Investment and Portfolio Management(2009-10)

Q1- Distinguish between Investment, Speculation and Gambling. Discuss the different channel or alternative channel available to m an Invester for making Investment.

Answer:->> From an investment to a speculation is only a short step. A. buys a share of stock or a bond, pays for it, and lays it aside in order to derive an income from it. That is an investment. B. buys a stock or bond and holds it, expecting a rise in its value, when he may sell it at a profit. That is a speculation. B.'s transactions are perfectly legal, moral, and in every way legitimate. Every dealer in dry goods, groceries, or farm products, and a large proportion of those who buy land, buy with the expectation of selling again at a profit. Then again, one who buys property as an investment may find its market value so increased within even a very short time, that he concludes to turn his investment into a speculation, and sells, intending perhaps to buy another kind of property or investment. Thus we see by analysis, the operations of the investor, the merchant and the speculator are essentially the same in principle, and to condemn one is to condemn all....................
Henry Clews, before a Legislative Committee in New York, said: "Speculation is a method of adjusting differences of opinion as to future values, whether of products or of stocks. It regulates production by instantly advancing prices when there is a scarcity, thereby stimulating production, and by depressing prices when there is an overproduction/'

Speculators usually buy on a margin. Instead of paying for the stock in full, they virtually buy the stock on credit, leave it in the broker's possession, and pay enough cash on the purchase to cover any possibility of a loss to the broker. Thus instead of buying fifty shares of stock at $100 each and paying $5,000 for it in full, the buyer pays down, say $10 on each share, or 10 per cent. of the par value as a margin, and is thus able to buy ten times as much, with a corresponding increase in profit if the market proves favorable. Since he expects to soon sell the stock, it is not essential that he should buy wholly for cash. Nevertheless, it is an actual sale, and delivery of the stock to him is contemplated unless he otherwise disposes of it before delivery. The broker charges interest on the unpaid balance of the purchase money.

There is a point, however, where speculation degenerates into gambling. The feverish desire for sudden riches, and the fascination that attends the uncertainty of speculative operations, often lead men away from strictly legitimate transactions and they become reckless, - mere gamblers upon the turn of the market. The speculator is one who studies the condition of finance and trade, both present and future, with especial reference to their effect upon the stock market, and bases his action upon well drawn and conservative conclusions, shaping his course so as to meet conditions of the money market as he anticipates them. He exercises the same judgment and discrimination that a wholesale merchant or banker employs in the conduct of his business. The gambler in stocks, on the contrary, makes no calculations, but "goes it blind," buying and selling merely on his impulse, and "trusting to luck" for the result. His operations are not based upon a study of the future, but upon "tips." He makes no effort to control or meet future conditions. In short, he does not differ, so far as the intent is concerned, from one who puts money on a horse race or a throw of dice. No wonder such operators almost universally "go broke" sooner or later.


Q-3 eXPLAIN dIFFERENT YYPE of Risk and 2 meathod for measuring RISK.

Answer- >

# Systematic Risk - Systematic risk influences a large number of assets. A significant political event, for example, could affect several of the assets in your portfolio. It is virtually impossible to protect yourself against this type of risk.
Also known as "un-diversifiable risk" or "market risk."

# Unsystematic Risk - Unsystematic risk is sometimes referred to as "specific risk". This kind of risk affects a very small number of assets. An example is news that affects a specific stock such as a sudden strike by employees. Diversification is the only way to protect yourself from unsystematic risk. (We will discuss diversification later in this tutorial).

* Now that we've determined the fundamental types of risk, let's look at more specific types of risk, particularly when we talk about stocks and bonds.

* Credit or Default Risk - Credit risk is the risk that a company or individual will be unable to pay the contractual interest or principal on its debt obligations. This type of risk is of particular concern to investors who hold bonds in their portfolios. Government bonds, especially those issued by the federal government, have the least amount of default risk and the lowest returns, while corporate bonds tend to have the highest amount of default risk but also higher interest rates. Bonds with a lower chance of default are considered to be investment grade, while bonds with higher chances are considered to be junk bonds. Bond rating services, such as Moody's, allows investors to determine which bonds are investment-grade, and which bonds are junk. (To read more, see Junk Bonds: Everything You Need To Know, What Is A Corporate Credit Rating and Corporate Bonds: An Introduction To Credit Risk.)

* Country Risk - Country risk refers to the risk that a country won't be able to honor its financial commitments. When a country defaults on its obligations, this can harm the performance of all other financial instruments in that country as well as other countries it has relations with. Country risk applies to stocks, bonds, mutual funds, options and futures that are issued within a particular country. This type of risk is most often seen in emerging markets or countries that have a severe deficit. (For related reading, see What Is An Emerging Market Economy?)

* Foreign-Exchange Risk - When investing in foreign countries you must consider the fact that currency exchange rates can change the price of the asset as well. Foreign-exchange risk applies to all financial instruments that are in a currency other than your domestic currency. As an example, if you are a resident of America and invest in some Canadian stock in Canadian dollars, even if the share value appreciates, you may lose money if the Canadian dollar depreciates in relation to the American dollar.

Interest Rate Risk - Interest rate risk is the risk that an investment's value will change as a result of a change in interest rates. This risk affects the value of bonds more directly than stocks. (To learn more, read How Interest Rates Affect The Stock Market.)

* Political Risk - Political risk represents the financial risk that a country's government will suddenly change its policies. This is a major reason why developing countries lack foreign investment.

* Market Risk - This is the most familiar of all risks. Also referred to as volatility, market risk is the the day-to-day fluctuations in a stock's price. Market risk applies mainly to stocks and options. As a whole, stocks tend to perform well during a bull market and poorly during a bear market - volatility is not so much a cause but an effect of certain market forces. Volatility is a measure of risk because it refers to the behavior, or "temperament", of your investment rather than the reason for this behavior. Because market movement is the reason why people can make money from stocks, volatility is essential for returns, and the more unstable the investment the more chance there is that it will experience a dramatic change in either direction.

As you can see, there are several types of risk that a smart investor should consider and pay careful attention to.

==============================================================================================
ETC

Potential risk treatments

Once risks have been identified and assessed, all techniques to manage the risk fall into one or more of these four major categories:

* Avoidance (eliminate, withdraw from or not become involved)
* Reduction (optimise - mitigate)
* Sharing (transfer - outsource or insure)
* Retention (accept and budget)

Ideal use of these strategies may not be possible. Some of them may involve trade-offs that are not acceptable to the organization or person making the risk management decisions. Another source, from the US Department of Defense, Defense Acquisition University, calls these categories ACAT, for Avoid, Control, Accept, or Transfer. This use of the ACAT acronym is reminiscent of another ACAT (for Acquisition Category) used in US Defense industry procurements, in which Risk Management figures prominently in decision making and planning.

Risk avoidance
Includes not performing an activity that could carry risk. An example would be not buying a property or business in order to not take on the liability that comes with it. Another would be not flying in order to not take the risk that the airplane were to be hijacked. Avoidance may seem the answer to all risks, but avoiding risks also means losing out on the potential gain that accepting (retaining) the risk may have allowed. Not entering a business to avoid the risk of loss also avoids the possibility of earning profits.

Hazard Prevention
Hazard prevention refers to the prevention of risks in an emergency. The first and most effective stage of hazard prevention is the elimination of hazards. If this takes too long, is too costly, or is otherwise impractical, the second stage is mitigation.

Risk reduction
Risk reduction or "optimisation" involves reducing the severity of the loss or the likelihood of the loss from occurring. For example, sprinklers are designed to put out a fire to reduce the risk of loss by fire. This method may cause a greater loss by water damage and therefore may not be suitable. Halon fire suppression systems may mitigate that risk, but the cost may be prohibitive as a strategy.

Acknowledging that risks can be positive or negative, optimising risks means finding a balance between negative risk and the benefit of the operation or activity; and between risk redution and effort applied. By an offshore drilling contractor effectively applying HSE Management in its organisation, it can optimise risk to achieve levels of residual risk that are tolerable.[10]

Modern software development methodologies reduce risk by developing and delivering software incrementally. Early methodologies suffered from the fact that they only delivered software in the final phase of develpment; any problems encountered in earlier phases meant costly rework and often jeopardized the whole project. By developing in iterations, software projects can limit effort wasted to a single iteration.

Outsourcing could be an example of risk reduction if the outsourcer can demonstrate higher capability at managing or reducing risks.[11] For example, a company may outsource only its software development, the manufacturing of hard goods, or customer support needs to another company, while handling the business management itself. This way, the company can concentrate more on business development without having to worry as much about the manufacturing process, managing the development team, or finding a physical location for a call center.

Risk sharing
Briefly defined as "sharing with another party the burden of loss or the benefit of gain, from a risk, and the measures to reduce a risk."...................

The term of 'risk transfer' is often used in place of risk sharing in the mistaken belief that you can transfer a risk to a third party through insurance or outsourcing. In practice if the insurance company or contractor go bankrupt or end up in court, the original risk is likely to still revert to the first party. As such in the terminology of practitioners and scholars alike, the purchase of an insurance contract is often described as a "transfer of risk." However, technically speaking, the buyer of the contract generally retains legal responsibility for the losses "transferred", meaning that insurance may be described more accurately as a post-event compensatory mechanism. For example, a personal injuries insurance policy does not transfer the risk of a car accident to the insurance company. The risk still lies with the policy holder namely the person who has been in the accident. The insurance policy simply provides that if an accident (the event) occurs involving the policy holder then some compensation may be payable to the policy holder that is commensurate to the suffering/damage.

Some ways of managing risk fall into multiple categories. Risk retention pools are technically retaining the risk for the group, but spreading it over the whole group involves transfer among individual members of the group. This is different from traditional insurance, in that no premium is exchanged between members of the group up front, but instead losses are assessed to all members of the group.

Risk retention
Involves accepting the loss, or benefit of gain, from a risk when it occurs. True self insurance falls in this category. Risk retention is a viable strategy for small risks where the cost of insuring against the risk would be greater over time than the total losses sustained. All risks that are not avoided or transferred are retained by default. This includes risks that are so large or catastrophic that they either cannot be insured against or the premiums would be infeasible. War is an example since most property and risks are not insured against war, so the loss attributed by war is retained by the insured. Also any amounts of potential loss (risk) over the amount insured is retained risk. This may also be acceptable if the chance of a very large loss is small or if the cost to insure for greater coverage amounts is so great it would hinder the goals of the organization too much.
===============================================================

Q2- Concept of Return. How statical method help in measuring REturn in Investment.

Ans - Return on investment is essentially profit made by an investor. Profits and losses must be analyzed carefully, as simple percentage comparisons give misleading answers. Risk refers to the probability of depreciation as well as its potential magnitude, which can exceed original invested amount. Risk and return on investment are directly correlated; higher risk begets a smaller chance of high return and vice versa.

Return on Investment (ROI)
1. The term refers to how much money is gained or lost after an investment. If you invest $1,000 and get back $1,080, you have an $80 (8 percent) return on the investment.

A negative return looks like this: You invest $1,000 and a year later only $900 remains. Return in this case was negative $100, or negative 10 percent. The percentage is in relation to original amount invested.

Unbalanced Percentages
2. Gains and losses do not balance out with percentages. For example, $1,000 invested has a -10 percent annual return. So a year later, $1,000 is reduced to $900. Now, if that $900 had a 10 percent positive annual return the year after that, 10 pecent of $900 is $90. Therefore, the total after two years is $990, less than the starting $1,000. The numbers work slightly against the investor even though percentages even out.

Risk: Depreciation Probability
3. Risk is a comprehensive term. It encompasses probability and magnitude of a loss. Buying stock allows a possibility that amount invested disappears from your account as the company goes out of business. That is bigger risk than buying a well-rated bond in terms of depreciation probability. A well-rated bond is less likely to give negative return on investment than stocks. Therefore, as a general rule, stocks have a higher depreciation probability.

Higher risk corresponds to higher returns. Let's examine what influences bond interest rate. If the seller has a record of success, people will feel comfortable giving the seller money for a promised return later. The seller knows this, and therefore can offer a low rate. A buyer may feel safe and therefore purchase the debt, or not if they decide that the low return isn't worth having their money tied up with the issuer for years.

Low Risk and Return
By contrast, if the bond issuer has a questionable reliability record, it will take promise of a larger return (a "junk bond") to entice investors. A buyer may be greedy for the possibility of high returns and purchase the bond or decline by deciding the potential payoff isn't worth the possibility of losing some, if not all, of the original invested amount.