Assignment on Capital Market and Investment

Introduction

Portfolio construction is one of the art that any finance expert have. There are number of tools and methods that are used to construct the portfolio by the business firms. In the current report, 5 assets will be included namely bond, equity, mutual fund, fixed interest and commodity. All these things are included in the portfolio in the specific proportion in order to make same in the balanced manner and best return can be earned on same. Appropriate allocation will be given to the debt and equity in the portfolio and by doing so return will be maximized on the portfolio.  By considering risk and return profile of each investment avenue allocation of fund is done among different securities. Investment will be made for the one year time period but same in the fixed deposit will be for five years so that better amount of return can be earned on the investment. Investor is risk averse in nature and due to this reason in balanced manner portfolio is prepared and proportion of 20% is given to the equity in the portfolio.  30% proportion will be given to bond in the portfolio and same proportion will be given to the mutual fund in the portfolio so that 60% of the invested corpus remain in safe zone.

Portfolio Assets 

Selection of assets in the portfolio and rationale behind choice

  • Bond: Bond is the one of the main asset on which investors at large scale makes an investment. There are number of reasons due to which investment is made in the bond. One of the main feature of bond is that in same invested amount remain protected and its value cannot be depreciated. On investment low rate of return can be earned. It can be said that investment is safe and on same return is earned (Glode, 2011). However, return is low but investment is safe. Investor is risk averse in nature and due to this reason it is very important to make moderate portion of investment safe. Due to this reason it is decided that 30% investment will be made bond. In recent time period it is observed that more and more mutual fund houses and investors are making investment in bond because equity market is unstable and turmoil in same reduce investor confidence on the stock market in terms of returns. In past few months in global and domestic market investors lose money because there is a pessimistic environment in the both markets and due to this reason large investors that track market very closely become panic and sold equity in bulk which lead to decline in the shares and index value. Thus, it is very important to protect some amount of money from devaluation. Hence, investment is made in the bond for capital appreciation and safety of same.  
  • Equity: Equity is another investment avenue where investment can be made. It must be noted that very low rate of return is generated by the debt schemes and bonds. By making entire investment in the equity one cannot earn sufficient amount of return on the invested amount (Kosowski, 2011). Thus, it is necessary to take some degree of risk so that desired return can be generated by the portfolio. It can be said that there is huge importance of equity for the investors. Research results reflects that in past year return of 11% is generated by the FTSE index and stocks also give sufficient return to the investors.owever, beta value of the stocks is very high in range of 0.70 to 1.15 (Financial times,2017). Thus, there is a very high risk on the investment amount and at same time there is a high income earning opportunity in the equity. Investor is risk averse in nature and it is very important to earn sufficient amount of return on the invested amount. Thus, proportion of 20% is given to the equity in the portfolio. It can be said that by considering profile of the investor and market condition as well as return that can be generated by the portfolio 20% allocation to equity is appropriate. Reasons for selection of firms is given below.
  1. 3i group plc: 3i group plc is one of that largest company that is working in finance industry. There are multiple reasons du to which mentioned firm is taken in to account. It must be noted that UK economy is coming on track gradually and due ti this reason demand for finance will increase. Thus, it is expected that in the upcoming time period revenue of the mentioned firm will increase. Return of 60.20% is generated by the mentioned company share. Thus, in the upcoming time period better return can be generated by the mentioned firm shares.
  2. Ashteadgroup: Ashtead group is operating a rental business and is one of well-known firm. Return of 91.65% is generated by the mentioned firm in the past year and its beta value is 0.89 which reflects that if FTSE will increase then stock can generate good amount of return.
  3. Baraattdevelopment: Barratt development is operating in the home construction business. With elevation in economic growth of the UK demand for homes will increase in the upcoming time period. Hence, it is expected that firm will earn good amount of return in the upcoming time period. Hence, mentioned firm is included in the portfolio.
  4. Intercontinentalhotels: Intercontinental hotel is taken in the portfolio as it is working in the tourism industry. Tourism industry is one of the industry in the UK that is growing at fast rate. Return of 33.85% was generated by the mentioned firm in the past year and its beta value is 0.95. Thus, by considering past performance of stock, anticipated high growth of industry and high beta value it is expected that good amount of return can be generated by the mentioned firm. Due to this reason mentioned firm is included in the portfolio.  
  5. Sagegroup: Sage group is working in the software and computer science. Beta value is 1.12 and return percentage is 2.67%. Mentioned firm is operating in the technology sector and same is growing at rapid pace. Thus, it is expected that mentioned firm may grow at rapid pace in the business. Hence, Sage group is included in the portfolio.

  • Mutualfund: Mutual fund is the one of the main investment avenue on which in current time period most of investors and institutional investors are taking interest. This is because investment in the mutual fund scheme to some extent ensure that invested money will be safe and moderate amount of return will be earned on same. There are varied sort of mutual fund schemes like balanced, growth and debt. All these things are different from each other. Balanced mutual scheme is one under which in balanced manner investment is made in the debt and equity. On other hand, there is a growth scheme under which entire investment is made in the equity that comes in the blue chip category or highly profitable firms. Debt schemes are one under which investment is made in the debt instruments about 80% of the investment amount. In the current portfolio 30% allocation is made to the mutual fund scheme and by doing so it is ensured that moderate return will be earned on the investment and capital will remain safe. Under mutual fund scheme investment will be made on the AAP balanced fund under which in balanced manner investment is made in the debt and equity. 60% investment is made in equity and 40% investment is made on debt in the mutual fund scheme. It can be said that 30% investment is made in the mutual fund scheme and by using same portfolio risk is controlled.  
  • Fixedinterest: After making entire investment in different securities the remaining amount will be invested in the bank deposits. It is necessary to make investment in the bank deposits because investment in same is secured at specific interest rate. It is very important to earn interest at different rates on varied securities because by doing so it is ensured that in some securities huge amount of return will be earned. It can be said that there is huge importance of the fixed interest investment in the portfolio (Hoepner, Rammal and Rezec, 2011). In the current report, 10% allocation is made to the fixed interest bank deposit.
  • Commodity: Under category of commodity investment will be made in the bullion and under this specific number of lots will be purchased. There are some specific reasons due to which investment is made in the gold. It must be noted that in there is inverse relationship between equity and gold. This means that when share price declined demand of gold increased in the market. Gold is considered as safe heaven and when there is turmoil in the stock market investors usually makes an investment in gold in order to earn sufficient return on the portfolio.

Investment Theories

Efficient market hypothesis theory

Efficient market hypothesis theory is one of the most important theory that state that it is impossible to beat the market in terms of performance. Means that specific stock or firms shares cannot give return more than same is generated by the index. This means that even any news comes in the market due to same any stock cannot outperform market. It is assumed in the theory market is efficient and when any news comes in the market its effect is incorporated in all firms shares automatically. This means that all firms shares traded at fair value in the market and according to news relevant effect comes in the shares price. This theory believed that any company share never remain undervalued or overvalued in the market. This theory can be used in the portfolio construction and by following same one without using discounted cash flow and other equity valuation model can take inclusion decisions in respect to the financial instrument in the portfolio. Simply one have to identify the risk and return profile that is associated with the product and must accordingly make decision in respect to including any specific security in the portfolio. By using this theory one can also estimate maximum likely return that can be earned on the portfolio. Means that as per this theory stocks cannot beat the market return. Thus, if for the last three month FTSE grow by 6% then it can be assumed that stocks or portfolio of same will generated return of less than 6% which may be 4% to 5% (Agapova, 2011). Thus, by using this theory one can estimate likely return that can be generated by the portfolio. It can be said that by using mentioned theory standard return that need to be earned can be determined.   

Capital asset pricing model

Capital asset pricing model is the one of the most important theory that can be used by the individuals to make decisions in respect to investment. This model help one in calculating the required rate of return on the investment amount. In this regard some variables are taken in to account namely beta, risk free rate of return and market return. In order to compute required rate of return first of all value of risk free rate of return is taken in to account. Thereafter, from the market return risk free rate of return is deducted and same is multiplied by beta. Then computed value is added to the risk free rate of return to compute required rate of return in the portfolio. Risk free rate of return is subtracted from the market return because same react the risk premium. The excess return that is earned on the specific security is multiplied by beta because it reflect the rate of variation that may come in the return of any stock with small change in the index value. By doing so it is identified that with change in index what value may be of risk premium then risk free rate of return is added to same in order to calculate real return that can be earned on the investment amount. By using this model one can identify the return that one needs to earn for the risk that is taken on investment (Chen, Ferson and Peters, 2010). If required rate of return is high and market is expected to be unstable in the upcoming time period then in that case one can abstain from making investment in specific company share whose CAPM value is high. Thus, capital asset pricing model can be used in the portfolio construction

Modern portfolio theory

Modern portfolio theory is the one of the most important theory that is used to construct the portfolio. This theory was prepared by the Harry Markowitz. This theory state that investor that is risk averse in nature can maximize the return at a given level of risk. It is the one of the main theory that is used in the current time period to construct portfolio. There are number of advanced tools and methods that are used to create optimum portfolio. By using efficient frontier method different portfolio are created at different level of risk with maximum return. It can be said that modern portfolio theory is the one of the important theory that is used to construct the portfolio. This theory state that portfolio must be diversified in nature and under this multiple security must be included in the portfolio. Inclusion of more security lead to reduction in risk of portfolio (Bogle, 2015). This theory is used in the current time period and under this portfolio managers while constructing portfolio include number of securities like equity, bond and mutual fund etc. There are number of calculations that are done by the portfolio managers to construct the portfolio and under this excel is usually used to develop efficient frontier chart. By viewing a chart one easily identify the portfolio and proportion that different stocks and securities must have on the portfolio.   

Investment styles

Investment style refers to the investment strategy like active and passive strategy. Active strategy refers to the strategy under which elements of the portfolio are changed frequently. On other hand, passive strategy is the one under which investment is kept in the specific security for the long time period. There is a huge difference between both strategy in terms of usage and change in the portfolio. Under active strategy it is assumed that market is highly volatile in nature and due to this reason it is necessary to change the portfolio. Thus, active strategy is followed and under this portfolio is changed frequently by the managers. On other hand, in case of the passive strategy it is assumed that market will not change frequently and it will reach to certain level after different fluctuations. Hence, under passive strategy investment is made in the portfolio for long time period (Gil-Bazo, Ruiz-Verdú. and Santos, 2010). This investment theory is used at large scale by the portfolio managers because by doing so return on same is maximized. In the current time period most of portfolio managers are using active strategy because market is highly volatile in nature and by using mentioned strategy higher return can be earned on the invested amount.

Portfolio Evaluation

Table 1 Weight percentage and portfolio return

Initial investment

150000

Weight

Expected return

Weighted return

Bond

45000

30.00%

9%

2.700%

Equity

30027

20.00%

46%

9.117%

Mutual fund

45000

30.00%

0.07%

0.020%

Fixed interest

14523

10.00%

11%

1.149%

Commodities (Gold)

15450

10.00%

16.18%

1.618%

Total

150000

100%

Portfolio return

14.605%

Table 2 Return and beta profile of stocks

S.NO

Companies

Price

Return (%) y-o-y

Beta

Industry

1

3i group plc

772.5

60.20%

1.71

Financial

2

Ashtead Group

1624

91.85%

0.89

Rentals

3

Barratt development (BDEV)

588

12.51%

0.67

Home construction

4

Intercontinental hotels (IHG)

3853

33.85%

0.95

Tourism

5

Sage group (SGE)

653

2.67%

1.12

Software and computer service

Table 3 Expected return and total investment on stocks

Companies

Price

Stocks

Total investment

Expected return

Weight

3i group plc

772.5

4

3090

102.23%

10.29%

Ashtead Group

1624

4

6496

81.86%

21.63%

Barratt development (BDEV)

588

3

1764

8.71%

5.87%

Intercontinental hotels (IHG)

3853

4

15412

32.21%

51.33%

Sage group (SGE)

653

5

3265.0

2.87%

10.87%

 

 

 

30027.0

 

100.00%

Table 4 Gain or loss on portfolio

Companies

Price

Expected return

Stocks

Expected price

Capital gain

Total value at end

Total capital gain

3i group plc

772.5

102.23%

4

1562

789.74

6248.97

3159

Ashtead Group

1624

81.86%

4

2953

1329.35

11813.40

5317

Barratt development (BDEV)

588

8.71%

3

639

51.22

1917.67

154

Intercontinental hotels (IHG)

3853

32.21%

4

5094

1240.95

20375.82

4964

Sage group (SGE)

653

2.87%

5

672

18.74

3358.72

94

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total capital gain

13688

 

 

 

 

 

 

New value

43714.58

 

 

 

 

 

 

Opening value

30027.00

 

 

 

 

 

 

Gain/loss

13687.58

Table 5 Return on bond

Bond

Item

Price

Number of units

Total value

CAGR

End value

Capital gain

 

UK Gilt Treasury Stk 5%

104.351

431

45000

9

49050

4050

Table 6Return on mutual fund schemes

Mutual fund

Liquid fund

1

2

3

4

CAGR

Value at end

Capital gain

1

71 AAP Balanced fund

15%

3%

3%

7%

7%

45030.38671

30.3867057

Table 7 Investment on bullion

Commodities (Gold)

Bullion

CAGR for 6 months

Final value

Lots

Earlier price

Final price

Total capital gain

1

1030

16.18%

1196.672727

15

15450

17950.09091

2500.090909

Table 8 Investment on bank deposits

 

Fixed interest

Value at end

Capital gain

1

2.20%

16192.38481

1669.4

Table 9 Capital gain on portfolio

Securities

Amount

Income

Capital gain

Capital gain %

Bond

45000

49050

4050

18.46%

Liquidity

45000

45030.38671

30.38670569

0.14%

Fixed interest

14523

16192

1669

7.61%

Equity

30027

43715

13688

62.39%

Commodities (Gold)

15450

17950

2500

11.40%

Results

150000

171937

21937

100.00%

Table 10 Expected return on portfolio

S.NO

Companies

Price

Return (%) y-o-y

Beta

Expected return

1

3i group plc

772.5

0.602

1.71

102.23%

2

Ashtead Group

1624

0.9185

0.89

81.86%

3

Barratt development (BDEV)

588

0.1251

0.67

8.71%

4

Intercontinental hotels (IHG)

3853

0.3385

0.95

32.21%

5

Sage group (SGE)

653

0.0267

1.12

2.87%

  • Bond: Benchmark refers to the standatrd against which performnace of the bond is compared. It must be noted that in case of bonds government bond is used as standard. In the present case investment is proposed to be made in the bond which is relarted to the government. Hence, it is diffiuctl to determine the standard for bond in the current portfolio. In case one make an investment in any bond that is related to the private company government bond can used as standard.  It can be said that there is huge importance of the benchmarks because by using same performnace of the specific security is measured. It is very important to track down the performnace of the portfolio because by doing so it can be decided by an individual whether investment can be carried out on specoific security or not (Nohel, Wang and Zheng, 2010). One on time can decide to exit from the investmenbt and can make same on the most profitable avenue. It can be said that there is a signficent importance of the bechmarking for equity investors. One must take due care while selecting anything as bechmark for the portfolio because by comparing performance of same with the bechmark accurate performnance of the portoflio is measured.   
  • Equity: In case of equity bechmark will be FTSE 100. This is because all investment in the equity is made in the firms that comes in the category of equity and is component of the FTSE 100 index. In order to measure performnace of the equity portoflio percentage change of same will be compared with the index and by doing so it will be identified whether portoflio perform well or worst. It can be observed that investment of 30027 is made in the equity and after investment its value is 43714 which means that return of 43% is earned on the invested amount. On other hand, FTSE yearly return is 15% which reflets that portfolio outperofrm the index and give sufficient amount of reutrn to the investor. It can be observed that higher return is obtaind on the 3i group plc of 102.23% followed by Asthead group 81.86%, Baratt development 8.71%, Intercontinental hotels 32.21% and Sage group 2.87%.
  • Mutual fund: In case of mutual fund scheme Mixed Investment 20-60% Shares will be considered as benchmark. Sector refers to the any standard that is used as parameter to compare the performance of fund with the standard. Mixed Investment 20-60% Shares refers to the 60% equity and 40% debt which show the balance between equity and debt in the market. It must be noted that mutual fund scheme that is included in the portfolio is also balanced fund. Mixed Investment 20-60% Shares also indicate balance between debt and equity (Financial times,2017). It can be said that appropriate benchmark is set for the mutual fund scheme. Point to be noted is that there is very low return on the mutual fund scheme which is 0.07% which is lower than the standard. In the upcoming time period value of mutual fund can increase at rapid pace. This is because in the balanced fund majority of portion is covered by equity. If in case market will be in uptrend return on portfolio can be increased.
  • Fixe dinterest: Rate of intertest that is given on average basis by the commercial banks in the UK for fixed interest deposits can be considered as standard for the interest that is received on the deposits that are with the commercial bank in the portfolio. On comparison of the return that is obtained on fixed deposit with the standard value it can be identified that similar returns are geenrated. Hence, it can be said that suffieient amount of retunr is geenrated by the portfolio.
  • Commodity: In case of gold price that is given by the LBMA which is also known as London Bullion market association will be taken as standard and by considering same performance of the portfolio can be measured (7IM AAP Balanced class C inc, 2017).  On compariosn of gold price with the standard it can be said that good amount of return is earned on the invested amount.

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