line are concerned
about whether venture capitalists engage in economic value maximization or wealth transfer
(Lerner and Hardymon, 2002).

At the investing stage, venture capitalists invest in entrepreneurial ventures. The following features
characterize this stage. First, venture capitalists usually inject their funds into entrepreneurial
ventures in stages (Gompers, 1995). Staging facilitates making investment decisions based on the
latest market and venture developments.

Second, venture capitalists are active in monitoring ventures (Gorrnan and Sahlman, 1989;
Sahlman, 1990), with their board seats, voting rights, and other control rights. Venture capitalists
can have control rights that are disproportionate to their equity interests (Klausner and Litvak,
2001). Third, venture capitalists often syndicate their investments (Lerner, 1994; Lockett and
Wright, 2001).

Fourth, instead of the senior debt claims that characterize bank finance, venture capitalists rely
on convertible preferred stock, which is intended to align the management's economic incentives
and to protect investor interests (Kaplan and Stromberg, 2001; Sahlman, 1990).

Private equity
This mode of financing involves the equity provision for the business ventures that are not listed
on any stock exchange. The private equity financing can be tapped for developing new
technologies and products, expansion of working capital, making new acquisitions or for
strengthening the balance sheet of the business.

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As per KPMG (2001) the private equity can be classified into three broad classes which are
development capital, venture capital, and funding of buy-outs. The assistance from private equity
in the initial stages comes in the form of venture capital. The venture capitalists provide seed
capital and also offer financial assistance in the start-up stage.

In the expansionary or development stage, private equity assistance comes in the form of
development capital. Here the funds are granted for the business ventures in the break-even stage
or in times of trading profitability. In the later stages, private equity assistance comes in the form
of buyout capital. Here these investors facilitate the takeover of the business by the company
management from the owners. Unlike development and venture capital, the buyout proceeds go
towards settling the claims of business owners (Ebony Consulting International (Pty) Ltd, n.d.).

Conclusion

It is necessary to scrutinize the timing of investment while undertaking the investment in equity
shares. Equity financing and timing of investment are considered to be the two sides of the same
coin, this is because both these concepts are crucial for taking an appropriate investment decision
and for obtaining the effective rate of return on such investments. Both investments and
financing decisions are closely related to each other.

This is because; the issue of equity shares or investment in equity is closely related to the stock
markets also. Investing in equity shares is quite risky, but at the same time, it is the most
beneficial return on investments, as compared to other forms of finance. So, equity financing is a
fundamental concept with risk and return concept, and the timing of such investment is
prominent.

Speculation increases the level of risk incidence to the investor. It should be noted however that
speculation is assuming of calculated risks and is not dependent on pure chance or luck.

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