Investment Analysis & Portfolio Management †Samples for Students

Question: Discuss about the Investment Analysis and Portfolio Management. Answer: Introduction The assignment considers and takes into account the utilization of the satisfactory financial derivatives. The derivatives are utilized by the managers of the portfolio for enhancing the returns and gains from the investments. The derivatives help in the increase of the amount of exposure faced by the investors and helps them in hedging the entire exposure of the capital market. They are the options that help the managers of the portfolio and the investments in applying the theories of investment that are relevant for the application. The derivative options help the investors in making exponential gains. The assignment also considers the evaluation of the derivatives under imaginary and theoretical situations. There are four categories of instruments of derivatives and the assignment has considered the analysis and the evaluation of the four instruments of derivatives. The analysis also consists of the recommendations given on to the managers of the portfolios. The analysis also help s in the attaining the capability of an investor to enhance the earnings by the usage of a variety of instruments of derivatives. Types of financial derivatives in the portfolio management As stated above, there are four categories of the instruments of derivatives that can be used for the management of the portfolio. The categories are as under: Future contract derivative The contracts that are conducted through the use of exchange and provide allowance to the investors for making sufficient decisions of investments are referred to as the Future contracts. They have a variety of similarities with the forward contracts that are discussed in the next part. It is similar on the basis that the sale of specific commodities is carried on a date that is in future. The commodity prices are fixed as per the present date and the same helps in the reduction of the volatility in the prices that the investors forecast for the date in future (Berezhnoy et al. 2014). They are contracts that use the exchanges. They are conducted with the help of a medium that puts an obligation on the various parties for the fulfilment of the bargaining part. They have a functioning and conducting on a format that is pre designed in nature. It is required to be proceeded by the investors in the process of the conduction of the transactions and the investments. In addition, such contracts for the most part follow the settlement of the contract on a daily basis. It considers the realisation of all the amounts of profits and losses on the period subsequent to the day of trading. In such contracts the buyers and sellers do not form any agreements and they basically carry out the transactions with the exchange (Bodie 2013). Illustration of a future contract Particulars Value Value Buying Gold 100 ounce Current Gold price 1250 = 125,000 (1250 * 100) Future contract 1285 = 128,500 (1285 * 100) Expected Price 1360 = 136,000 (1360 * 100) Reduction in losses 7500 Table 1: Forward contract (Source: Created by author) It can be understood from the above example of future contract that with the adaptation of the Future contract, there was a reduction in the losses of the transaction. There was a decline in the value of Gold i.e. the amount worth $8,500.The decline in losses was because of the lockage of the prices of gold that allowed the investors in reducing the losses towards attaining the commodity. Thus, this helps in effective investments of the money of investors (Brent 2013). Forward contract derivative They are the oldest and the simplest form of the instruments and have applicability till a limited time i.e. for that day only. They are taken into action by the investors for controlling or hedging the losses for the future period. It is an agreement for a later date made today and is made between the two parties that have regards with the sale of the instrument or the product. It had been in use until the invention of the derivative instrument named future contracts and as discussed in the above section. A number of investors have been using the contracts in an effective manner for conducting the tolerable exposure within the market (Frino et al. 2014). It was stated that the forward contracts have to be conducted and is generally conducted among the two counterparties or the parties. The contract does not consider the possibility of the exchange being accountable for the transaction done. While, on the other hand, there was an argument that by using the future contracts, there may not be any allowance or obligation on the part of the other parties that may commit towards the fulfilling of the contract terms. The particulars and the details related to the forward contracts are kept in a secret and confidential manner. It is hidden from the public and there is no condition of providing the pertinent information concerning the contract. The instrument of Forward contract is helpful in allowing an effective control towards the investors in terms of the rising prices. It also helps in the reduction of the losses that possibly can occur within the capital market as it has a volatile condition (Khumawala et al. 2016). The contracts are used by the bank to manage the exchange in currency. Illustration of a forward contract: Particulars Value Value AUD payment 1,000,000 Current AUD/USD Rate 0.76 760,000 (1,000,000 * 0.76) Expected AUD/USD Rate 0.73 730,000 (1,000,000 * 0.73) Forward Contract Rate 0.74 740,000 (1,000,000 * 0.74) Reduction in losses 10,000 (740,000-730,000) Table 2: Forward contract (Source: Created by author) The firm that uses the rate of AUD $ must be converted to $ as the conversion will lead to the reduction of the volatile nature of the payment to be made under the contract. The entire usage of such contract aids in the reduction of the amount of loss by about $10,000 as calculated in the table above. The same became possible by the application of the forward contract that reduced the fluctuation of the rate of exchange and thus reduced the risk faced by person at the time of exchange (Johnson 2015). Option contract derivative The Option contract of the instruments of derivative is used by the investors for the effective Hedging or getting secured from the exposure faced by the investors within the capital market. The contract provides allowance towards the investors for the effectiveness in the hedging process for getting secured against the categories ofthe volatility in future that are expected by the investors (Hou 2017). The two categories of options comprise of the call and the put options. The call option provides a right to the investors to buy a product or commodity at a specific price and at the later date. On the other hand, the put option provides a right to the investors to sell a product or commodity at a specific price and at the later date. In addition, such contract helps in providing the choice of an effective nature towards the traders. It provides a choice that will assist in the effective speculation of the market and by reduction of the expected and expanded losses that will form part of the investment period (Pinzur 2016). The contract requires adequate measures to be undertaken at the time of conduction of the trades related to the options. Thus, the exchange measures can be applied for the same. With the provision of the smaller amounts of premium, the trades of option majorly allow the investors in increasing the exposures related to the market. The premium costs can be ignored and it allows in the reduction of the risks with the increase in the capacity of investments. The future gains from the investment are gained by these contracts as it has a basis on the volatility of the future prices. The option contractors incur the major expenditure that is the amount of premium charged on the conduct of the trades and the use of premiums are done to allow towards the reduction of the overall blockage of the capital (Salazar 2014). Illustration of an option contract: Particulars Value Value Selling shares of Samsung 1000 Buying Put Option Current price 152 152,000 (1,000 * 152) Strike price 150 150,000 (1,000 * 150) Premium 5 5,000 (1,000 * 5) Expected Price 140 140,000 (1,000 * 140) Actual Price 149 149,000 (1,000 * 149) Reduction in losses 4000 (149000-140000) Table 3: Forward contract (Source: Created by author) The above example depict that the option prices of the Samsung had not followed the speculation of $140 and the same resulted in the loss of the investor as $4000. The strike price was $150 and premium $5. The prices of Samsung resulted in loss of $4000 by the investor and premium of $5,000 was paid. If the investor does not trade, he will be responsible to pay a premium amount higher than the incurred losses. Swaps derivative The Swaps derivative is one of the most complex and complicated category of derivatives. It involves the speculation and research done before the initiation of the trade. They are conducted on various numbers of participants that include the adoption of fixed and floating rates of interest. The adoption of fixed and floating rates of interest increases the entire gains from the trades and investments. The swap derivatives permit the investors to swap the rates of interests and the currency of underlying nature towards the enhancement of the financial income. The companies can easily avoid the obstructions faced by the means of the rates of foreign exchange towards the overall return from investment (Takino 2016). The swaps are conducted for the process of negotiation among two or more parties for obtaining relevant benefits. It helps in the reduction of a variety of risks occurring from investment. Amount to be invested 100,000 Interest rate 1st country Interest rate 2nd country Exchange rate 4 0.25 Savings 8% 3% Loan 9% 4% Invested amount $400,000 Interest received $32,000 Converted to 2nd country $8,000 Invested amount $100,000 Invested paid $3,000 Total income $5,000 It can be evaluated that there can be a gain of $32000 that has been converted to $8000. Investigation of the appeal of using derivatives in imaginary situations The above categories of the derivative instruments are practicable in nature but, the most effective one is the futures contract. Such contracts provide allowance to the investors for conducting trades devoid of any risks attached. The theoretical scenarios discussed above reflect the assistance provided by the trading done by the options and futures. These options help the investors to form effective decisions with regard to the investments and also effective conducting of the trades in the entire market. The forward contracts must be avoided in the construction of the portfolio by the investors and the managers of the Portfolio (Schwager and Etzkorn 2017). Additionally, the swap trades should be avoided by the managers of portfolio. The swap trades comprise of interest rates of swap that is complex job carried out by the companies. Consequently, there must be employment of the contracts like future and options that will assist a manager of portfolio to perform and convey the required rate of return obtained from the investment (Chance and Brooks 2015). Conclusions and Recommendations The overall assessment of the assignment shows that the contracts of derivatives provides allowance to the investors in suffice investment in the market place. The investors use the instruments of derivatives like future, options, forward and the contracts of swaps. On the other hand, the most effective one is the futures contract. Such contracts provide allowance to the investors for conducting trades devoid of any risks attached. It also provides effective profitability. Thus, the use of options will help in the adequate investment instrument for conducting the trades at high ends. The managers of the portfolio must effectively use the contracts for preparing the portfolio and gaining returns and productivity. References Berezhnoy, V.I., Berezhnaya, E.V., Berezhnaya, O.V., Telnova, N.N., Ostapenko, E.A. and Shatalova, O.I., 2014. Methodology of application of the systematic and derivative analysis of the conditions of the local raw materials market development.Life Sci. J,11(8), pp.600-602. Bingham, N.H. and Kiesel, R., 2013.Risk-neutral valuation: Pricing and hedging of financial derivatives. Springer Science Business Media. 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