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A Diversified Investment Portfolio

Introduction

A well diversified portfolio is a kind of investment that has spread its securities and clearly approximates the systematic risk of the market and the unsystematic risk of the market of each security that has been deployed.This reduces the risks associated with one security and increases the chances of profitability or maybe at least reducing the loss, in general the broader the diversification the lower the risk and the higher the chances of profitability.

Investments

This is a procedure for purchasing other items of value with an expectation to get high returns in the future. This is always significant in the business. The item acquired should have a financial value. The items that people or business and financial institutions frequently invest in are on the stocks, Bonds, mutual funds and treasury bonds (Haynes 2011).

Bonds

A bond is a form of a loan contract that is given by an individual, corporation or government who can be termed as bond issuers. The bond issuer gives it to an investor. In this case the investor gives the issuer of the bond some agreed amount of money. This man is used by the issuer of the bond in business that is they invest the money in business to get profit. The profit analyzed is then given to the receiver of the bond as per the agreement on interest payment. The interest is to be paid for a set period of time that the two parties agreed on. The loan borrowed by the issuer of bond from the investor is then paid at the end of interest payment time.

Investing in Corporate bonds

These are bonds sold by corporate institutions. Their main aim of selling bond is to raise a lot of money. This money is majorly used in big projects. Corporations do not tax to raise money.

Portfolio Strategies and assessments

Bond is good for short term investment. Safety of principle is a good objective in bond investment. This brings a lot of income. The income is also current.

Bonds should be bought at different maturity levels. This is for the case of buying several bonds. The bonds should in be invested in this sequence. Two year bond maturing 2004, three year bond maturing in 2005, four year bond maturing in 2006, five year bond maturing in 2007 an so on an so on. The money received from the bond that is to mature in 2004 should be used to acquire bonds maturing in a later date.

Diversification

An investor can diversify his or her investment. This can be possible by investing in other sources such as stocks. Bond and stocks are inversely related in terms of pricing or cost. When the bonds prices increase, the stocks prices decrease. An investor can target stocks and bonds and invest in both. There exist a low correlation between bonds and stocks. This can result in high returns to an investor.

Bond Yield

Bonds can be compared on the basis of time. This is termed as yield to maturity. This measure the return when bonds are held to maturity and when the bonds are purchased. The terms of purchasing can be premium bonds, discounted bonds or at par bonds. This type of bond yield does not show which bond type in terms of maturity, will have a fluctuation in its pricing. Therefore, it is not prudent to compare bond in terms of yield to maturity.

As an investor, there is a requirement to return bonds when called. This could be due to provision of low interest rates by the bond issuer. This type is called yield to call. Yield to maturity type may be at times higher or lower than the yield to call. One should be able to compare bonds in terms of difference in maturity and coupon type. This fall in under the period it takes to pick or collect interest from the bonds. Shorter bond duration or period of maturity indicates reduced risks linked to interest. On the other hand, sensitivity to interest changes is coupled to higher durations.

The executed quarterly

For example, if an investor put $10,000 in a 1-year corporate bond that paid an annual interest rate of 4%, compounded quarterly, the corporate bond would earn 1% interest per quarter on the account balance. The account balance includes interest previously credited to the account.

Compound Interest Example
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
Capital at the beginning of the period $10,000 $10,100 $10,201 $10,303.01
Dollar return for the period $100 $101 $102.01 $103.0301
Account Balance at end of the period $10,100.00 $10,201 $10,303.01 $10,406.0401
Quarterly ROI 1% 1% 1% 1%

Hence, the expected rate of return would be 1% in the quarterly basis.Rate of return here indicates the cash flows the investment would receive in the period.

Computing the beta Kc = Rf + beta x ( Km – Rf )

Risks of Bonds

Different factors are associated with risks connected to bonds. The risks are as follows; call ability, reinvestment rate, interest rate risks, inflation risks and credit risks. Short term treasury bill are termed as the safest bond category but, they have low returns. Longer maturing bonds have great risks. This is followed by other bonds associated with the government. There are other forms of risks. Some could be interest rate related, some are ratings related and others depict re-investments rate risks. The reinvestment rate risk is due to recall on bonds. This happens when a bond issuer calls for return of bonds so that they can be charged at lower interests. This occurs if in any case there were dates set by the issuer to protect him or his corporation from paying high risks. The risks can however be avoided by –

Avoiding bonds that are priced over the par and are especially known as premium bonds.One may also read the prospectus of a company’s bonds to determine if they can be called for either credit or interest rate reasons. Another way is by buying discount bonds to avoid early redemption.

Investment in preferred stocks or common stocks of worth 100 shares.

Preferred shares- are the class of shares that are usually accorded a certain class of rights or privileges and preferences to investors who buy them.such privileges may include being given the first opportunity to receive dividends when the company earns profits. Other privileges may also being the first in buying shares when the company ha s a rights issue.These are known as preferential rights. He also has claims against the company’s assets in case the company goes bankrupt

While common stocks would include the classes of stocks or shares payment of dividends is not guaranteed as compared to preferred stock. However common stocks also pay dividends as declared yearly on quarterly basis.They get dividends also when the share prices increase.Secondly they benefit by being able to vote for the management board with regards to how many shares one has.

So this would pop up the question as to which kind of stock you would buy.

This is an issue of how much risk you can afford to take, against how much profit potential you will be seeking. A very conservative investor will be attracted towards the seniority of preferred stock over common stock, while recognizing that this safety comes with much lower profit potential. Essentially, preferred stockholders accept the guaranteed but relatively low-yield dividend.

A moderate investor will find common stock more appealing because of its potential for growth in value, and should be willing to live with market risk. The risks of common stock are mitigated by paying attention to the capital strength of the issuing company. Thus, common stock in a large company is going to be safer than that of a small company. However, the profit potential (and market risk) of the smaller company is going to be greater than that of the larger company. Picking the right company and the right kind of stock is determined by risk tolerance as well as your knowledge and experience. It is always a balancing act between two opposing forces: profit/loss potential, versus safety.

Details of security in this portfolio

High yield investments are every investor’s dream strategy. In the large variety of high yield investments, most would prefer low risk choices as the safest investment strategy. This is very essential taking into fact that the strategies that would earn you high returns would also end up getting you into higher risks.

Annuities would be another way to grow your money. Many annuities would guarantee a certain amount every month and they may either meet or exceed this amount.

If you are willing to bear the additional risk, emerging market debt securities could be a good addition to your investment portfolio. While these are what you are looking for, they also carry a substantial amount of risk.

Overall, these choices carry a high degree of risk so you must be prepared to accept this level of risk before you choose these instruments. While there are genuinely good choices in the market, there are many fakes as well that promise the moon but deliver, well, nothing. Don’t just go for empty promises in the name of high yield investments do your research thoroughly before you invest

An example of executed quarterly and annualized return on a portfolio and expected return:

(1) (2) (3) (4) (5) 6
Ending
quarter
Beginning
Price
Capital
Price
Current
Gain
(1) – (2)
Annual
Income
Return
(3)  (4)
HPR
(5)/(2)
Q1 $54.00 $42.50 $11.50 $0.82 $12.32 28.99%
Q2 74.25 54.00 20.25 1.28 21.53 39.87
Q3 81.00 74.25 6.75 1.64 8.39 11.30
Q4 91.25 81.00 10.25 1.91 12.16 15.01

Holding period return =(ending price-beginning price+ current income )

Beginning price return i

Computing the beta Kc = Rf + beta x ( Km – Rf )

The risks associated with trading in stocks

One must consider investing in stocks after considering not only the returns, but also the risks involved that are involved. Even though you cannot eliminate the risks completely, you can limit them to some extent. A well balanced and diversified investment portfolio can maximize your returns and at the same time reduce your risk. Some of the major risks associated with investing in stocks, may include;

Economical risks – This is when the economy suffers due to reasons like recessions natural disasters ,terrorist attacks etc, this as a result may make the value of your stocks to perform poorly and hence be a risk factor to the stock performance.

Inflation – Inflation also has a negative effect on all kinds of investments, including stocks. Unless you own stocks of food production companies and consumer durables industry that tend to earn abnormal profits during inflation, one needs to keep inflation into consideration when making investments in stocks in the long-term.

Market risk – When the market goes down , most of the stocks- good or bad perform poorly and and as result are affected negatively as everyone wants to sell their stocks but no one wants to buy other stocks that are trading in the financial markets (Horwil, 2006).

Ideas on how to reduce risks related to investing in stocks

  1. Learn: No matter how wise you are, knowledge always translates into power. Knowledge makes it easier to see issues and address them early and also helps you get more for the initial steps involved.
  2. Research in targeted companies/Check around: New opportunities present themselves often, but before you invest in stocks you have to be careful and research on the companies you are interested in. you may also take a keen interest on the proxy statement which contains the details of its board of directors for investment.
  3. Hire Help: Getting help when you are starting out is priceless, especially when you are talking about investing large amounts of money. There are professionals out there that have tons of experience in the financial field, and you can easily use their experience to make money for yourself. Check out a few different professionals before settling on the one to hire, but never hesitate to hire help when you need it.
  4. Research/Questions are important: It may seem stupid, but it is very important that you get every one of your questions answered before you put your money into a venture. You can do this by reading the company’s financial reports which are either published or posted on the company’s website. You can also subscribe via sms to get financial updates via your phone. There are very many ways to get answers, but the internet is one of the best resources that one could have. Not only can you learn about investing here, but you can ask questions and find answers to just about anything you can think of, regardless of how small or insignificant it might seem.

Investment strategy for investing in mutual funds and their assessment

Mutual funds is a trust that pools together savings of a number of individuals who share a financial goal like a collection of stocks or bonds which are grouped together and sold as a single unit. In your investment strategy one should consider hiring a professional who can help you to deliver the best plan for your investment in mutual funds.They can also help you develop a plan for your investments, which consist of your goals, investment strategies and the amount that is needed before starting to use the money (Kuria, 2011).

When investing in mutual funds the strategy that one would look at while investing would be to look at the risks involved in the portfolio versus the returns. If you want a higher return you should be prepared for a higher risk and one should be able to study the individual companies which are very necessary (Nicholson, 2009). You need to learn which company provides the best investment by studying the financial reports.

Details of this security

Mutual funds experience risks since most of the time they are not insured by the government. One can forecast future outcomes by making an evaluation of how the mutual funds perform in a particular part. Every mutual fund is usually allocated a fund manager, whose main job is to keep an eye on how the fund is growing.They conduct various types of research on this area of investments with the help of financial analysts.

Mutual funds are also affordable since they accommodate investors who don’t have a lot of money to invest.

Compound Interest Example
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
Capital at the beginning of the period $17,500 17,850 18,207 18,571.14
Dollar return for the period $350 357 364.14 371.4228
Account Balance at end of the period $ 17,850 18,207 18,571.14 18,942.5628
Quarterly ROI 2% 2% 2% 2%

The return for the period would be 2%

Computing the beta Kc = Rf + beta x (Km – Rf)

Risks involved in investing in mutual funds

  • Market Risk. The possibility that stock fund or bond fund prices overall will decline over short or even extended periods. Stock and bond markets tend to move in cycles, with periods when prices rise and other periods when prices fall.
  • Country Risk. The possibility that political events (a war, national elections), financial problems (rising inflation, government default), or natural disasters (an earthquake, a poor harvest) will weaken a country’s economy and cause investments in that country to decline.
  • Industry Risk. The possibility that a group of stocks in a single industry will decline in price due to developments in that industry.
  • . Call Risk The possibility that falling interest rates will cause a bond issuer to redeem—or call—its high-yielding bond before the bond’s maturity date (Nicholson, 2009).
  • Credit Risk. The possibility that a bond issuer will fail to repay interest and principal in a timely manner. Also called default risk.
  • Manager Risk. The possibility that an actively managed mutual fund’s investment adviser will fail to execute the fund’s investment strategy effectively resulting in the failure of stated objectives.
  • Currency Risk. The possibility that returns could be reduced for Americans investing in foreign securities because of a rise in the value of the U.S. dollar against foreign currencies. Also called exchange-rate risk.
  • Income Risk. The possibility that a fixed-income fund’s dividends will decline as a result of falling overall interest rates..
  • Inflation Risk. The possibility that increases in the cost of living will reduce or eliminate a fund’s real inflation-adjusted returns.
  • Interest Rate Risk. The possibility that a bond fund will decline in value because of an increase in interest rates.
  • Principal Risk. The possibility that an investment will go down in value, or “lose money,” from the original or invested amount.

One may avoid risks related to investing in mutual funds in the following ways.

One may design a portfolio that minimizes risks as well as maximizing the returns based on one personal risk tolerance –this is one’s ability to handle the inevitable declines in the value of his /her investments.It is also advisable to invest in mutual accounts used as tax deferred accounts which allows investors to delay paying taxes on investments such as retirement.Or one may also invest in tax free accounts which let you make after tax contribution into investment accounts that can then gain tax free money.

Investment in futures contracts and futures positions

A futures contract is an agreement between two parties: i) the lender – the party who agrees to deliver a commodity for the agreed upon price, and ii) the holder – the party who agrees to receive a commodity and pay the agreed upon price. Also include future positions.

Summary and details of securities in the futures contracts and options

Contracts in the futures market are a result of competitive price discovery. Prices are quoted as they would be in the cash market: in dollars and cents or per unit (gold ounces, bushels, barrels, index points, percentages and so on).

Prices on futures contracts, however, have a minimum amount that they can move. These minimums are established by the futures exchanges and are known as “ticks.” For example, the minimum sum that a bag of maize can move upwards or downwards in a day is a quarter of one U.S. cent. For futures investors, it’s important to understand how the minimum price movement for each commodity will affect the size of the contract in question. If you had a maize contract for 5,000 bags, a minimum of $3500 per contract (0.70 cents x 5,000) could be gained or lost on that particular contract in one day. In this case, the daily price limit is seventy cents per bushel (Nicholson, 2009).

Futures prices also have a price change limit that determines the prices between which the contracts can trade on a daily basis. The price change limit is added to and subtracted from the previous day’s close figures and the results remain the upper and lower price boundary for the day.

In futures contracts one may either decide to go long or short. If they go long, they are trying to profit from an expected future price increase. When they go short one is looking to make a profit from a declined price levels.By selling his now the contract can be repurchased in the future at a lower price thus generating a profit.

The futures market is a global marketplace, initially was created as a place for farmers and merchandisers to buy and sell commodities for either spot or future delivery. This was done to lessen the risk of both waste and scarcity

“Going long,” “going short,” and “spreads” are the most common strategies used when trading on the futures market.

Futures accounts are credited or debited daily depending on profits or losses incurred. The futures market is also characterized as being highly leveraged due to its margins; although leverage works as a double-edged sword. It’s important to understand the arithmetic of leverage when calculating profit and loss, as well as the minimum price movements and daily price limits at which contracts can trade

Rather than trade in physical commodities, futures markets buy and sell futures contracts, which state the price per unit, type, value, quality and quantity of the commodity in question, as well as the month the contract expires.

The players in the futures market are hedgers and speculators. A hedger tries to minimize risk by buying or selling now in an effort to avoid rising or declining prices. Conversely, the speculator will try to profit from the risks by buying or selling now in anticipation of rising or declining prices (Kuria, 2011).

The CFTC and the NFA are the regulatory bodies governing and monitoring futures markets in the U.S. It is important to know your rights..

Once you make the decision to trade in commodities, there are several ways to participate in the futures market. All of them involve risk – some more than others. You can trade your own account, have a managed account or join a commodity pool.

Quarterly and annualized return on the portfolio

For example, let’s say that, with an initial margin of $4,000 in June, mike the speculator buys one September contract of gold at $450 per ounce, for a total of 1,000 ounces or $450,000. By buying in may, mike is going long, with the expectation that the price of gold will rise by the time the contract expires in august. Which is that quarter.

By July, the price of gold increases by $2 to $452 per ounce and Joe decides to sell the contract in order to realize a profit. The 1,000 ounce contract would now be worth $452,000 and the profit would be $2,000. Given the very high leverage (remember the initial margin was $2,000), by going long, Joe made a 100% profit!.Hence the return rate for this period would be 100% (Haynes 2011).

Computing the beta Kc = Rf + beta x (Km – Rf )

Risks involved in investing in futures contracts

Futures contracts are considered to be some of the riskiest investments in the financial markets – they are for professionals only. It is like gambling.

Also one might lose a lot of money when there is experience of volatility markets.

In order to avoid these risks one should avoid investing when the markets are experiencing volatility (Horwil, 2006). Also one should study well the operations of the market since it requires experts.

Reference List

Haynes, R. (2011). Building a Mutual Fund Portlio. The Wisdom journal, 1.1.

Horwil, J. (2006). Investments Fundamentals. Financial Wisdom Journal, 5.

Kuria, N. (2011). Investments: Future Contracts. New Jersey, NJ: Investopedia.

Nicholson, C. (2009). Risks in stock investments. New York, NY: Wrightbooks Pub.

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