2/6/2012 Group 1
. Iqramul Hasan Atik (36) Arzuman Fatema (49) Mosharref Husain (51)
Submission Date: February 06.Term Paper
Tarik Hossain Lecturer Department of Accounting & Information Systems Comilla University
Group 1 Consisting of: Farhana Afroje (07) Gulam Mostafa (35) Md.
2012. Sincerely yours
Farhana Afroje (on behalf of the Group 1)
. We thank you in advance.Comilla University Comilla
Tarik Hossain Lecturer Department of Accounting & Information Systems Comilla University Sir. We appreciate your selection of our topic of this term paper. Here is the term paper you asked us to prepare on January 24. This term paper includes the sections required according to the topic you asked us to select. We are confident that you will like our works.
Mosharref Hossain (51). in time. I would like to express our deep sense of gratitude to our course coordinator Tarik Hossain for his able guidance and useful suggestions. I want to thank all of them for all their valuable assistance in the term paper. Needless to mention that Gulam Mostafa (35).ACKNOWLEDGEMENTS
I take immense pleasure in thanking the Almighty Allah for making us capable of preparing and submitting this term paper. that is all of my group members have made unlimited effort to make this task successful. Arzuman Fatema (49). Words are inadequate in offering my thanks to my classmates for their cordial help with adequate information in preparing the term paper. Md. (Farhana Afroje) On behalf of Group 1
. which helped us in completing the term paper.
Sincerely. Iqramul Hasan Atik (36).
Finally differences between systematic and unsystematic risk are highlighted. In the measurement of risk and return we pointed out different formulas of determining risk and returns of investment.
This term paper highlights on the following topics: ♦ Forms of Investment ♦ The Setting of Investment Objectives ♦ Measurement of Risk & Return ♦ Systematic and Unsystematic Risk ♦ Differences between Risk & Return Under the forms of investment we discussed financial asset and real asset and also different categories of them. which are systematic and unsystematic risk. The discussion of the next section includes setting right objectives of an investment. The major two types of risk are discussed in the next portion.
1 2.TABLE OF CONTENTS
1 FORMS OF INVESTMENT 2 THE SETTING OF INVESTMENT OBJECTIVES 2.2 4.8 3.1 22.214.171.124 2. LONG-TERM ORIENTATION TAX FACTOR EASE OF MANAGEMENT RETIREMENT RISK MEASURES MEASURES
1 2 2 2 3 3 3 3 4 4 4 5 5 6 6 6 6 6 7 2 3
3 MEASUREMENT OF RISK AND RETURN RISK RETURN
4 SYSTEMATIC AND UNSYSTEMATIC RISK SYSTEMATIC RISK Interest Rate Risk Market Risk Purchasing Power Risk UNSYSTEMATIC RISK Business Risk Financial Risk
5 DIFFERENCES BETWEEN SYSTEMATIC AND UNSYSTEMATIC RISK 7 6 CONCLUSION BIBLIOGRAPHY Bibliography 8 9
.1 4.1 3.2 4.2 RISK AND SAFETY PRINCIPLE CURRENT INCOME VS.1.3 4.1.2 4.2.5 2.6 2.7 2. CAPITAL APPRECIATION LIQUIDITY CONSIDERATIONS SHORT-TERM VS.3 2.1 4.2 2.
within an expected period of time. held. Investment is putting money
into something with the expectation of gain that upon thorough analysis has a high degree of security for the principal amount. Precious gems Diamonds Rubies Sapphires
4. bonds Corporate bonds 4. Real asset on the other hand is am actual tangible asset that may be seen. bond etc. Equity claims – indirect Investment company shares (mutual funds) Pension funds Whole life insurance Retirement accounts 3. Creditors claims Savings account Money market funds Commercial paper Treasury bills. Example of real assts comprises real estate. Preference stock
1. bonds Municipal notes.Real estate Office building Apartments Shopping centres Personal residences 2. A financial claim on an asset that is usually documented by some form of legal representation can be defined as financial asset. Precious metals Gold Silver
3. felt. or collected.
1 Forms of Investment
Investment at first is broken down into financial assets and real assets. Collectibles Art Antiques Coins Rare Books
. gold etc.Investment has different meanings. notes. Investment is also defined as the commitment of current funds in anticipation of receiving a larger future flow of funds. as well as security of return.Equity claims – direct Common stock Warrant Options 2. Financial asset and real asset are again divided into several different categories which we will highlight on a table:
Table 1: Financial Assets and Real Assets
1. Financial assets include stock.
chemicals. It is not only the inherent risk in an asset that must be considered but also the extent to which that risk is being diversified away in a portfolio. 2. In purchasing stocks. Although.2 Current Income vs. We consult on the factors to be taken into consideration when defining the fund’s objectives and overall investment policy in respect of current legislative requirements and best practice. Other Cattle Oil Common metals
2 The Setting of Investment Objectives
Setting clear investment objectives is a key to developing a successful investment strategy and for providing a framework for making decisions with respect to the prudent operation of a fund. while common stocks generally do well in a positive economic environment. Those searching for price gains may look toward smaller. or electronics. Commodity features
5. Lastly. In general. emerging firms in high technology. it is separate.1 Risk and Safety Principle Tolerance for risk is a very personal decision. or apparel. it will thrive on bad news. mature firms in such industries as public utilities. the investor with a need for current income may opt for high-yielding. 2. the age and economic condition of risk are also important variables in determining the level of risk that an investor can actually handle with. Capital Appreciation Investors seeking for current income and seeking for capital appreciation obviously differ in setting their investment objectives. energy. this decision is closely tied to an evaluation of risk.5. Investors can invest on low risk government instruments or longer-term debt instruments and common stock based on their degree of tolerance of risk. markets tend to provide higher returns in exchange for baring higher risk.
. But the investor hopes for an increase in value to provide the desire return. and a question that is difficult for many investors to answer. There is not only the risk of losing invested capital directly but also the danger of a loss in purchasing power. For example if we invest in gold. The latter firms may pay no cash dividend. It is important to be honest in assessing whether an investor is comfortable with market volatility. and the level he can tolerate.
It is essential to recognize the need to convert investments into cash at the appropriate times. Transaction costs or commissions involved in the transfer of ownership do affect liquidity of an investment indirectly. Most financial assets deal with a high degree of liquidity. short-term traders often use technical analysis. Stocks and bonds can generally be sold within a matter of seconds at a price reasonably close to the last traded value. Finding both in one type of investment is really unlikely. Long-term Orientation In setting investment objectives. Market strategies may also be long term or short term in scope.5 Tax Factor An investor may pursue certain investments in order to adopt tax minimization as part of his or her investment strategy.4 Short-term vs. may want to seek investments with favourable tax treatment in order to lessen his or her overall income tax burden. months. whereas many real assets have transaction costs that run from 5 percent to 25 percent or more. which is based on evaluating market indicators series and charting. It is a common phenomenon that a house or a piece of commercial real estate sits on the market for weeks. But it is not true in case of real assets such as real estate. They may buy a stock at 15 and hope to liquidate if it goes to 20. 2. To help reach decisions. Those who take a longer-term perspective try to identify fundamentally sound companies for a buyand-sold approach. Those who attempt to engage in short-term market tactics are temped traders. it must be decided whether to assume a short-term or long-term orientation in managing the funds and evaluating performance. for example. A highly-paid executive. or years.3 Liquidity Considerations Liquidity is the ease with which an investor can convert investments to cash at fair market value. A long-term investor does not necessarily anticipate being able to buy right at the bottom or sell at the exact pack. Financial assets are generally traded on a relatively low commission basis. Making contributions to a tax-sheltered retirement plan can be an effective tax minimization strategy. 2.The investor needs to understand there is generally a trade-off between growth and income. 2.
the advantages of one often come at the expense of the benefits of another. he or she must often sacrifice some income and safety. Sound portfolio management makes life easy and ensures having more time to actually run portfolio and less time performing administrative aspects of the management process.2. and so forth. for instance. Those who wish to remain single will still be called on to advise others as to the appropriateness of a given investment strategy for their family needs. As we have seen from each of the objectives discussed above. There is another measure of risk also used in the investment community and that is beta. his or her stage of life. with all other potential objectives occupying less significant weight in the overall scheme. family situation.8 Risk The risk for an investment is related to the uncertainty associated with the outcomes from an investment. Out of the multitude of possibilities out there. marital status. most portfolios will be guided by one pre-eminent objective.6 Ease of Management After making purchases into portfolio one will be required to manage the portfolio.
. If an investor desires growth.7 Retirement Even the relatively young must begin to consider the effect of their investment decisions on their retirement and the estates they will someday pass along to their “potential families”. The beta measures the risk of a security relative to the market which is called systematic risk that cannot be diversified away in a portfolio of stocks and so it has special importance to the investors. Choosing a single strategic objective and assigning weightings to all other possible objectives is a process that depends on such factors as the investor's temperament. Therefore. each investor is sure to find an appropriate mix of investment opportunities. Risk is thus variability of returns of an investment. portfolio management software should be no different. The desired or required rate of return for a given investment is generally related to the risk associated with that investment. 2. 2. It should be advanced enough to grow as the portfolio grows and have all the right tools for the most important job in investing. As one invests more and more one becomes more knowledgeable about investing and portfolio management.
3. The only way to know this is to measure it in investment portfolio.3 Measurement of Risk and Return
It is important to understand where to investment return is generated and where to take risk. If risk is not measured it cannot be managed.(∑X)² There is another formula for calculating this systematic risk.2 Measures of Return
Like risk returns can also be measured by different formulas. We can measure risk and return and show where to take risk and estimate return. which we will now point out:
. That is:
3.1 Measures of Risk As risk is deviation in returns it is denoted by σ and is calculated by the following formula: σ= i=1n[(Xi-X)² р(Xi)] Market risk is called systematic or non-diversifiable risk which is measured by the following formula:
Again β can be calculated as: n∑XY – (∑X) β =(∑Y) n∑X² .
X= i=1nXi p (Xi) P1.Forecasted dividend + Forecasted end of the period stock price Return. return is measured as.P0 Probable return.Rf) Where. R = Initial investment Expected return. Ri= Rf + βi (Rm . R = DP0 + P0 Where. Rf = Risk free rate of return Rm = Return on risky portfolio
4 Systematic and Unsystematic Risk
The total variability in returns of a security represents the total risk of that security. Thus. Systematic risk and unsystematic risk are the two components of total risk. Total Risk = Systematic Risk + Unsystematic Risk
. P1 = Estimated market price after one year P0 = Current Market Price D = Anticipated dividend Earnings after tax Return on Assets = Total assets EBIT Return on capital employed = Total capital employed EAT Return on Equity = Shareholders’ equity Sales EAT Return on investment = × Total Sales assets Under Capital Asset Pricing Model.
product category.1.1 Systematic Risk Systematic risk is due to risk factors that affect the entire market such as investment policy changes. foreign investment policy. 4.5 percent. 80 which is equivalent to 12. shift in socio-economic parameters. 4. 10 on an investment of Tk. 100 issued with a coupon rate of ten percent when the market rate is also the same. However the systematic risks are unavoidable and the market does compensate for taking exposure to such risks.2 Market Risk Market risk is a type of systematic share that affects shares. research and
. It is beyond the control of investors and cannot be mitigated to a large extent.4.5 percent which is the same as the market interest rate. They are: 4. 4. change in taxation clauses. When the price is reduced to Tk. If subsequent to the issue. Systematic risk is broken into three categories. the market interest rate moves up to 12. This risk cannot be diversified away. It is a risk that can be avoided and the market does not compensate for taking such risks. no investor will buy the bond with 10 percent coupon interest rate unless the holder of the bond reduces the price to Tk. 80. A bond having a face value of Tk.2 Unsystematic Risk Unsystematic risk is due to factors specific to an industry or a company like labour unions. global security threats and measures etc. In contrast to this.1.1 Interest Rate Risk Interest rate risk is the chance that an unexpected change in interest rates will negatively affect the value of an investment.1. the unsystematic risk can be mitigated through portfolio diversification. It is the chance that the cash flows from an investment won't be worth as much in the future because of changes in purchasing power due to inflation. It is the day-to-day potential for an investor to experience losses from fluctuations in securities prices. 80.3 Purchasing Power Risk Risk that sudden changes in prices of consumables adversely affect the investor’s actual return from investment is referred to as purchasing power risk. purchaser of the bond gets interest of Tk.
input costs.development. and overall economic climate and government regulations. 4. Another example would be a mining company. competition.2.2 Financial Risk Financial risk is the risk that a company will not have adequate cash flow to meet financial obligations. A company with a higher business risk should choose a capital structure that has a lower debt ratio to ensure that it can meet its financial obligations at all times. including sales volume. Business risk is influenced by numerous factors.
. pricing. per-unit price.2. For example the unique risk of an ice-cream owner would be the weather. Unsystematic risk that can be eliminated by diversification. Financial risk is the additional risk a shareholder bears when a company uses debt in addition to equity financing. or that it will experience a loss rather than a profit.
5 Differences between Systematic and Unsystematic Risk
Table 2: Differences of systematic and unsystematic risk
Systematic risk is due to risk factors that affect the entire market. Companies that issue more debt instruments would have higher financial risk than companies financed mostly or entirely by equity. In bad weather the company would obviously generate worse sales then in sunny weather.1 Business Risk Business risk he possibility that a company will have lower than anticipated profits.
Unsystematic risk is due to factors specific to an industry or a company. The return they generate from the sale of the commodity’s their mine is determined by commodity prices. marketing strategy etc. Therefore the price of commodities would be an unsystematic risk. This risk is again categorised into two categories: 4.
economy. market risk and purchasing power risk. either his success will remain under doubt. Every investor should follow different technical analysis to become sure about his investment and to have a sound return for which he actually invests.
Unsystematic risk has two categories: business risk and financial risk. He needs to know exact answers of the questions related to his investments.
Unsystematic risk is measured through the mitigation of the systematic risk factor. It affects only specific industry or company.
Setting investment in right way includes many important decision and situations. Since these whole market though factors affect only one some sectors are more company. Measure of systematic risk is beta (β). this can be diversified away by type of risk is called non investing in more than one diversifiable risk because company because each no amount of company is different and diversification can reduce therefore this risk is also this risk. This risk can be reduced through diversification.Categorie s Diversific ation Effect Measure
Systematic risk has three categories: interest rate risk. interest rates etc in a right way can actually have his expected return on hand. or there may similarly any change in the be strike of workers which interest rates affect the leads to losses. industry level. this type of risk affected then others. It affects all the companies or industries of the market. called diversifiable risk. may be poor.
. It cannot be diversified away. An investor who can examine the market. Global turmoil will affect It may be possible that the whole stock market management of a company and not any single stock.
www. www.com 8. Hirt Stanely B. brainmass. wiki.com 9.ehow.com 7. Block 2. 4. www. Portfolio Management S.com 6.letslearnfinance.answers. Class lecture delivered by honourable course coordinator.google. en.wikipedia.com 5.Bibliography
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