Running head: FINANCIAL MARKETS AND INVESTMENTS DECISIONS

FINANCIAL MARKETS AND INVESTMENTS DECISIONS.

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 FINANCIAL MARKETS AND INVESTMENTS DECISIONS 2

INTRODUCTION

Midea Group Company is an international technologies firm located in China, dealing in

digital business, customer appliances, computerization & industrial automation systems, and

HVAC systems. Midea provides different goods and services, such as HVAC aligned on

residential and commercial air-conditioning, heating and ventilation systems, consumer

applications including laundry appliances and various small home appliances. A financial market

is defined as a space where bonds, equity, currencies, and securities are traded. It serves as an

agent between investors in resource and capital mobilization. Financial markets create liquidity

that allows businesses to grow. There are different types of financial markets which include

stock markets, bond markets, forex markets, money markets, derivatives markets, over-the-

counter markets, and debt markets (Caprio, et al.,2012). A financial institution is any entity that

offers intermediary services between consumers and debt or equity providing banking and

investment services. Financial institutions include commercial banks, central banks, insurance

companies, brokerage firms, savings and loans organizations, and mortgage companies. A

financial instrument is a monetary agreement or contract between two or more parties that can be

traded, it can either be in form of cash, debit, or shares.

 FINANCIAL MARKETS AND INVESTMENTS DECISIONS 3

Securities are financial instruments that can be traded in exchange markets. They include

treasury interest-earning securities, stocks, bonds, warrants, debentures, derivatives, equity, and

debt securities. Portfolio risk analysis involves looking at the risk associated with the investment

to an asset to determine its appropriateness to investors and the expected return on such

investment (Ioannou, et al., 2020). In this report we shall be dealing with investment

management, investors, asset and markets, real-world fictions, investments styles, risk and

return, pricing, variance analysis, return predictability, behavioral finance, and limits to

arbitrage, cost of capital, cash flows, and growth of dividends, review of bond prices and yields,

bond portfolios and risk, financial crisis and international diversification in Midea group ltd

company.

INTRODUCTION TO INVESTMENT MANAGEMENT

An investment is an asset acquired to generate money, equity, capital, income, interest, or

appreciation (Mukhtorovna & Mukhtorovich, 2020).

Types of investments

There are different types of investments that the company has undertaken:

Stock: it is an investment in a specific company that involves buying from the company’s

share of equity or assets. The company has issued both preferential and ordinary shares. Midea

group ltd has a share outstanding of 7.04 billion and a public float of 4.4 billion.

Bonds: these are loans made to a government or another company. The company has

recently bought security bonds from the government.

Real estate: The company has built residential real estate.

Foreign investments: The company is currently having investments all over the world as

it is involved in forex.
 FINANCIAL MARKETS AND INVESTMENTS DECISIONS 4

Investment management is the process of managing various investments including

securities, bonds, shares, forex. It involves devising methods of acquiring settling and disposing

of investments (Klimova, 2019). Investment management services include asset

allocation, financial statement analysis, stock selection, monitoring of existing investments, and

portfolio strategy and implementation. Investment management ensures that investors get value

for their money (Ioannou, et al., 2020).

INVESTORS, ASSETS AND MARKETS

An investor is a person, organization, or government that puts money or capital in a

venture with an expectation of returns and profits. Investors are very selective on the investments

they want to pursue. The company should package itself in a way that will attract more investors.

The company is also expected to conduct due diligence before embarking on any investment.

Midea group ltd has investors all over the world and they are guaranteed value for their money.

Assets are the tangible material or stock or valuable commodity that the company owns

and can be used as collateral when looking for investments and loans. The company has both

fixed assets such as land, vehicles, buildings, furniture, plant, and equipment and current assets

such as stock and cash. The market is an arena in which a business operates. The company

operates in three markets: domestic markets, global markets, and government markets. The

company has investments with the general public in the country as well as customers outside the

country and they have purchased treasury bonds as well as supplying goods to government

organizations. The management of domestic markets and government has been easy due to the

direct contact but for the global market, the company is not yet in a good position to

communicate with the clients.

REAL-WORLD FRICTIONS AND INVESTMENT STYLES

 FINANCIAL MARKETS AND INVESTMENTS DECISIONS 5

Investors need to carefully select their investment style which includes active, passive,

growth, market capitalization, buy and hold and value investments styles (Melikyan, 2019). Due

to the real-world frictions, an organization cannot depend on one type of investment style. Each

new investment poses new risks thus requiring a better style for investment.

 RISK AND RETURN, EXPECTATIONS, PRICING

Risk and return are highly correlated when it comes to investments. The more the

anticipated returns the more the risk associated with the investment. Risks include market risks,

liquidity risks, concentration risks, credit risk, reinvestment risk, inflation risk, and longevity

risk. The company has a department for risk management and analysis.

Return on investment is the anticipated gains or losses accrued from an investment and

they are expressed in percentage. ROI can be measured by use of the following approaches.

A. Return on investment= net return on investment/cost of investment*100%

B. Return on investment=Final value of investment- initial Value of

Investment/ Cost of Investment * 100%

The risks and returns analysis enables investors to have expectations on pricing of

investments.

Midea group ltd achieved a return on asset of 4.65% and a return on equity of 22.37%

as at 2020

MARKOWITZ MEAN-VARIANCE ANALYSIS

Harry Markowitz is considered as the founder of contemporary portfolio theory.

According to Harry Markowitz investors are only concerned with two factors of investment, is
 FINANCIAL MARKETS AND INVESTMENTS DECISIONS 6

risk and return but by diversification of portfolio, it is easy to tradeoff between the two (Darabi

& Baghban, 2018). The reason for this theory is that the risk of an individual asset has no direct

impact on the investor but the contribution it makes to the total investors' risks (Darabi &

Baghban, 2018).

The Markowitz mean-variance analysis is modified by introducing risk-free assets such

as government securities. Then he can construct a new set of portfolios which is the combination

of risk-free investments and risky investments (Darabi & Baghban, 2018). The company has not

been practicing the Markowitz mean-variance analysis instead they have been analyzing single

asset risks and grouping them separately.

BLACK-LITTERMAN

Black Litterman is an asset model which allows portfolio managers to incorporate ideas

to the Capital Asset pricing model equilibrium returns to create a more diversified portfolio. It

was developed by Fisher Black and Bob Litterman in the 1990s (Kolm, 2021). To avoid the

limitations of modern mean-variance analysis investors incorporate the use of the Black

Litterman model. The modern portfolio model assumes that the risks and returns on investments

will continue without interruptions into the future. The future has uncertainties that’s why the

black Litterman model was developed. The BL system integrates pragmatic market information

along with investors' predictions of future anticipated outcomes, grounded on models like CAPM

or others (Kolm & Ritter, 2017). The company has started using the Black Litterman model

though it is not yet steady with its application.

 FINANCIAL MARKETS AND INVESTMENTS DECISIONS 7

CAPM, APT, AND FACTOR MODELS

William Sharpe, an economist and Nobel laureate came up with the CAPM in his book

“Portfolio Theory and Capital Markets (Suroso, et al., 2018). The Capital Asset Pricing system

explains the connection between systematic rate and the anticipated return on investments mainly

stocks. CAPM is mainly used for riskier investments thus the inclusion market risk premium in

the system. The method is used to gauge the right market value of a stock. Therefore, when the

rate of risk variates, or other aspects in the market make an investment uncertain, the method is

utilized to re-determine pricing and projecting for expected returns (Suroso, et al., 2018). The

idea of CAPM is that investors will generate higher returns from riskier investments. CAPM can

be calculated as follows:

Expected return= Risk- free rate + (beta*market risk premium)

The expected return is what the investor will gain from the investment, the risk-free rate

is the yield of a 10-year bond, beta is the representation of the stock risk which should not be

more than 1, and market risk premium asset returns beyond just risk-free rate. Arbitrage pricing

theory was developed in 1976 by Stephen Rose, it is a method used for estimating the price of an

asset during investment, the theory assumes that asset pricing is dependent on other factors such

as security and market issues (Suroso, et al., 2018). It is an alternative to capital asset pricing

model. This model is important because it helps investors in determining whether assets and

securities are overvalued or undervalued. It is calculated using the following formula:

E(rj) = rf + bj1RP1 + bj2RP2 + bj3RP3 + bj4RP4 + ... + bjnRPn

 FINANCIAL MARKETS AND INVESTMENTS DECISIONS 8

where:

E(rj) = the asset's expected rate of return

rf = the risk-free rate

bj = the sensitivity of the asset's return to the particular factor

RP = the risk premium associated with the particular factor

It is hard to apply Apt method because underlying factors take a lot of time to be

researched on.

BEHAVIOURAL FINANCE AND LIMITS TO ARBITRAGE

Behavioral Finance is the science where psychology impacts the conduct of players in the

market, at personal and collective level, and the consequent effect on markets. (Kapoor &

Prosad, 2017). Behavioral finance has two bases, limits to arbitrage and psychology. It is

assumed that in efficient markets there will be no arbitrage whereas in inefficient market there

will be arbitrage.

COST OF CAPITAL (EQUITY, DEBT AND WACC)

Cost of capital is the degree of return the firm expects to earn from its investments in

order to raise its market share value. Cost of capital includes debt, weighted average cost of

capital, and cost of equity. I looked at the cost of capital in Midea group ltd as follows:

Cost of capital= cost of equity +cost of debt

Cost of equity = Rf+ b (E(Rm)-Rf)

 FINANCIAL MARKETS AND INVESTMENTS DECISIONS 9

Where

 Rf = Risk free rate

 b= Beta of stock/company

 E (Rm) – Rf = Equity Risk premium

Cost of debt=interest expense (1-tax rate)

Cost of wacc= Cost of equity*(1-D/D+E) + Cost of debt after tax* (D/D+E)

CASH FLOW, GROWTH, TERMINAL VALUE AND DIVIDEND MODELS

Terminal value is the net worth of an asset, business, company or organization beyond

the forecasted duration when cash flows can be anticipated. Cash flows is the total amount of

liquidity being transferred in and out of the business. cash flows models include operating,

investing and financing cash flows. The Midea group company had the following cash flows

from investing activities:

Cash flow from investing 30th June 30th June 30th June 2019 30th june2020

activities 2020 2020 consolidated company

consolidated company

Cash received from disposal 57,675,750 26,879,915 42,310,300 15,451,529

of investments

Cash received from returns 2,872,302 695,269 7,820,383 5,866,529

on investments
 FINANCIAL MARKETS AND INVESTMENTS DECISIONS 10

Sub-total of cash inflows 60,548,053 27,575,184 50,130,683 21,318,058

Cash paid to acquire fixed (2,060,864) (1,931,628) (96,957) (74,831)

assets, intangible assets and

other long-term assets

Net cash flows from 58,487,187 25,643,556 50,033,725 21,244,227

investing activities

Dividend models include the Modigliani and millers model, Gordon model, and Walters model.

The Modigliani and millers model assumes that the dividend of a share is immaterial since it does not

touch the wealth of the shareholders. The model suggest that the value is determined by firms’ earnings

which in turn is determined by the investment policy. It assumes that the companies operate in perfect

capital markets, no taxes, risks of uncertainties do not exist, and that the firm has a fixed investment

policy. The Walters model believes that the choice of divided plan always influences the firms' value.

The method shows the association between the IRR and the cost of capital in influencing dividend

policy. The model assumes that there is a constant cost of capital and constant returns on investments,

the firm finances all its operations via retained earnings and there are no issues of debt capital, all

earnings are given as earnings or reinvested back into the company, the beginning earnings and

dividends never change and that the firm has an infinite life. The Gordons model was developed by

Myron Gordon and it’s the most popular and adopted model of dividends. It assumes that a company is

an all-equity organization, it does not receive external financing, the internal rate of return of the firm is

constant, the suitable discount rate of the firm is also fixed, the corporate taxes do not exist, and that the

firms' streams of income are perpetual (Mwangi, 2017).

The following were the dividends payables from the Midea group ltd in the recent past.
 FINANCIAL MARKETS AND INVESTMENTS DECISIONS 11

Dividend History for Midea group ltd

Bonus Issue/
Dividend Ex-entitlement/
Announce by Reserve
Year End (Per 10 Date of Record Ex-dividend Payable Day
Date (Per 10
shares) Date
shares)

2019
2020/05/27 ¥16.000 -/- 2020/06/01 2020/06/02 2020/06/02
Final

2018
2019/05/23 ¥13.040 -/- 2019/05/29 2019/05/30 2019/05/30
Final

2017
2018/04/26 ¥12.000 -/- 2018/05/03 2018/05/04 2018/05/04
Final

2016
2017/05/03 ¥10.000 -/- 2017/05/09 2017/05/10 2017/05/10
Final

2015
2016/04/29 ¥12.000 -/- 2016/05/05 2016/05/06 2016/05/06
Final

2015
2016/04/29 - -/5.00 2016/05/05 2016/05/06 2016/05/06
Final

2014
2015/04/24 ¥10.000 -/- 2015/04/29 2015/04/30 2015/04/30
Final

2013
2014/04/23 ¥20.000 -/- 2014/04/29 2014/04/30 2014/04/30
Final

2014/04/23 2013 - -/15.00 2014/04/29 2014/04/30 2014/04/30

 FINANCIAL MARKETS AND INVESTMENTS DECISIONS 12

Final

FCFE AND FCFF VALUATION

Many organizations instead of using dividends to measure earnings per share they use

Free cash flows to firm (FCFF) and Free cash flows to equity (FCFE).

Free cash flows to firm is the cash flows available to firm after paying out the operating

expenses including taxes are paid and all working and fixed investments are made.

FCFF= EBIT – Taxes + Depreciation (non-cash costs) – Capital spending – Increase in

net working capital – Change in other assets + Terminal value.

For example, using Midea group ltd financial reports 2019 we calculated their FCFF as

follows:

EBIT=29,990,391

TAXES=39,478

DEPRECIATION=57,876

CAPITAL SPENDING=24,934,455

INCREASE IN WORKING CAPITAL=1,435,768

=29,990,391-39478-57876-24,934,455-1,435,768
 FINANCIAL MARKETS AND INVESTMENTS DECISIONS 13

3,522,814.

Free cash flows to equity (FCFE) is the cash flows after taxes, reinvestments and debt

cash flows. FCFE comprises of capital left when interest, operating cost, and principle are made.

FCFE is derived as shown below.

FCFE= EBIT – interest – taxes + depreciation (non-cash costs) – capital expenditures –

increase in net working capital – principal debt repayments + new debt issues + terminal value.

Midea group ltd is not yet using these methods of determining their value.

REVIEW OF BOND PRICES AND YIELDS

Midea group ltd issued in February 2020 an announcement that the firm planned to

repurchase 50 million to 100 million shares in 12 months at a maximum price of CNY 140 per

share for employee stock ownership and incentive plans. This shows that management remains

confident in the outlook of the company. The firm is still doing well with the recent issue of a

$700,000,000 corporate bond.

TERM STRUCTURE OF INTEREST RATES

The standard interest rate in China is 3.85% as of March 2021. Midea group ltd is a

company in china and according to this report, I have concluded that Midea group has received

loans and issued out loans and debentures. Their interest income as of 2019 was 3,807,136 and

an interest expense of 880,703.

 FINANCIAL MARKETS AND INVESTMENTS DECISIONS 14

STRUCTURED PRODUCTS AND SECURITISATION

Media group ltd operates with structured products which include: consumer appliances,

robotic and industrial automation equipment, heating and aeration structures, refrigerators,

laundry appliances, kitchenette applications, and other automotive. The products are well

branded and given serial numbers to avoid long processes during selling and packaging. Media

group ltd has proper handling equipment. The security of the products, bonds, and shares is

assured to the public because the company publishes its financial information on the internet.

THE FINANCIAL CRISIS

In 2017 Media group limited acquired KUKA a German robot manufacturing company.

After the acquisition, KUKA sales started to drop drastically despite the huge investment the

company had made. The deterioration of sales did not stop thus Media group started to convert

Kuka from a traditional home application manufacturer to an industrialized technology group.

The investment was huge and getting returns from it was like a nightmare. The agreement

between Midea group and Kuka was that Midea group was not to interfere with the operations of

Kuka till after the lapse of ten years which will be ending by 2024. However, these actions did

not inhibit KUKA’s share price from falling. From the acquisition of Midea to today, the stock

price of KUKA fell nearly 90%. Thus, making Midea Group be in a midst of a financial storm.

INTERNATIONAL DIVERSIFICATION

International diversification is the process of a company, person, firm, or government

investing outside their nation. Companies diversify due to: not all investments perform well at

the same time and in the same environment, investments are affected differently by the world
 FINANCIAL MARKETS AND INVESTMENTS DECISIONS 15

economic factors such as interest rate, foreign rate, exchange rate, and inflation rates. Companies

can invest internationally through developed markets, frontier markets, and developed markets.

Midea group ltd has diversified its operations all over the world. Its headquarters is in

Foshan, China, and has branches in eighteen other countries.

RECOMMENDATIONS

1. Increase bonds to the government to help in mitigating thecovid-19 corona

virus pandemic in china.

2. Issue debenture to upcoming companies on reduced rates.

3. Buy treasury securities whose purpose is clear to the public

4. Avoid entering in long term investments without a clear risk portfolio

analysis like the one with KUKA.

5. Create more locations on other continents such as Africa.

6. Increase your corporate social responsibility to other continents.

7. The company should increase its investments on real estates.

CONCLUSION

In conclusion, the Midea Group ltd has done a good job in connection to financial

markets and instruments. I predict that in the next four years, Midea Group ltd will be among the

top notch world companies. The management is encouraged to use the techniques provided in the

report to make better investment decisions.

 FINANCIAL MARKETS AND INVESTMENTS DECISIONS 16

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 FINANCIAL MARKETS AND INVESTMENTS DECISIONS 17

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