INVESTMENT AND PORTFOLIO MANAGEMENT by benbenzhou

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									PORTFOLIO MANAGEMENT



 MARKETS FOR SECURITIES
MARKETS FOR SECURITIES
       MARKETS FOR SECURITIES
Definition:
    A security market is a place or medium where buying
    and selling of securities takes place.
    Most of the countries in the world have developed such
    markets to facilitate security trading as it is considered
    to play a significant role in the economy.
    Security markets can be broadly classified in:
       Primary markets, and
       Secondary markets.
    Another classification is:
       Money markets, and
       Capital markets
    Market mechanisms make possible the transfer of funds
    from surplus to deficit sectors, efficiently and at low
    cost.
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Security Market


                                   Equity Market


                      Primary Market            Secondary market


                                       Debt Market


             Government            Corporate Debt
                                                            Money Market
           Securities Market           Market


                                  Derivatives Market



                        Options Market          Future Markets
    MARKETS FOR SECURITIES
The top ten stock markets of the world
• 1- New York Stock Exchange
• 2- Tokyo Stock Exchange
• 3- NASDAQ
• 4- London Stock Exchange
• 5- Euronext
• 6- Toronto Stock Exchange
• 7- Frankfurt Stock Exchange (Deutsche Börse)
• 8- Madrid Stock Exchange (BME Spanish
   Exchanges)
• 9- Hong Kong Stock Exchange
• 10- SWX Swiss Exchange
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MARKETS FOR SECURITIES
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GCC Stock Markets
• TASI (Saudi Stock Market)
• DFM (Dubai Financial Market)
• ADX (Abudhabi Securities Exchange)
• KSE (Kuwait Stock Exchange)
• BSE (Bahrain Stock Exchange)
• MSM (Muscat Securities Market)
• QE (Qatar Exchange)
• ASE (Amman Stock Exchange)
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Pakistan Stock Markets
Islamabad Stock Exchange (ISE)
Lahore Stock Exchange (LSE)
Karachi Stock Exchange (KSE):
•   A stock market was established in 1947.
•   Started with 5 companies with a paid-up capital of
    Rs.37 million.
•   Currently Karachi Stock exchange is now owned
    by 200 members.
•   1850 terminals exist at broker end.
•   651 companies are listed with KSE.
•   Trading through an electronic trading system
•   Market capitalization, as of June 30, 2009, US$
    26.48 billion.
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Characteristics of Good Stock Markets
•   To determine the appropriate price, participants must have timely
    and accurate information on the volume and prices of past
    transactions and on all currently outstanding bids and offers.
    Therefore, one attribute of a good market is timely and accurate
    information.
•   Another prime requirement is liquidity, the ability to buy or sell an
    asset quickly and at a known price—that is, a price not
    substantially different from the prices for prior transactions,
    assuming no new information is available.
•   A component of liquidity is price continuity, which means that
    prices do not change much from one transaction to the next
    unless substantial new information becomes available.
•   A market with price continuity requires depth, which means that
    numerous potential buyers and sellers must be willing to trade at
    prices above and below the current market price.
•   Another factor contributing to a good market is the transaction
    cost.
•   Prices to adjust quickly to new information regarding supply or
    demand, which means that prices reflect all available information
    about the asset. This attribute is referred to as external
    efficiency or informational efficiency.
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Key Terminologies:
Stock Exchanges: It is an institution where securities that have already
      been issued are bought and sold. Presently there are three stock
      exchanges in Pakistan. The oldest and most important one is Karachi
      Stock Exchange.
Listed Securities: Securities that are listed on various stock exchanges and
      hence eligible for being traded.
Depositories: A depository is an institution which dematerializes physical
      certificates and effects transfer of ownership by electronic book
      entries.
Brokers: Brokers are registered members of the stock exchanges through
      whom investors transact.
Under-writers: An under-writer agrees to subscribe to a given number of
      shares (or any other security) in the even the public subscription is
      inadequate. The under-writer, in a essence, stands guarantee for
      public subscription.
Bankers to an issue: The Bankers to an issue collect money on behalf of
      the company from the applicants.
Venture Capital Funds: A Venture Capital Fund is a pool of capital which is
      essentially invested in equity shares or equity-linked instruments of
      unlisted companies.
               MARKETS FOR SECURITIES
Broker/Brokerage House/Representative
•    A stock broker or stockbroker is a regulated professional broker who
     buys and sells shares and other securities through market.
•    A registered representative is an individual from brokerage house, with
     whom the investor has most contact. Based on the type of investor the
     brokerage houses can be divided into the following:
    –      Dealing with investor of modest size primarily interested in odd-lots
    –      Addressing the wealthier investors.
    –      Focusing on institutional business.
•       Analytical reports for different interest groups are published or issued by
        these brokers.
•       While selecting a brokerage an investor should see the following
        attributes:
    –      Equipped with a research department
    –      Have qualified staff that can provide first hand market analysis
    –      Provide assistance to companies for raising funds or new securities.
    –      Equipped with a research library
•       Following attributes should be considered while selecting a
        representative
    –      Educational qualifications, experience, investment philosophies and goals
    –      Availability and level of burden
    –      Not always trying to sell something to the investor
    –      Have a good knowledge of scripts owned by the investor.
    –      Able to keep investor update and give adequate advices.
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Primary Markets:
• Securities available for the first time are
   offered through the Primary Markets.
   These are primarily arranges additional
   funds for the coffers of the issuer.
   Whereas in the secondary markets just
   change in hands takes place.
• After going through the primary markets
   the securities can be traded in the
   secondary markets.
         MARKETS FOR SECURITIES

Primary Markets:
Investment Banker (IB):
•   The traditional middleman in the Primary markets is
    called Investment Banker.
•   IB’s primary responsibility is to bring buyers and
    sellers.
As an Underwriter:
•   IB normally buys the new issue from the issuer at the
    agreed upon price and hope to resell it to the investing
    public at a higher price.
•   In this capacity, IB are said to underwrite, or
    guarantee, an issue.
•   Usually IBs joined hand (make a syndicate) to
    underwrite an issue. In such case the commission of
    the IB will be according to its purchase.
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Primary Markets:
          MARKETS FOR SECURITIES

Primary Markets:
As a best-efforts /agency arrangement
•   In this case IB does not underwrite the issue but only
    facilitate to sell the scripts through its best efforts. Any
    unsold script is returned back to the issuer. It happens
    in two situations:
   –    When a company is small or the issuer is new to the market.
   –    The issuer is confident with the script and hope a higher prices
        can be obtained from the market.
Private Placement:
•    At times issuers make direct sales to the investor
     groups or institutions. This is called Private Placement.
•    In cases the IB acts as a facilitator to locate investor
     for direct sales, and charge a commission for it.
        MARKETS FOR SECURITIES
Secondary Markets:
• The stock once sold to the investor can be
  traded in the Secondary Markets.
• Organized Exchanges are physical market-
  places where the agents of buyers and sellers
  operate through the auction process.
• The transactions in the Secondary Markets can
  be divided into:
  – Organized Exchange
  – Over-the-counter (OTC)
• The primary middleman is categorized as:
  – Broker: It acts as an agent
  – Dealer: It acts as principal dealer in transaction.
        MARKETS FOR SECURITIES

Secondary Markets:
• The over-the-counter (OTC) market includes
  trading in all stocks not listed on one of the
  exchanges.
• The OTC market is not a formal organization
  with membership requirements or a specific list
  of stocks deemed eligible for trading.
• In theory, any security can be traded on the OTC
  market as long as a registered dealer is willing
  to make a market in the security (willing to buy
  and sell shares of the stock).
         MARKETS FOR SECURITIES

Secondary Markets:
•  Every market lists certain stocks for trading. KSE
   has a list of 651 companies.
•  These companies have to follow certain rules
   and regulations and pay annual fees for
   maintaining their name in the registered list.
•  The initial listing requirements are:
  –   Number of shareholders
  –   Minimum demonstrated earnings
  –   Asset size
  –   Number of shares outstanding
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Secondary Markets:
   A person is eligible for registration as a broker, in the
   Karachi Stock Exchange if s/he:
•  is a member of the stock exchange;
•  is not less than twenty one years of age;
•  is a citizen of Pakistan;
•  has at least passed graduation or equivalent
   examination from an institution recognized by the
   Government;
•  Provided that the SECP may relax the educational
   qualification in suitable cases on merit having regard to
   the applicant’s experience;
•  has not been adjudicated as insolvent or has
   suspended payment or has compounded with his
   creditors;
•  has experience of not less than five years in the
   business of buying selling or dealing in securities
         MARKETS FOR SECURITIES

Secondary Markets:
  Members of the stock exchange performs various
  functions in the market. These are:
  Commission Brokers: Get commission on selling
  and buying on behalf of the investors
  Odd-lot dealers: Deals in lower denominations of
  shares generally for small investors
  Registered Traders: Involved in direct selling and
  purchasing and do not require to pay any
  commission
  Specialist: Generally assigned to ensure
  marketability of a specified share and enter into
  transaction that are not routine.
  Bond Broker: deals in bond trading
          MARKETS FOR SECURITIES
Secondary Markets:
Listed Stock Tables:
• All the stock listed and traded in the stock market, in a
  particular day is provided in the trade screen.
• The trade screen changes with the interval of time or when
  and where a transaction takes place.
• The stock tables varies from one stock exchange to
  another. It may include following information:
      Symbol: A symbol is allotted to every listed company
      Trades: Number of trades
      High: The highest price at which a transaction has taken place
      Low: The lowest price at which a transaction has taken place
      Close: The price at which the last transaction occurred
      Volume: The total number of shares traded in the market
      Value: The value of the shares transacted in the market.
      Change: The net increase or decrease in closing Price from yesterday
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Secondary Markets:
Types of Orders/Transactions
• Buy Order: This given by an investor in anticipation of rise in price of a
  stock. The investor can qualify its order according to its preferences.
• Sell Order: On contrary when an investor anticipates a fall in script value
  which s/he is holding, s/he places a sell order. Sell-Long Order is given
  to broker when the investor foresees continuous decline in the share
  value. Sell-Short Order is placed when an investor would like to take
  advantage of bearish trend of a script.
• Market Order: Under a market order the broker is required to sell or
  purchase a particular stock immediately no matter what the prevailing
  price is. This is the quickest and least expensive way in which you can
  complete your order.
  Volatile markets may deprive you of the possibility of getting a price
  close to the one that is listed last. Additionally, you are not guaranteed
  that you will get the last price listed if you are following the market order.
• Limit Order: Under a limit order the broker is required to sell or buy a
  particular stock at a pre-specified price. Once the desired price is
  reached, the order is completed. Otherwise, the order is not filled. The
  investor must also indicate how long the limit order will be outstanding.
  Limit orders are helpful since they provide investors with an entry and
  exit point through the setting of the price.
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Secondary Markets:
Types of Orders with respect to Time:
• Round Lots: The order is in a number of a Unit considered
  as whole lot in a specified Stock Market.
• Odd-Lots: An order less than a unit of trading is considered
  as odd-lot
Types of Orders with respect to Time:
• Day Order: It remains active only for the trading day.
  Unless and until advised by the investor, the broker
  continues to execute the order during the day. However,
  it is suspended with the close of market for that.
• Week Orders: In general the order expires at the end of
  the calendar week.
• Open Orders: It remains effective until it is cancelled by
  the investor. These are also called GTC (good-till-
  cancelled) orders. These are generally issued in
  conjunction with limit orders. However, these orders are
  susceptible to higher risk.
          MARKETS FOR SECURITIES
Margin Trading:
• Borrowing money from bank or a broker to execute a
  securities transaction is referred to as using margin.
• The amount of money an investor can borrow depends
  upon specific regulations of the market/regulating
  agency of the country. The margin (%) varies from type
  of security an individual is borrowing. For a broker this
  amount of money is sometimes considered as collateral
  against the borrowing.
• The regulatory authority of a country specifies the limit of
  borrowing or Margin in term of percentage for different
  types of securities.
• If a customer buys shares of Rs.10,000 and puts up
  Rs.7,000 in cash, his margin is Rs.7,000 or 70% of the
  value of the shares acquired.
      MARKETS FOR SECURITIES
Margin Trading – Example
 If Zaid enter into transaction for 1,000 shares each at a price of
 Rs.20, an amount of Rs.20,000 is required.
 Zaid has decided to provide 50% (as per the regulations) of the cash
 with the broker. The margin account of Zaid with the broker reflects
 following details:
 Stock Rs.20,000                 Debt: Rs.10,000
                                 Equity: Rs.10,000
 Margin =       10,000 / 20,000 = 0.5 = 50%
 If the stock falls gradually and the value of the share reaches
 Rs.17.00
 The value of the stock will reach Rs.17,000
 The Margin Account of Zaid will reflect as follows:
  Stock Rs.17,000                Debt: Rs.10,000
                                 Equity: Rs.7,000
 New Margin = 7,000 / 20,000 = 0.412 = 41.20%
 It is Important to note that:
  – The shock of the falling price needs to be absorbed by the customer
  – The lenders (broker’s) risk is rising as the borrowed funds are more
    than the equity.
       MARKETS FOR SECURITIES
Margin Trading – Example (Continued)
  If the stock continues to fall, it will further increases the
  broker’s risk. However, the broker will stop at a point,
  perhaps as per the regulations, and will ask the
  customer to raise his/her equity. The point at which the
  broker will ask to raise his equity can be worked out as
  follows:
                                            Loan
  Market value of securities =    --------------------
                                        1-Cut off Margin
  Let us consider that the cut-off margin is 30%, the broker will ask the
  customer to deposit additional equity when:
                                     Loan          10,000
  Market value of securities = -------------- = ------- = Rs.14,286
                                 1-Cut off Margin (1-0.3)
  If the maintenance margin falls below 30%, the broker will send a
  margin call to the customer asking to to additional deposit of funds
  within a certain time frame
     MARKETS FOR SECURITIES

Margin Trading – Example (Continued)
 Consider If the stock continues to fall further and
 the share value reached at Rs.13, the new
 Margin can be worked out as follows:
  Stock Rs.13,000      Debt:      Rs.10,000
                       Equity:    Rs.3,000
            3,000
 Margin =   ------- = 23%
            13,000
 To lift the margin to 30% maintenance level requires
 equity of 30% of Rs.13,000 which is equal to Rs3,900.
 This will lead to a further deposit of Rs.900 by the
 customer.
          MARKETS FOR SECURITIES

• Margin Trading – Example (Continued).
  Now suppose the price of the share rises from Rs20 to
  Rs.25. the new position of the customer account will be
  as follows:
   Stock Rs.25,000     Debt: Rs.10,000
                       Equity: Rs.15,000

              15,000
  Margin = ------- = 60%
             25,000

• The investor can now buy additional stock of Rs.5,000
  without investing a single Rupee. This will decrease its
  margin to 50% which is the initial requirement under the
  regulation.
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Security Market Indicators:
• If an investor owns more than a few stocks or
  bonds, it is cumbersome to follow each stock or
  bond individually to determine the composite
  performance of the portfolio.
• Also, there is an intuitive notion that most
  individual stocks or bonds move with the
  aggregate market. Therefore, if the overall
  market rose, an individual’s portfolio probably
  also increased in value.
• To supply investors with a composite report on
  market performance, some financial publications
  or investment firms have developed stock
  market and bond market indexes.
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Security Market Indicators: Uses
• As benchmarks to evaluate the performance
  of professional money managers
• To create and monitor an index fund
• To measure market rates of return in
  economic studies
• For predicting future market movements by
  technicians
• As a proxy for the market portfolio of risky
  assets when calculating the systematic risk of
  an asset.
         MARKETS FOR SECURITIES

Security Market Indicators:
• We hear a lot about what happens to the Dow
  Jones Industrial Average (DJIA) each day.
• In addition, you might also hear about other
  stock indexes, such as the S&P 500 index, the
  Nasdaq composite, or even the Nikkei Average.
  These indexes change by differing amounts.
• The indexes are organized by the weighting of
  the sample of stocks based on:
   – the price-weighted series - some of the most popular
     indexes are in this category.
   – The next group is the market-value-weighted series,
     which is the technique currently used for most
     indexes.
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Security Market Indicators:
A price-weighted series is an arithmetic average of
current prices, which means that index movements are
influenced by the differential prices of the components.
            MARKETS FOR SECURITIES

  Security Market Indicators:
• A market-value-weighted series is generated by deriving the
  initial total market value of all stocks used in the series (Market
  Value = Number of Shares Outstanding X Current Market Price).
• This initial figure is typically established as the base and
  assigned an index value (the most popular beginning index value
  is 100, but it can vary—say, 10, 50).
• Subsequently, a new market value is computed for all securities
  in the index, and the current market value is compared to the
  initial ―base‖ value to determine the percentage of change, which
  in turn is applied to the beginning index value.
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Security Market Indicators:
          MARKETS FOR SECURITIES

Security Market Indicators:
DEMONSTRATION OF THE IMPACT OF DIFFERENT VALUES ON A
MARKET-VALUE-WEIGHTED STOCK INDEX
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Security Market Indicators: A Global Overview
            MARKETS FOR SECURITIES

The expected return from an investment is defined as:
Expected Return = A respective sum of (Probability of
  Returns) X (Possible Returns)
• Let us begin our analysis of the effect of risk with an example of
  perfect certainty wherein the investor is absolutely certain of a return
  of 5 percent.
• Perfect certainty allows only one possible return, and the probability
  of receiving that return is 1.0. Few investments provide certain
  returns.
• In the case of perfect certainty, there is only one value for PiRi:
        • E(Ri) = (1.0)(0.05) = 0.05
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In an alternative scenario, suppose an investor believed an
   investment could provide several different rates of return
   depending on different possible economic conditions. As an
   example, in
• a strong economic environment with high corporate profits and
   little or no inflation, the investor might expect the rate of return
   on common stocks during the next year to reach as high as 20
   percent.
• In contrast, if there is an economic decline with a higher-than-
   average rate of inflation, the investor might expect the rate of
   return on common stocks during the next year to be –20
   percent.
• Finally, with no major change in the economic environment, the
   rate of return during the next year would probably approach the
   long-run average of 10 percent.
• The investor might estimate probabilities for each of these
   economic scenarios based on past experience and the current
   outlook.
INTRODUCTION TO THE SECURITY ANALYSIS

• The measures of risk for an investment are:
  – Variance of rates of return
  – Standard deviation of rates of return
  – Coefficient of variation of rates of return (standard
    deviation/means)
  – Covariance of returns with the market portfolio (beta)
• The sources of risk are:
  –   Business risk
  –   Financial risk
  –   Liquidity risk
  –   Exchange rate risk
  –   Country risk
INTRODUCTION TO THE SECURITY ANALYSIS
   INVESTMENT – RECALLING SOME BASIC CONCEPTS




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