Finance Courswork

Date: Nov 23, 2018


The task of this coursework is to conduct analysis and create the most effective investment plan. A person should always think about his/her future. Today we work, but we may retire tomorrow or simply be unable to work and, respectively, earn money. That is why we have to think about our future and save some money, when we earn them, in order to be able to guarantee a financially stable life in the future. Also, it is important to mention about the so-called time value of money. The main message of this concept is that 1 dollar today is worth more than 1 dollar tomorrow. That is why we have to invest money in order to keep their value and get the highest benefit. On the other hand, such investments should be made reasonably, according to a specific plan.

Our investment plan is going to consist of the following sections: macroeconomic analysis and analysis of financial markets, theoretical concepts of an effective portfolio, description of investment alternatives, as well as forecasts of potential revenues. Also, we would like to explain some strategies of diversification and hedging. Some attention is going to be paid to different attitudes to risk. It should be done in order to choose the most appropriate investment strategy. Finally, passive and active approaches to the investment strategy and performance will be considered.

Analysis of Overall Economic Situation

First of all, we must say a few words about the overall economic situation in the world and in a particular country. The reason for it is that it is going to influence our investment decisions and profitability of our investment portfolio. We are living in the conditions of the global financial crisis and its consequences. The reason for the crisis was fundamental disorders in financial system and speculations with particular groups of financial assets. Commercial banks and other financial institutions, seeking for higher profits, developed risky and unreliable financial instruments. Usage of these instruments has led to creation of a speculative credit pyramid. As a result, at the end that period collapsed and the world faced the most terrible consequences of the global financial crisis. The following period was associated with a crisis of trust in financial system, inflation and debt problems in many countries in the world, especially Europe. Nowadays, we cannot say that the crisis is over. For example, such country as Greece still suffers, because of its consequences. Generally, we are living in the conditions of economic volatility and uncertainty. It should be accounted in the process of development of an investment plan.

Usually, uncertainty and volatility are associated with such item as risk. That is why it would be reasonable to say a few words about risk. We would like to begin with providing the definition of the terms “diversifiable” and “non-diversifiable” risk. As for us, one of the most appropriate definitions is the following:

Diversifiable risk is the risk of price change due to unique circumstances of a specific security, as opposed to the overall market. This risk can be virtually eliminated from a portfolio through diversification; it is also called unsystematic risk (“Diversifiable Risk Definition”).

Thus, as we can see, this is the risk, related to some specific item or security in our case. An investor is able to manage this particular kind of risk via diversification of a portfolio. In fact, there are a lot of concepts and techniques that help investors execute this function. A non-diversifiable risk is something opposite to it.

A non-diversifiable risk is the kind of risk, which is common to an entire class of assets or liabilities. The value of investments may decline over a given time period simply because of economic changes or other events that impact large portions of the market (“Undiversifiable Risk Definition”).

This kind of risk is also called systematic or market risk. It means that it cannot be eliminated via diversification, because it is a characteristic of the whole market or a class of assets. Inventors can protect themselves from this risk via investing into different markets or different classes of assets.

Therefore, there are two kinds of risk. One of them simply cannot be eliminated, since it is associated with the overall movement of a financial system. The second one can be eliminated via investments into different assets, which is called diversification, and other instruments of risk hedging. We are going to discuss these instruments below.

Generally, an overall economic situation can be described via the following words. The world is living in the consequences of the global financial crisis. The main consequences are decline of the stock markets, lack of liquidity and economic trust, economic uncertainty and volatility and crisis in a real economy. It is believed that the consequences will be felt for the next few years. The investment strategy under consideration is a midterm strategy. It is being developed for 3-5 years. Taking it into account, the portfolio will mainly consist of stable and fixed assets. They are associated with lower risks. It is the most appropriate solution for the case under consideration. It is going to be proved in the following question of the research.

Analysis of Attitude to Risk

As a matter of fact, we are living in the conditions of economic uncertainty and volatility. It is associated with some risks. In order to create the most effective investment portfolio we have to hedge these risks, using such an instrument as diversification. However, our task is to define our personal attitude to risk. It is important to understand that there is reverse correlation between risk and return. Higher return is associated with higher risk. That is why, it is essential to understand our own attitude to risk and the price we are going to pay for higher profits.

Personal attitude to risk can be defined via a lot of methods. First of all, it is possible to explore our own personality independently. In fact, examples of daily life can be applied to making investment decisions. Second of all, it is possible to use special techniques and instruments to define an attitude to risk. Usually it is better to do with professionals in this area that have appropriate methodology and experience.

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Conservative investment strategy should be used in the case under consideration. The reason for it is that a potential investor is considered as quite reluctant to risk. That is why midterm and long-term investments with moderate return would be the best option for an investor. Thus, a great share of investments will be devoted to cash, deposits and fixed financial instruments.

Theoretical Framework of Making Investment Decisions and Creation

Investment portfolio will be created via CAPM. That is the reason why we have to provide information about essence of this model. To answer the following question of this case study we have to provide definition of the Capital Asset Pricing Model (CAMP).

“The Capital Asset Pricing Model is a model that describes the relationship between risk and expected return; it is used in the pricing of risky securities” (Capital Asset Pricing Model Definition).

This particular concept is one of the most popular theories in the world of investments. Using it, investors are able to determine the risk of some particular securities or a market in general. It also helps investors calculate the expected rate of return on their portfolios. In other words, it is a great instrument that can be used in the process of making investment decisions. The expected rate of return is calculated, using the following formula: Risk free rate plus Beta ratio multiplied by the difference between the expected market return minus the risk-free rate.

The main idea of CAPM for investors is that they should be compensated in two ways: time value of money and risk. The first part of the mentioned formula represents the time value of money. It is represented by the risk-free rate that describes the value that investors should receive in any case.

The second part of the formula represents risk of investing money in some particular asset. In fact, it demonstrates the amount of compensation an investor needs for taking on additional risk.

The main message of CAPM for investors is that if the expected rate of return on some asset, which is calculated, taking into account its risk, risk-free rate and rate of return on the market portfolio, does not meet a desired level, then the investment should not be undertaken. Thus, it is a great instrument of evaluation whether an investment should be made or not. Also, it shows a possible profitability of investments and let investors prepare some strategic investment plans.

In general, the Capital Asset Pricing Model is a great instrument of making investment decisions. It is not surprising that it has become so popular in the recent years. In the circumstances of the global financial crisis, it has lost its efficiency, but we tend to believe in its future. Probably, some modifications of this model are going to be the most popular investment instruments in the nearest future.

This concept is related to the Markowitz portfolio theory, which is explained below. The possibilities for investors have significantly increased in recent years. Access to the markets is easier nowadays and there are a lot of different investment instruments. However, making good investments is not an easy task. We can even say that this is a science with its special patterns and characteristics. One of the popular theoretical concepts that explore the secrets of investments is the portfolio theory, invented by Harry Markowitz. According to the definition of portfolio theory:

“Prior to Markowitz's work, investors focused on assessing the risks and rewards of individual securities in constructing their portfolios. Standard investment advice was to identify those securities that offered the best opportunities for gain with the least risk and then construct a portfolio from these. Detailing mathematics of diversification, he proposed that investors focus on selecting portfolios based on their overall risk-reward characteristics instead of merely compiling portfolios from securities that each individually has attractive risk-reward characteristics. In a nutshell, inventors should select portfolios, not individual securities” (Portfolio Theory).

According to this theory, investors choose not the separate financial assets, but the portfolio of these assets, which are characterised with a range of indicators, the best combination of which influences an investor’s decision. Among these indicators we may differentiate the following ones: risk-free rate, correlation, covariance, expected risk, expected return, and risk premium among others.

One of integral elements of portfolio theory is the so-called Sharpe ratio. This indicator is a measure of risk. Simply speaking it measures the level of risk premium that can be got from investments into the assets, which are not a part of the so-called market portfolio. Usually, performance of this market portfolio is measured via performance of a fund index. Also, it shows risk premium over the so-called risk-free rate. LIBOR is considered as a risk-free rate in the case under consideration.

Asset Allocation in the Portfolio

One of the main principles of the modern portfolio theory is the principle of diversification. Usage of this principle and approach should help an investor minimise its risks via investing money in different assets. According to the initial conditions all the possible assets are available. Among them the following ones may be pointed out: fixed income assets, shares, real estate, gold, commodities etc.

First of all, it would be reasonable to mention the assets, which are not going to be the part of the investment portfolio. Commodities and some other real assets cannot be considered as an appropriate option for the analysed case. The reason for it is that such an approach requires active participation in the investment process. Such a goal cannot be reached, since a potential investor works and does not have enough time to follow all the investment decisions. He/she does not also want to rely a lot on some investment professionals, since they may require significant commissions. Also, a potential investor is a typical person who does not have sufficient knowledge in market of commodities and real assets. Frankly speaking, we believe that commodities are a good option for long-term investments, while they are not able to bring significant benefits in the short run and midterm.

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Also, we believe that gold cannot be considered as a good investment option nowadays. The reason for it is quite obvious. Prices of gold have demonstrated significant growth in the last years. We can say that these prices have reached their peak. That is why it can be supposed that the growth is going to end soon. As a result, this investment option has not been considered.

Taking into account my investment and risks preferences, my investment portfolio is going to have the following structure.

Shares 10%
Cash 15%
Bank deposits 25%
Financial assets with fixed income 25%
Real estate 15%
Real assets 10%

Cash will be invested with the following yield – LIBOR + 1%. Bank deposits are also going to be diversified between different commercial banks. Investment into financial assets with fixed income is going to be focused on treasuries and governmental bonds. However, some share will be devoted to corporate bonds of well-known and stable companies. As it can be seen from the table above, 10% will be invested in real estate. This estate is going to be residential. It will be bought and granted for rent. The following table provides distribution of money between the assets in money terms, taking into account that a potential investor has 2 000 000.00.

Shares 200 000.00
Cash 300 000.00
Bank deposits 500 000.00
Financial assets with fixed income 500 000.00
Real estate 300 000.00
Real assets 200 000.00

Analysis of Portfolio of Shares

We believe that there is no need to explain the essence of fixed assets, since they are really stable; attention should be paid to shares. We have chosen 10 shares for the investment portfolio. Some recent indicators are provided in the following table.

Symbol Last % Change
BCOM 29,50 0.00%
CPTS 12,34 0.98%
CYD 19,45 8.17%
TECUA 9,93 7.23%
SGB 9,25 0.00%
STEC 16,92 1.56%
IL 17,70 0.00%
AACC 3,32 0.60%
KID 4,76 1.92%
ZA 5,70 -4.04%

Also, you can evaluate the structure of the portfolio, looking at the following diagram. The portfolio is really well diversified. The shares of all stocks are almost equal. We would like to say that it is quite a good strategy in the conditions of the global financial crisis, which is characterised with severe economic fluctuations. It is important to hedge the risks in such circumstances, and diversification is one of the strategies of such hedging.

Despite the fact of high degree of diversification, the stocks are characterised with a high level of correlation. We can explain it by the fact that almost every stock has demonstrated high pace of growth during the analysed period.

Comparison of Shares’ Portfolio with Fund Index

Analysing performance of portfolio we can compare its dynamics with dynamics of the respective market indices. In such a way, we will be able to determine whether our strategy was more successful than the so-called index fund strategy. Also, we will be able to determine the degree of reluctance of the portfolio to the overall economic conditions.

First of all, we would like to provide a definition of the term “index fund”. In our opinion, one of the most appropriate definitions is the following:

“Index funds mimic the movement of the index in which it follows. The index can follow the respective market by using two methods: (1) buying every stock in the index and weighting it appropriately, and (2) buying a selected group of stocks which best represent the sector” (Index Funds Definition & Investment Strategy).

Simply speaking, people that use this strategy when buying stocks that are represented in the market index. In such a case, dynamics of their portfolios usually repeat the overall dynamics of the market. Therefore, it is the best type of strategy for people that do not desire to risk a lot.

We bought stocks on 11.05.2011. Respectively, we have to evaluate the dynamics of the market indices starting from that date till today. Moreover, we will evaluate the following two indexes – NASDAQ Composite and DJIA. Their dynamics from that period are described in the table below.

NASDAQ Composite -5.85%
DJIA -4.39%
Our portfolio 10.99%

As we can see from the table, the main fund indices have demonstrated decline for the analysed period. It means that our portfolio has not only outperformed the market, but has managed to grow in the conditions of decline on the market. We have chosen stocks that have outperformed the so-called market basket of stocks. That is why we can say that our strategy is indeed successful.

Also, we can state that stocks represented in this portfolio are not vulnerable to the overall economic conditions and fluctuations. Decline of the fund market may be explained by tough economic conditions in the world in the recent months. However, stocks in this portfolio have not been affected by these conditions. Probably, it is caused by specific characteristics of the industry or a company, in particular.

Analysis of Industrial and Geographical Allocation

This part of the paper will focus on the analysis of the best performing stocks in this portfolio. The symbols of these stocks are KID, CYD and AACC. They represent the following companies: Kid Brands Inc (KID), China Yuchai International Limited (CYD) and Asset Acceptance Capital (AACC). In turn, the companies represent the following industries: recreational products, capital goods and business services.

At the beginning we need to analyse the situation in these particular industries. One of the main factors that may influence conditions of the recreational industry is the level of consumer spending. The global financial crisis, of course, has harmed this indicator, but, in fact, recreation spending has always been on a stable level. Nowadays, when the crisis has passed its peak, this spending is even growing.

The following two companies represent industries that provide goods and services for other businesses. The global business has started to overcome the consequences of the global financial crisis. In such circumstances, the pace of its growth may be even higher. That is why it may require appropriate goods and services to maintain performance. Such conditions open a lot of opportunities for the B2B sector. Thus, as we can see the analysed industries are characterised with quite supportive conditions for the companies from the portfolio to grow. Consequently, we can consider success of an industry as one of the factors of growth of the companies’ stocks.

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We cannot relate the success of stocks only to the success of the industry in general. We should understand that the companies can make some steps on their own that may stimulate such a positive dynamics. In fact, the analysed companies are characterised with good financial conditions and high level and quality of management. These are also the factors that stimulated positive dynamics of the analysed stocks.

Pasive and Active Investment Strategies

There are a lot of types of investment strategies. The final selection depends on preferences of each separate investor and overall economic conditions. Generally, two main groups of investment strategies may be pointed out: passive and active investment strategies. The second group is based on active and even “aggressive” participation of an investor in the process. Investment positions are constantly changed accordingly to the changes of conjuncture of financial markets. An investor makes his/her own decisions and does not use some clich?s. Passive investment strategy is based on midterm investments and not risky decisions. Usually, such investors buy shares that are the part of fund index. As a result, usually their portfolios are not able to outrun the market index. We believe that there is no the best or the worst strategy. A lot depends on the surrounding factors. We can be sure that the optimal option is combination of the both above mentioned approaches to investment.


To conclude, this paper described the overall economic conditions in the world. We are living in the conditions of the global financial crisis. It is associated with economic uncertainty and volatility. They are related to high risk, which a potential investor is not ready to accept, because of the risk preferences. That is the reason why an investor prefers long term investments with moderate return. Moderate return is associated with lower risks. Thus, the main share in my portfolio is occupied with fixed income financial instruments. Also, the portfolio of shares is really well diversified, since we believe that it is the best instrument of hedging risks under modern financial conditions.

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