Investment Funds (Module 6) PDF

SCHOOL OF BUSINESS, HOSPITALITY AND TOURISM MANAGEMENT Module 6: Investment Funds BA_CAPITAL MKT FM - BSBA FM Bico, Emmanuel D. Garcia, Angeline D. Til-Adan, Charie Mae V. Team Chipmun...

SCHOOL OF BUSINESS, HOSPITALITY AND TOURISM MANAGEMENT Module 6: Investment Funds BA_CAPITAL MKT FM - BSBA FM Bico, Emmanuel D. Garcia, Angeline D. Til-Adan, Charie Mae V. Team Chipmunks 1  SCHOOL OF BUSINESS, HOSPITALITY AND TOURISM MANAGEMENT Table of Contents Learning Objectives............................................................................................................................................ 4 Introduction............................................................................................................................................................ 5 Discussion of Main Topics and Subtopics................................................................................................ 5 INVESTMENT FUNDS................................................................................................................ 5 How Investment Funds Work?.............................................................................................................. 5 Types of Funds:....................................................................................................................................... 6 MUTUAL FUNDS........................................................................................................................ 6 Why invest in mutual funds?.................................................................................................................. 7 How do you typically earn a return from a mutual fund?................................................................... 7 VARIOUS TYPES OF MUTUAL FUNDS............................................................................................ 7 ADVANTAGES IN INVESTING IN MUTUAL FUNDS....................................................................... 8 DISADVANTAGES IN INVESTING IN MUTUAL FUNDS................................................................ 8 EXCHANGE TRADED FUNDS (ETFS)....................................................................................... 9 INVESTING IN ETFs............................................................................................................................ 10 Types of ETFs........................................................................................................................................ 10 ADVANTAGES OF ETFs..................................................................................................................... 10 DISADVANTAGES OF ETFs.............................................................................................................. 10 HEDGE FUNDS........................................................................................................................ 11 What do hedge funds invest in?.......................................................................................................... 11 KEY FEATURES OF HEDGE FUNDS.............................................................................................. 11 STRUCTURE OF HEDGE FUNDS.................................................................................................... 12 ADVANTAGES OF HEDGE FUNDS................................................................................................. 12 DISADVANTAGES OF HEDGE FUNDS........................................................................................... 12 MUTUAL FUNDS, EXHANGE TRADED FUNDS (ETFs), AND HEDGE FUNDS...................... 13 PORTFOLIO DIVERSIFICATION.............................................................................................. 14 Benefits of Diversification..................................................................................................................... 14 TYPES OF DIVERSIFICATION.......................................................................................................... 14 ASSET ALLOCATION.............................................................................................................. 15 Why Is Asset Allocation Important?.................................................................................................... 15 KEY PRINCIPLES OF ASSET ALLOCATION.................................................................................. 15 2  SCHOOL OF BUSINESS, HOSPITALITY AND TOURISM MANAGEMENT TYPES OF ASSET ALLOCATION STRATEGIES........................................................................... 16 FACTORS INFLUENCING ASSET ALLOCATION.......................................................................... 16 PORTFOLIO DIVERSIFICATION & ASSET ALLOCATION........................................................... 16 Differences Between Diversification and Asset Allocation.............................................................. 17 Net Asset Value (NAV) and fund performance evaluation.................................................... 17 Calculation of NAV................................................................................................................................ 17 FUND PERFORMANCE EVALUATION.................................................................................... 18 KEY COMPONENTS OF FUND PERFORMANCE EVALUATION............................................... 18 Importance of Fund Performance Evaluation................................................................................... 19 How NAV relates to evaluating fund performance:.......................................................................... 19 Conclusion........................................................................................................................................................... 20 References........................................................................................................................................................... 21 3  SCHOOL OF BUSINESS, HOSPITALITY AND TOURISM MANAGEMENT Module 6: Investment Funds Learning Objectives 1. To define what is investment fund and how does it work. Define what investment funds are and explain their purpose in pooling capital from multiple investors to create diversified portfolios. 2. To differentiate the types of investment funds. Identify and describe the various types of investment funds, including mutual funds, exchange-traded funds (ETFs), and hedge funds, along with their structure, advantages and disadvantages. 3. To explore portfolio diversification. Explain the concept of portfolio diversification and its importance in reducing risk by spreading investments across different asset classes and sectors. 4. To learn more about asset allocation. Discuss the principles of asset allocation, why is it important, types of asset allocation strategies and discuss the factors influencing asset allocation. 5. To analyze the differences between diversification and asset allocation. Analyze the how different diversification is to asset allocation in terms of scope, purpose and implementation. 6. To understand the net asset value (NAV) and fund performance evaluation. Discuss the net asset value, how to calculate NAV, and discuss fund performance evaluation, key components of fund performance evaluation, its importance and How NAV relates to evaluating fund performance. 4  SCHOOL OF BUSINESS, HOSPITALITY AND TOURISM MANAGEMENT Introduction Saving and investing have become increasingly crucial for everyone because of the unpredictable economic conditions. Thus, people nowadays have started to save and have started to invest in various investments funds. Investment funds are pooled investment vehicles that aggregate capital from numerous investors, enabling them to invest in a diversified portfolio of securities. This structure provides a streamlined way for individuals to access financial markets and benefit from collective investment strategies. Investment funds come in various forms, including mutual funds, exchange-traded funds (ETFs), and hedge funds, each with distinct characteristics and management approaches. A significant advantage of these funds is the professional management they offer, where skilled portfolio managers conduct extensive research and make informed investment choices on behalf of the investors. Additionally, investment funds facilitate diversification, allowing individuals to spread their risk across a variety of assets, which can help reduce potential losses. They also leverage economies of scale, resulting in lower transaction costs that are typically passed on to investors as reduced fees. Furthermore, investment funds enhance accessibility, enabling even small investors to engage in a wide range of asset classes and strategies that may otherwise be difficult to access. With the added benefit of liquidity, as many funds allow for straightforward redemption of shares, investment funds are valuable tools for individuals aiming to achieve their financial objectives while effectively managing risk. Discussion of Main Topics and Subtopics INVESTMENT FUNDS An investment fund is a financial vehicle that pools capital from multiple investors to collectively invest in a diversified portfolio of securities, such as stocks, bonds, and other assets. This structure allows individual investors to access a broader range of investment opportunities and professional management that they might not achieve on their own. How Investment Funds Work? Investment funds operate by gathering money from various investors, which is then managed by professional fund managers. These managers make decisions regarding the fund's investments based on its objectives and strategies. These are the breakdown of how they function: 1. Pooling of Capital: Investors contribute money to the fund, acquiring shares or units in return. Each investor retains ownership of their shares but does not directly control investment decisions. 2. Professional Management: A fund manager oversees the investment strategy, deciding which securities to buy or sell, and when to do so. This management aims to maximize returns while managing risks according to the fund's goals. 5  SCHOOL OF BUSINESS, HOSPITALITY AND TOURISM MANAGEMENT 3. Diversification: By pooling resources, investment funds can invest in a wider array of assets, which helps to mitigate risk. Diversification is a key advantage, as it reduces the impact of poor performance from any single investment. Types of Funds: There are various types of investment funds, including: a. Mutual Funds: These are open-end funds that issue new shares as investors add money and redeem shares when investors withdraw. b. Exchange-Traded Funds (ETFs): Similar to mutual funds but traded on stock exchanges, allowing for intraday buying and selling. c. Hedge Funds: These are typically available only to accredited investors and use a variety of strategies to achieve high returns, often involving higher risk. 4. Fees and Expenses: Investment funds charge fees for management and administration, which can affect overall returns. Common fees include management fees, performance fees, and operational costs. 5. Returns: The fund generates returns through capital appreciation and income from investments. Profits can be reinvested or distributed to investors as dividends. Investment funds provide a way for individual investors to access professional investment management and diversified portfolios, making them a popular choice for many looking to grow their wealth over time. To summarize, investment funds are financial vehicles that pool capital from multiple investors to invest in a diversified portfolio of securities, such as stocks and bonds. This structure allows individual investors to access professional management and a broader range of investment opportunities. Investors contribute money to the fund in exchange for shares, while professional fund managers make investment decisions based on the fund’s objectives and strategies, aiming to maximize returns and manage risks. The pooling of resources enables diversification, which helps mitigate risk. There are various types of investment funds, including mutual funds, exchange-traded funds (ETFs), and hedge funds, each with distinct characteristics. Investment funds charge fees for management and administration, which can affect overall returns. Ultimately, these funds generate returns through capital appreciation and income from investments, making them a popular choice for individuals looking to grow their wealth over time. MUTUAL FUNDS It is an investment vehicle that pools money from multiple investors to purchase a diversified portfolio of stocks, bonds, or other securities (according to the fund's stated strategy). It allows individual investors to gain exposure to a professionally managed portfolio and potentially benefit from economies of scale, while spreading risk across multiple investments. Mutual funds are known by the kinds of securities they invest in, their investment objectives, and the type of returns they seek. Mutual funds are defined as portfolio of investment. So, when an individual buys or shares in a mutual fund, they gain part-ownership of all the underlying assets the fund owns. 6  SCHOOL OF BUSINESS, HOSPITALITY AND TOURISM MANAGEMENT The fund's performance depends on how its collective assets are doing. When these assets increase in value, so does the value of the fund's shares. Conversely, when the assets decrease in value, so does the value of the shares. Why invest in mutual funds? Diversification Mutual funds let you access a wide mix of asset classes, including domestic and international stocks, bonds, and commodities. Low costs Because a mutual fund buys and sells large amounts of securities at a time, its transaction costs are typically lower than what you would pay as an individual investor. Professional management You get the benefit of having a professional manager reviewing and researching the fund's portfolio on an ongoing basis. How do you typically earn a return from a mutual fund? Dividends and interest A fund may earn income from dividends on stocks or interest on bonds, which is passed along to its shareholders (minus any expenses). Capital gain distributions If the fund sells securities that have increased in price, the fund has a capital gain Tooltip. Most funds pass along these gains, minus any capital losses, to investors at the end of the year. Fund share price increase If the fund's securities increase in price during the time you own the fund and the manager holds onto them, the fund's shares increase in value. You can then sell your fund shares for a profit. VARIOUS TYPES OF MUTUAL FUNDS 1. STOCK FUNDS- this fund invests principally in equity or stocks. 2. BONDS FUNDS- is a mutual fund that generates a consistent and minimum return is part of the fixed-income category. focus on investments that pay a set rate of return, such as government bonds, corporate bonds, and other debt instruments. The bonds should generate interest income that's passed on to the shareholders, with limited investment risk. 7  SCHOOL OF BUSINESS, HOSPITALITY AND TOURISM MANAGEMENT 3. MONEY MARKET MUTUAL FUNDS- money market consists of safe, risk-free, short-term debt instruments, mostly government Treasury bills. The returns on them aren't substantial. - A typical return is a little more than the amount earned in a regular checking or savings account and a little less than the average certificate of deposit (CD). - often used as a temporary holding place for cash that will be used for future investments or for an emergency fund. While low risk, they aren't insured by the Federal Deposit Insurance Corporation (FDIC) like savings accounts or CDs. ADVANTAGES IN INVESTING IN MUTUAL FUNDS 1. Diversification - or the mixing of investments and assets within a portfolio to reduce risk. A diversified portfolio has securities with different capitalizations and industries and bonds with varying maturities and issuers. 2. Potential for Higher Returns - Mutual funds offer higher returns than traditional saving instruments like fixed deposits. By investing in a mix of assets and leveraging market opportunities, mutual funds can generate significant returns over the long term. This potential is particularly appealing to investors looking to beat inflation and grow their wealth. 3. Easy Access - mutual funds can be bought and sold with relative ease, making them highly liquid investments. Also, for certain types of assets, like foreign equities or exotic commodities, mutual funds are often the most workable way—sometimes the only way—for individual investors to participate. 4. Professional Management - professional investment manager uses research and skillful trading. 5. Transparency - mutual funds are subject to industry regulations meant to ensure accountability and fairness for investors. 6. Liquidity - Mutual funds are known for their liquidity. Investors can buy or sell units of a mutual fund at the fund's current Net Asset Value (NAV), typically on any business day. This ease of entry and exit makes mutual funds an attractive option for investors who might need quick access to their funds, unlike investments like real estate, which can be time-consuming and complex to liquidate. DISADVANTAGES IN INVESTING IN MUTUAL FUNDS 1. No Federal Deposit Insurance Corporation (FDIC) Guarantee - like many other investments without a guaranteed return, there is always the possibility that the value of your mutual fund will depreciate. 2. Cash Drag - mutual funds require a significant part of their portfolios to be held in cash to satisfy share redemptions each day. 8  SCHOOL OF BUSINESS, HOSPITALITY AND TOURISM MANAGEMENT 3. End-of-day training only - mutual fund allows you to request that your shares be converted into cash at any time. 4. Taxes - when the mutual fund manager sells a security, a capital-gains tax is triggered, which can be extended to you. 5. Costs and Fees - Mutual funds incur various charges, including management fees, entry and exit loads, and other operational expenses. These fees can impact the overall returns, especially in actively managed funds where management fees tend to be higher. 6. Market Risk - Investments in mutual funds are subject to market risks. The value of the fund’s holdings can fluctuate based on market conditions, which means that the investment value can go down and up, and investors may not get back the amount they originally invested. 7. Lack of Control - Investors in mutual funds do not have control over the specific investments made by the fund. The fund managers make the decisions about which stocks or bonds to buy or sell and might not always align with an individual investor’s preferences. In summary, mutual funds are investment vehicles that pool money from multiple investors to purchase a diversified portfolio of securities, such as stocks and bonds, based on the fund's stated strategy. This allows individual investors to access professionally managed portfolios and benefit from economies of scale while spreading risk across various investments. When investors buy shares in a mutual fund, they gain part-ownership of the underlying assets, and the fund's performance is directly tied to the value of these assets. Key advantages of mutual funds include diversification, low transaction costs, professional management, and liquidity, making them accessible to a wide range of investors. Returns can be earned through dividends, capital gains distributions, and increases in share price. However, mutual funds also come with disadvantages, such as market risk, management fees, and lack of control over specific investments. Overall, mutual funds offer a convenient way for investors to diversify their portfolios and potentially achieve higher returns compared to traditional savings instruments. EXCHANGE TRADED FUNDS (ETFS) Exchange traded funds (ETFs) are investment funds that track a specific index, sector, commodity, or other asset. They are a type of pooled investment security that can be bought and sold on a stock exchange like individual stocks. An Exchange-Traded Fund (ETF) is a type of investment fund that holds a collection of assets, such as stocks, bonds, commodities, or currencies, and is traded on stock exchanges much like individual stocks. ETFs are designed to track the performance of a specific index, sector, or asset class, providing investors with a way to gain exposure to a diversified portfolio without having to buy each individual security. ETFs combine features of both mutual funds and stocks. Like mutual funds, they offer investors an interest in a professionally managed, diversified portfolio of investments. However, unlike mutual funds, ETF shares trade like stocks on exchanges, with prices fluctuating throughout the day based on market demand. 9  SCHOOL OF BUSINESS, HOSPITALITY AND TOURISM MANAGEMENT INVESTING IN ETFs ETFs can be a cost-effective way to gain diversified exposure to a broad range of assets. They allow investors to build a portfolio with one, many, or only ETFs. When investing in ETFs, it's important to consider factors like the expense ratio, tracking error, liquidity, and fit with your investment goals and risk tolerance. Types of ETFs There are various types of ETFs, including: Stock ETFs: Focused on equities. Bond ETFs: Invested in fixed-income securities. Commodity ETFs: Hold physical commodities like gold or oil. Currency ETFs: Invest in currencies or currency baskets. Index ETFs: Track specific market indices like the S&P 500. Leveraged and Inverse ETFs: Use financial derivatives to amplify returns or profit from declines in market value. ADVANTAGES OF ETFs 1. Diversification - ETFs provide exposure to a wide range of assets, allowing investors to diversify their portfolios and mitigate risk. 2. Cost Effectiveness - ETFs typically have lower expense ratios compared to actively managed mutual funds due to their passive management structure. 3. Liquidity - ETFs can be bought and sold throughout the trading day on stock exchanges, providing investors with flexibility and the ability to react quickly to market changes. 4. Tax Efficiency - ETFs can be more tax-efficient than mutual funds due to their structure and the ability to do in-kind redemptions, which can help avoid short-term capital gains. 5. Flexibility - ETFs can be traded like stocks, allowing investors to use various trading strategies such as short selling, buying on margin, and trading options. DISADVANTAGES OF ETFs 1. Trading Cost - Although ETFs have lower annual expenses, investors may incur brokerage commissions each time they buy or sell shares, which can add up with frequent trading. 2. Bid-ask Spreads - The difference between the highest price a buyer is willing to pay and the lowest price a seller is willing to accept can be wider in ETFs with lower trading volumes or investing in less liquid markets. 10  SCHOOL OF BUSINESS, HOSPITALITY AND TOURISM MANAGEMENT 3. Market Impact - Large trades in ETFs can potentially impact the underlying securities, especially in less liquid markets or during volatile market conditions. 4. Tracking Error - ETFs may not perfectly track their underlying index or benchmark due to factors such as fees, expenses, and the inability to perfectly replicate the index. 5. Counterparty Risk - In the case of some ETFs, such as leveraged or inverse ETFs, there is a risk associated with the counterparties providing the leverage or derivatives used to achieve the desired exposure. To sum up it all, exchange-Traded Funds (ETFs) are investment funds that hold a collection of assets such as stocks, bonds, commodities, or currencies, and are traded on stock exchanges like individual stocks. They are designed to track the performance of a specific index, sector, or asset class, providing investors with a diversified portfolio without the need to purchase each individual security. ETFs combine features of mutual funds and stocks, offering professional management and diversification while allowing shares to be bought and sold throughout the trading day. Key advantages of ETFs include cost-effectiveness due to lower expense ratios, liquidity, and tax efficiency. However, they also come with disadvantages such as trading costs, bid-ask spreads, and the risk of tracking errors. Overall, ETFs offer a flexible and accessible way for investors to gain exposure to various asset classes while managing risk. HEDGE FUNDS Hedge funds are pooled investment funds that employ various aggressive strategies to maximize returns for wealthy investors. Unlike mutual funds, hedge funds are less regulated and typically require a minimum investment of $1 million or a high annual income, making them accessible primarily to accredited investors. A hedge fund is a form of alternative investment that pools capital from individual or institutional investors to invest in varied assets, often relying on complex techniques to build its portfolio and manage risk. Hedge funds can invest in anything from real estate to currencies and other alternative assets; this is one of many ways in which hedge funds differ from mutual funds, which normally only invest in stocks or bonds. The aim of all hedge funds is to maximize investor returns and eliminate risk, regardless of whether the market is going up or down. What do hedge funds invest in? Land, real estate, currencies, derivatives and other alternative assets – in short, anything. The only thing limiting the scope of any hedge fund is its mandate. KEY FEATURES OF HEDGE FUNDS Investment Strategies: Hedge funds can invest in a wide array of assets, including stocks, bonds, and derivatives, often using leverage to amplify returns. 11  SCHOOL OF BUSINESS, HOSPITALITY AND TOURISM MANAGEMENT Fee Structure: The typical fee arrangement is known as "2 and 20," where the GP charges a 2% management fee and a 20% performance fee on profits above a specified benchmark. Service Providers: Hedge funds often engage various service providers, such as prime brokers for trade execution and administrators for fund valuation and operations. Liquidity: Hedge funds usually have limited liquidity, with investors often facing lock-up periods before they can redeem their shares. STRUCTURE OF HEDGE FUNDS - Hedge funds are commonly structured as limited partnerships: 1. General Partner (GP): The fund manager who makes investment decisions and has unlimited liability. 2. Limited Partners (LPs): Investors who contribute capital but have limited liability, restricted to their investment amount. They are passive participants in the fund's management. ADVANTAGES OF HEDGE FUNDS 1. Potential for high returns: Hedge funds often employ aggressive strategies, including leverage and derivatives, aiming for high returns regardless of market conditions. 2. Diversification: They provide access to alternative investments that can help diversify a portfolio beyond traditional stocks and bonds. 3. Flexibility in strategies: Hedge funds can utilize a variety of strategies such as long/short positions, event-driven tactics, and global macroeconomic analysis, allowing them to adapt to changing market conditions. 4. Expert Management: Hedge fund managers are typically highly experienced, employing sophisticated risk management techniques to navigate complex investments. DISADVANTAGES OF HEDGE FUNDS 1. High Fees: Hedge funds often charge substantial management (around 2%) and performance fees (up to 20% of profits), which can eat into returns. 2. Lack of Transparency: They are less regulated than mutual funds, making it difficult for investors to track performance and understand the underlying risks. 3. Illiquidity: Many hedge funds impose lock-up periods during which investors cannot withdraw their capital, limiting liquidity. 4. Complex Strategies: The use of leverage and derivatives can amplify losses, leading to significant risks, particularly in volatile markets. 5. High Minimum Investments: Hedge funds typically require substantial initial investments, making them accessible primarily to high-net-worth individuals. In conclusion, hedge funds are pooled investment vehicles that employ diverse strategies to generate returns for wealthy investors, often relying on complex techniques like leverage and derivatives. Unlike mutual funds, they have a wide investment scope, including alternative assets 12  SCHOOL OF BUSINESS, HOSPITALITY AND TOURISM MANAGEMENT such as real estate, currencies, and commodities. Hedge funds aim to maximize returns and minimize risk regardless of market conditions. Key features include flexible investment strategies, a "2 and 20" fee structure, engagement of service providers, and limited liquidity. Structured as limited partnerships, hedge funds have a general partner (GP) who manages investments and limited partners (LPs) who contribute capital. Advantages include the potential for high returns, diversification, strategy flexibility, and expert management. However, hedge funds also have drawbacks, such as high fees, lack of transparency, illiquidity, complex strategies, and high minimum investments, making them accessible primarily to accredited investors. MUTUAL FUNDS, EXHANGE TRADED FUNDS (ETFs), AND HEDGE FUNDS Mutual funds, exchange-traded funds (ETFs), and hedge funds are all pooled investment vehicles, but they differ significantly in structure, regulation, fees, and investment strategies. MUTUAL FUNDS Accessibility: Open to the general public with low minimum investment requirements. Regulation: Heavily regulated, requiring regular disclosures and adherence to strict guidelines. Fees: Typically charge a management fee of 1-2% and do not take a share of profits. Investment Strategy: Generally conservative, focusing on stocks and bonds, and cannot engage in high-risk strategies like short selling. Liquidity: Shares are bought and sold at the end of the trading day at the net asset value (NAV) price. EXHANGE TRADED FUNDS (ETFs) Accessibility: Also available to the general public, similar to mutual funds. Regulation: Governed by regulations similar to mutual funds but are traded on exchanges. Fees: Generally lower fees than mutual funds, with no performance fees. Investment Strategy: Typically track an index and can include a variety of asset classes. They can be traded throughout the day like stocks. Liquidity: High liquidity, allowing for intraday trading. HEDGE FUNDS Accessibility: Limited to accredited investors, often requiring high minimum investments. Regulation: Lightly regulated, allowing for more flexibility in investment strategies. Fees: Higher fees, usually around 2% management plus 20% performance fees. Investment Strategy: Employ aggressive strategies, including leverage, derivatives, and short selling, aiming for high returns regardless of market conditions. Liquidity: Generally low, often with lock-in periods and restrictive redemption policies. 13  SCHOOL OF BUSINESS, HOSPITALITY AND TOURISM MANAGEMENT PORTFOLIO DIVERSIFICATION Portfolio diversification is a risk management technique that involves mixing a wide variety of investments within a portfolio. The primary goal is to limit exposure to any single asset or risk, thereby smoothing out potential volatility in investment returns. A well-diversified portfolio typically includes a mix of different asset types, such as stocks, bonds, real estate, and commodities, to mitigate risks associated with market fluctuations. Portfolio diversification is an investment strategy aimed at reducing risk by spreading investments across various asset classes, sectors, and geographies. The core principle is that different assets often perform differently under varying market conditions, so losses in one area can be offset by gains in another. Benefits of Diversification Risk Reduction: By spreading investments across various assets, diversification helps mitigate the impact of poor performance in any single investment or asset class. This can lead to a more stable overall portfolio performance. Smoother Returns: A diversified portfolio tends to experience less volatility compared to a concentrated portfolio, as the positive performance of some investments can offset the negative performance of others. Potential for Higher Returns: While diversification aims to reduce risk, it can also enhance potential returns by capturing gains from different asset classes that perform well at different times. Protection Against Market Fluctuations: Diversification can help protect against systemic risks and market downturns, as different assets may respond differently to economic changes. TYPES OF DIVERSIFICATION Asset Class Diversification: Involves investing in different asset types, such as stocks, bonds, real estate, and commodities, each with unique risk-return profiles. Geographic Diversification: Spreading investments across different countries or regions to mitigate risks associated with specific economies. Industry Diversification: Investing in various sectors to avoid concentration risk in any single industry. *Correlation: Effective diversification relies on selecting assets that are not perfectly correlated. This means that when one asset's value decreases, another may increase, balancing the overall portfolio performance. *Limitations: While diversification can reduce unsystematic risk (specific to individual investments), it cannot eliminate systematic risk (market-wide risks) entirely. Thus, a diversified portfolio can still experience losses during market downturns. 14  SCHOOL OF BUSINESS, HOSPITALITY AND TOURISM MANAGEMENT To summarize, portfolio diversification is an investment strategy that aims to reduce risk by spreading investments across various asset classes, sectors, and geographies. The primary goal is to limit exposure to any single asset or risk, thereby smoothing out potential volatility in investment returns. A well-diversified portfolio typically includes a mix of different asset types, such as stocks, bonds, real estate, and commodities, to mitigate risks associated with market fluctuations. The core principle is that different assets often perform differently under varying market conditions, so losses in one area can be offset by gains in another. Key benefits of diversification include risk reduction, smoother returns, potential for higher returns, and protection against market fluctuations. Effective diversification relies on selecting assets that are not perfectly correlated, as this means that when one asset's value decreases, another may increase, balancing the overall portfolio performance. While diversification can reduce unsystematic risk (specific to individual investments), it cannot eliminate systematic risk (market-wide risks) entirely. Thus, a diversified portfolio can still experience losses during market downturns ASSET ALLOCATION Asset allocation is the process of dividing an investment portfolio among different asset classes, such as stocks, bonds, and cash equivalents, to balance risk and potential returns. It is a key strategy for managing investment risk and optimizing returns over the long term. Asset allocation is how investors divide their portfolios among different assets that might include equities, fixed-income assets, and cash and its equivalents. Investors ordinarily aim to balance risks and rewards based on financial goals, risk tolerance, and the investment horizon. Why Is Asset Allocation Important? There's no formula for the right asset allocation for everyone, but the consensus among most financial professionals is that asset allocation is one of the most important decisions investors make. Selecting individual securities within an asset class is done only after you decide how to divide your investments among stocks, bonds, and cash and cash equivalents. This will largely determine your investment results. Investors use different asset allocations for distinct goals. Someone saving to buy a new car in the next year might invest those savings in a conservative mix of cash, certificates of deposit, and short- term bonds. However, individuals saving for retirement decades away typically invest most of their retirement accounts in stocks because they have a lot of time to ride out the market's short-term fluctuations. KEY PRINCIPLES OF ASSET ALLOCATION Diversification: By investing in various asset classes, you can reduce the overall risk of your portfolio, as different assets often perform differently under varying market conditions. Risk Tolerance: Your asset allocation should align with your risk tolerance, which depends on factors like your age, investment horizon, and financial goals. 15  SCHOOL OF BUSINESS, HOSPITALITY AND TOURISM MANAGEMENT Time Horizon: Investors with a longer time horizon can typically afford to take on more risk and allocate a larger portion of their portfolio to stocks, while those with a shorter time horizon may prefer a more conservative approach. TYPES OF ASSET ALLOCATION STRATEGIES Strategic Asset Allocation: This involves setting a long-term target allocation based on your risk tolerance and investment objectives and rebalancing periodically to maintain the target mix. Tactical Asset Allocation: This involves actively adjusting the allocation based on short- term market conditions and expectations, with the goal of capitalizing on market opportunities. Core-Satellite Allocation: This combines a core portfolio of broadly diversified, low-cost index funds with satellite holdings of actively managed funds or specific sectors, to potentially enhance returns. FACTORS INFLUENCING ASSET ALLOCATION Age and Life Stage: Younger investors can typically afford to take on more risk, while older investors may prefer a more conservative approach as they approach retirement. Risk Tolerance: Some investors are more comfortable with market volatility than others, which should be reflected in their asset allocation. Investment Objectives: Investors with different goals, such as retirement planning or saving for a specific purpose, may have different asset allocation needs. Time Horizon: Investors with a longer time horizon can typically afford to take on more risk and allocate a larger portion of their portfolio to stocks. To conclude, asset allocation is the process of dividing an investment portfolio among different asset classes, such as stocks, bonds, and cash equivalents, to balance risk and potential returns. It is a crucial strategy for managing investment risk and optimizing long-term returns, as it determines how investments are allocated based on financial goals, risk tolerance, and investment horizon. The importance of asset allocation lies in its ability to influence overall investment results more significantly than the selection of individual securities. Different asset allocations are tailored to specific goals; for example, a conservative mix may be suitable for short-term savings, while a growth-oriented allocation is typical for long-term retirement planning. Key principles of asset allocation include diversification, aligning with risk tolerance, and considering the time horizon. Various strategies exist, such as strategic, tactical, and core-satellite allocation, each with its approach to managing assets based on market conditions and investor objectives. Factors influencing asset allocation include age, risk tolerance, investment objectives, and time horizon, with younger investors generally taking on more risk compared to those nearing retirement. PORTFOLIO DIVERSIFICATION & ASSET ALLOCATION Portfolio diversification and asset allocation are essential strategies in investment management aimed at optimizing returns while minimizing risk. 16  SCHOOL OF BUSINESS, HOSPITALITY AND TOURISM MANAGEMENT Asset Allocation: Dividing investments among different asset classes (stocks, bonds, real estate, etc.) to balance risk and return characteristics. Geographic and Sector Diversification: Investing in assets from different countries and industries to mitigate risks associated with specific economic conditions. Differences Between Diversification and Asset Allocation Purpose: Diversification aims to reduce risk by spreading investments within and across asset classes. Asset Allocation focuses on the overall strategy of how to distribute investments among different asset classes based on individual goals and risk tolerance. Scope: Diversification is about the variety of investments within the portfolio (e.g., different stocks or bonds). Asset Allocation is about the broader strategy of how much of the portfolio is invested in each asset class (e.g., the percentage of stocks versus bonds). Implementation: Diversification can be seen as a subset of asset allocation, as effective asset allocation often includes diversification strategies to manage risk. Asset Allocation sets the framework, while diversification is the method used to achieve a balanced risk profile within that framework. Net Asset Value (NAV) and fund performance evaluation Net asset value (NAV) is the value of an investment fund that is determined by subtracting its liabilities from its assets. The fund's per-share NAV is then obtained by dividing NAV by the number of shares outstanding. Net Asset Value (NAV) is a key financial metric used to determine the value of an investment fund, particularly mutual funds and exchange-traded funds (ETFs). It represents the difference between the total assets of the fund and its liabilities. Calculation of NAV The formula for calculating NAV is: NAV=Total Assets−Total Liabilities To find the per-share NAV, which is crucial for investors, the total NAV is divided by the number of outstanding shares: 17  SCHOOL OF BUSINESS, HOSPITALITY AND TOURISM MANAGEMENT NAV per share =NAV / Total Outstanding Shares NAV is typically calculated at the end of each trading day using the closing market prices of the fund's securities. Example: Assume that the fund has $100 million worth of investments in different securities. It also has $7 million of cash and cash equivalents on hand, $4 million in total receivables, and accrued income for the day of $75,000. As for liabilities, the fund has $13 million in short-term liabilities and $2 million in long-term liabilities. Accrued expenses for the day are $10,000. Furthermore, the fund has 5 million shares outstanding. 1. To determine per-share NAV, first calculate the fund's NAV: Total assets are: $100,000,000 + $7,000,000 + $4,000,000 + $75,000, or $111,075,000 Total liabilities are: $13,000,000 + $2,000,000 + $10,000, or $15,010,000 NAV = $111,075,000 - $15,010,000, or $96,065,000 2. Next, calculate per-share NAV: Per-share NAV = $96,065,000 / 5,000,000, or $19.21 FUND PERFORMANCE EVALUATION Fund performance evaluation is a systematic process used to assess the returns and risks associated with investment portfolios over specific periods. It plays a crucial role in investment management by providing insights into the effectiveness of investment strategies and decisions. Fund performance evaluation is the process of assessing how well an investment fund has performed over a specific period, taking into account both returns and risks. This evaluation is essential for investors to understand the effectiveness of their investments and to make informed decisions about future investments. KEY COMPONENTS OF FUND PERFORMANCE EVALUATION Performance Measurement: This involves calculating the overall returns of a portfolio, considering both risk and return dimensions. It provides a baseline for understanding how well a fund has performed. 18  SCHOOL OF BUSINESS, HOSPITALITY AND TOURISM MANAGEMENT Performance Attribution: This analysis breaks down the sources of returns, helping to identify which investment decisions contributed positively or negatively to performance. It can be based on returns, holdings, or transactions. Performance Appraisal: This step evaluates the skill of the investment manager by comparing actual returns against expected returns, often using benchmarks for context. Manager Selection: This involves deciding whether to hire, retain, or dismiss a fund manager based on their performance and investment strategy. Presentation of Results: Effective communication of performance results to stakeholders is essential, ensuring transparency and accountability in the investment process. *Overall, fund performance evaluation helps investors make informed decisions, align investments with goals, and improve future investment strategies. Importance of Fund Performance Evaluation Informed Decision-Making: Regular evaluation helps investors make informed decisions about whether to hold, buy, or sell fund shares. Manager Accountability: Performance evaluation holds fund managers accountable for their investment decisions and strategies, aiding in the selection and retention of skilled managers. Portfolio Optimization: By understanding fund performance, investors can adjust their portfolios to align with their financial goals and risk tolerance. How NAV relates to evaluating fund performance: Importance of NAV in Performance Evaluation Valuation of Fund Shares: NAV represents the per-share value of a fund, calculated by subtracting total liabilities from total assets and dividing by the number of outstanding shares. This value is crucial for investors to determine the price at which they can buy or sell fund shares. Tracking Performance Over Time: Investors often analyze changes in NAV over specific periods to gauge a fund's performance. By comparing NAV at different points, such as the beginning and end of a year, investors can assess growth or decline, although this should be contextualized with distributions like dividends and capital gains. Benchmarking: NAV can be compared against relevant benchmarks or peer funds to evaluate relative performance. A fund that consistently maintains a higher NAV than its peers may be considered a better performer. Market Trends and Volatility: NAV reflects the impact of market conditions on a fund’s assets. Significant fluctuations in NAV can indicate how well a fund is managed and its ability to navigate market volatility, providing insights into the effectiveness of its investment strategy. 19  SCHOOL OF BUSINESS, HOSPITALITY AND TOURISM MANAGEMENT Total Return Consideration: While NAV is a key metric, it is essential to consider total return, which includes capital gains and income distributions. This broader view provides a more accurate picture of the fund's performance, as NAV alone may not reflect the actual returns received by investors. In summary, NAV is a vital tool for monitoring and evaluating fund performance, but it should be used in conjunction with other performance metrics and contextual factors to provide a comprehensive assessment. Conclusion In conclusion, mutual funds, exchange-traded funds (ETFs), and hedge funds serve as key investment vehicles that pool capital from multiple investors, but they cater to different types of investors and offer varying levels of risk, returns, and accessibility. Mutual Funds are perhaps the most common and accessible form of pooled investment, appealing to a wide range of investors, including individuals with smaller amounts of capital. Mutual funds are professionally managed and provide diversification by investing in a variety of securities like stocks, bonds, or other assets. This diversification helps spread risk across many investments, reducing the impact of poor performance in any one security. Mutual funds are known for being easy to buy and sell, although their shares are priced at the end of the trading day, not intraday. Mutual funds charge fees for management and operational costs, which can reduce returns. However, they are ideal for investors seeking moderate returns with relatively lower risk, making them suitable for long-term growth strategies. Exchange-Traded Funds (ETFs) combine features of both mutual funds and individual stocks. Like mutual funds, ETFs are professionally managed and provide diversified exposure to various asset classes, such as equities, bonds, or commodities. However, unlike mutual funds, ETFs are traded on stock exchanges, allowing investors to buy and sell shares throughout the trading day at fluctuating prices. ETFs tend to have lower expense ratios due to their passive management style, often tracking an index or sector. They also offer tax advantages due to their unique structure. ETFs are highly liquid, making them attractive to investors who want flexibility and lower costs while maintaining diversified exposure to specific markets or sectors. They are ideal for investors looking for cost-effective, diversified, and easily tradable options. Hedge Funds are specialized investment funds designed for high-net-worth individuals and institutional investors. These funds employ aggressive strategies, such as leveraging, short selling, and derivative trading, to achieve high returns, often independent of overall market conditions. Hedge funds have a wide investment mandate, allowing them to invest in alternative assets such as real estate, currencies, and commodities, in addition to traditional securities. Hedge funds are less regulated than mutual funds and ETFs, leading to greater potential for both high returns and high risk. They are often structured with a "2 and 20" fee model, where investors pay 2% of their 20  SCHOOL OF BUSINESS, HOSPITALITY AND TOURISM MANAGEMENT investment in management fees and 20% of profits above a benchmark. While hedge funds can offer significant rewards, they come with limited liquidity (often requiring lock-up periods) and are generally only available to accredited investors due to their complexity and risk. All in all, mutual funds, ETFs, and hedge funds serve different investment needs based on factors such as risk tolerance, capital availability, and investment goals. *Mutual funds* offer broad access to professional management and diversification, making them suitable for average investors. *ETFs* provide similar benefits with greater liquidity and lower costs, appealing to those who prefer flexible trading options. *Hedge funds*, with their high-risk, high-reward strategies, cater to wealthy investors willing to take on more significant financial risks in exchange for potentially higher returns. Understanding the characteristics of each type of fund helps investors choose the right vehicle based on their individual financial objectives. References Medleva, V. (2017, September 19). Investment fund. Capital Com SV Investments Limited. https://capital.com/investment-fund-definition Chen, J. (2023, June 28). What is an investment fund? types of funds and history. Investopedia. https://www.investopedia.com/terms/i/investment-fund.asp ALFI - What is an investment fund? (n.d.). https://www.alfi.lu/en- gb/understandinginvesting/post/what-is-an-investment-fund Team, I. (2024, April 12). Hedge Fund: Definition, Examples, types, and strategies. Investopedia. https://www.investopedia.com/terms/h/hedgefund.asp Gad, S. (2024, February 3). What is a hedge fund? Investopedia. https://www.investopedia.com/articles/investing/102113/what-are-hedge-funds.asp Hedge Fund Investing & Regulation. (n.d.). CFA Institute. https://rpc.cfainstitute.org/en/policy/positions/hedge-funds Understanding mutual funds. (n.d.). Schwab Brokerage. https://www.schwab.com/mutual- funds/understand-mutual-funds#panel--66-long-94941 Palmer, B. (2024, February 28). Mutual funds: Advantages and disadvantages. Investopedia. https://www.investopedia.com/ask/answers/10/mutual-funds-advantages-disadvantages.asp Libretexts. (2023, March 10). Chapter 11: Portfolio Diversification and Asset Allocation. Business LibreTexts. https://biz.libretexts.org/Bookshelves/Finance/Introduction_to_Investments_(Paiano)/04%3A_Chapter_4/11 %3A_Portfolio_Diversification_and_Asset_Allocation 21 Bachelor of Science in Busines Administration - Major in Financial Management MARKET ANALYSIS AND RESEARCH JOSEPH G. TAYAG KHIANDRA M. SACRO QUEEN ROSHANA RODRIGO Capital Market (M/W/F 5:00PM-6:00PM) 1  TABLE OF CONTENTS II. Learning objectives..................................................................................................................... 3 III. Introduction................................................................................................................................ 3 IV. Discussion Fundamental vs. Technical Analysis............................................................................... 3-7 Economic Indicators and their impact on markets....................................................... 7-8 Research reports and their components....................................................................... 8-9 Efficient Market Hypothesis and its Implications......................................................... 9-11 V. Conclusion................................................................................................................................. 11 VI. References........................................................................................................................... 11-12 2 II. Learning Objectives  To identify the difference between fundamental analysis and technical analysis, and evaluate how each approach can be used to inform investment decisions.  To evaluate the significance of economic indicators to the market,  To learn the purpose and significance of research reports and components, and to learn how to use its components to make informed investment decisions,  and to have an overview about efficient market hypothesis and its implications. III. INTRODUCTION Market analysis and research are critical components of understanding capital markets and making informed investment decisions. Market analysis involves evaluating market trends, conditions, and dynamics to understand the environment in which investments are made. It aims to identify opportunities and risks within the market. Research refers to the systematic investigation of market data, financial metrics, and economic indicators to support investment decisions and strategies. There are 2 types of market analysis, the fundamental and technical analysis. This analysis can be used to determine what approach should be used in their decision making. In addition, understanding key economic indicators is essential for assessing market conditions and making informed predictions about future market movements. Moreover, research reports are crucial for systematically presenting findings and informing decision-making. They typically include components like an introduction, methodology, results, and discussion. Furthermore, the efficient market hypothesis (EMH) suggests that asset prices reflect all available information, making it challenging to consistently outperform the market. Understanding both concepts helps in evaluating research quality and financial strategies. IV. Discussion. Fundamental vs. Technical Analysis Fundamental analysis evaluates securities by trying to measure their intrinsic value. Analysts who rely on this method look for stocks trading at values different from their real value. When a given stock is considered overvalued, it is a good time for market exit, and when it is considered undervalued, it is a good time to open a new position. It also dives deep into a company's financial statements, industry trends, economic indicators, and qualitative factors like the quality of the firm's management and competitive advantages. Practitioners of fundamental analysis believe that by understanding a business's underlying health and potential, they can identify undervalued assets poised for growth. Components of fundamental analysis Economic Analysis a. Macroeconomic indicators: These factors provide a backdrop for understanding the overall economic environment in which a company operates. ex. GDP growth, inflation 3 rates, unemployment rates, interest rates, and government fiscal policies. b. Industry Analysis : This involves examining the specific industry in which a company operates, including industry trends, competitive landscape, regulatory environment, and the overall growth prospects of the industry. 2. Company analysis a. Financial statements: This includes analysing the balance sheet, income statement, and cash flow statement to assess the financial health and performance of the company. Balance sheet: Provides a snapshot of the company's assets, liabilities, and shareholders' equity at a specific point in time. Income statement: Shows the company's revenues, expenses, and profits over a period. Cash flow statement: Details the cash inflows and outflows from operating, investing, and financing activities. b. Ratios and metrics: Key financial ratios and metrics are used to gauge various aspects of a company's performance and financial health.  Liquidity ratios: Such as current ratio and quick ratio, which measure the companys ability to meet short-term obligations.  Profitability ratios: Such as net profit margin, return on assets (ROA), and return on equity (ROE), which evaluate the company's ability to generate profit.  Efficiency ratios: Such as inventory turnover and receivables turnover, which assess how effectively the company is using its assets.  Leverage ratios: Such as debt-to-equity ratio and interest coverage ratio, which measure the company's use of debt to finance its operations.  Valuation ratios: Such as price-to-earnings (P/E) ratio, price-to-book (P/B) ratio, and dividend yield, which help in assessing whether a stock is overvalued or undervalued.  Growth analysis: Evaluating past growth trends in revenue, earnings, and cash flows, and estimating future growth potential.  Management quality: Assessing the competence, experience, and track record of the company's management team, as well as their strategy and vision for the company's future.  Competitive position: Analyzing the company's competitive advantages, market share, and unique value proposition. 3. Qualitative factors  Business model: Understanding how the company makes money, its core products or services, and its target market.  Brand strength: Evaluating the strength and recognition of the company's brand in the marketplace.  Corporate governance: Assessing the company's governance practices, board structure, and shareholder rights.  Regulatory environment: Considering the impact of existing and potential regulations on the companys operations.  Market conditions: Analysing trends, consumer behaviour, and market conditions that could affect the company's performance. 4  4. External factors Political environment: Examining political stability, government policies, trade relations, and geopolitical risks that could impact the company. Technological changes: Considering the impact of technological advancements and innovations on the company and its industry. Social and environmental factors: Evaluating societal trends, consumer preferences, and environmental concerns that may influence the companys operations and reputation. Advantages of Fundamental Analysis Fundamental research seeks to satisfy the urge to understand what makes stocks and markets move. The primary purpose of analyzing fundamentals is to make judgments about which investments to own or when to buy or sell. Fundamental analysis gives the tools to understand the underlying value of securities and to determine whether securities are under‐ or over‐valued. Fundamental analysis can be applied to all types of securities, whether equities (valuation), bonds (credit risk), or commodities (demand/supply). It can also be applied to broader markets through economic analysis and investment strategy. FUNDAMENTAL ANALYSIS EXAMPLE: Let us consider an example to illustrate how fundamental analysis can be done in the Indian stock market. Suppose we want to analyze the fundamentals of a company named ABC Ltd. The following steps can be taken: 1. Understanding the business The first step is to do a qualitative analysis of the business. We have to check the products, promoters, and competitors of the company. We can study the mission, vision, and values of the company on their website. 2. Checking financial ratios As there is a long list of companies in the stock exchange, we can easily use financial ratios to select healthy companies from the stock market. We can check the following ratios: EPS (Earnings per share): Increasing EPS for the last 3-5 years is a good sign. Price to earnings (PE) ratio: Lowest among the industry peers. Return on equity: Average 3 years are less than 15% is preferred. Debt to equity: Less than 0.5 is preferred. Current ratio: Greater than 1 is preferred. 3. Past financial results We can easily check the past financial results of a company by analysing its all three financial statements like balance sheet, profit &loss statement, and Cash flow statement. The thumb rule is that if revenues or sales, net profit, and margin are increasing for the last 5 five years, then it might be a good stock to consider for long-term investment purposes. 4. Competitors analysis The next step is to make a comparison of a company with its peers in the industry. We can check the USP (Unique selling proposition), competitive advantage, product costing, product pricing, brand value, and future strategies of competitors in the industry. 5. Debt of the company The next step in how to do fundamental analysis of stocks is to check the total debt of the company, which means how much money a company owes to its creditors. After analyzing all these factors, we can arrive at an intrinsic value for ABC Ltd.s stock and decide whether it is undervalued or overvalued. Fundamental analysis provides a long-term perspective and helps investors make informed decisions based on a companys intrinsic value rather than short-term market fluctuations. It provides a more accurate picture of a companys value than technical analysis because it takes into account all factors affecting a company. Technical analysis focuses on statistical trends in the stock's price and volume over time. There are generally two different ways to approach technical analysis:  Top-down ( top-down approach is a macroeconomic analysis that looks at the overall economy before focusing on individual securities. Traders using this approach focus on short-term gains as opposed to long-term valuations. )  Bottom-up approach. (bottom-up approach focuses on individual stocks as opposed to a macroeconomic view. They seek value in their decisions and intend to hold a long-term view of their trades.) - evaluates financial assets, such as stocks, currencies, or commodities, by reviewing the historical price and volume data. Unlike fundamental analysis, which focuses on the intrinsic value of an asset, technical analysis examines the volume and price of shares over time. - Technical analysistakes into account the past changes in the price of a share and attempts to predict its future price movements and changes. Technical analysis is based on the assumption that patterns in stock price movements repeat themselves and can determine the best times for you to buy and sell. - it focuses only on the share price and trading volume, which are measured and presented at various tables and graphs. By analyzing these graphs, the investor can obtain information about certain trend formations and regularities in the price movement, the trading volume and their interdependence. Advantages of Technical Analysis Technical analysts focus on extracting information from the market itself. One example is market trends. Markets and securities develop trends, whether up, down or sideways, and technical analysis is adept at measuring the characteristics of those trends. 6  Technical analysis lends itself well to irrational markets since it focuses dispassionately on market movements. Technical analysis incorporates behavioral elements, such as measures of market sentiment. In practice, many investors combine aspects of both fundamental and technical approaches to inform their decisions. For example, an investor might use technical analysis to identify a stock that is trending upward and then use fundamental analysis to determine if the stock is undervalued or overvalued, or to determine whether its stock is a good investment. To sum it up, both aim to predict future price movements and identify profitable opportunities, they take very different approaches. Fundamental analysis examines an asset's intrinsic value by examining economic and financial factors, while technical analysis focuses solely on price action and chart patterns. Economic Indicators and their Impact to the Market Economic indicators are essential metrics that shed light on how well a nation's economy is doing. In the stock market, these indicators are frequently used to forecast future events and formulate strategic plans. This blog post will discuss the close relationship between stock prices and economic indicators, examining the effect of investment on economic growth and the ramifications for investors. Economic indicators are statistical data points that reveal details about many economic factors like trade, employment, growth, and inflation. These indicators can be classified as coincident, lagging, or leading based on how they relate to the entire economic cycle. While lagging indicators change after the economy has undergone specific changes, leading indicators typically change the economy as a whole. Coincidence indicators follow the general economic cycle in lockstep. Role of Economic Indicators in the Stock Market Economic indicators serve as road signs, providing information about the state of the economy. These indicators give investors vital information, just like weather forecasts do for the financial sector. The Gross Domestic Product (GDP), interest rates, unemployment rates, and inflation metrics like the Consumer Price Index (CPI) are examples of important indicators. Since these factors have a direct impact on stock values, understanding them is essential. The Impact of the Stock Market on Economic Growth 1. Gross Domestic Product or GDP A nation's GDP, which includes the total value of goods and services generated inside its boundaries, serves as a gauge for economic health. The GDP has a significant impact on stock market patterns. Positive GDP growth frequently causes business profits to rise and consumer spending to rise, which in turn raises stock prices. When GDP growth is strong, 7 investors become more confident and upbeat, which boosts market sentiment. On the other hand, a declining GDP could cause market turbulence and a pessimistic outlook 2. Inflation and Interest Rates Interest rates are the cost of borrowing money, whereas inflation is the pace at which the costs of goods and services rise over time. High rates of inflation might cause a drop in the stock market. 3. Unemployment Rate The unemployment rate gauges an economy's employment market health. Low unemployment rates are usually a sign of a healthy labour market, improved consumer confidence, and more spending, all of which have a beneficial effect on stock values. 4. Trade DataTrade data refers to information on a country's imports and exports. Changes in trade data can have a significant impact on stock prices. An increase in exports can lead to higher stock prices for companies involved in exporting goods. In contrast, an increase in imports can negatively affect domestic companies' performance, leading to lower stock prices. 5. Retail salesThe total amount of money that customers spend at retail establishments—both online and offline—on goods and services is referred to as retail sales. Poor retail sales may be a sign of low consumer confidence, which could further depress the market. Investors also keep an eye on the underlying trends in retail sales data, including the direction in which the numbers are moving and the industries leading or behind in retail sales. 6. Consumer Price Index (CPI) The Consumer Price Index is a vital tool for tracking changes in the prices of products and services that people commonly purchase, as well as for calculating inflation. Investors should understand CPI because it offers important information on consumer purchasing power and general inflationary pressures in a country. Increasing CPI numbers signal inflationary trends, which could drive up production costs for businesses and change consumer purchasing habits Research Reports and its components Research as a process involves several phases and documents produced in a sequence. The sequence and phases of progress have a definite effect on the quality of the final report and on the research documents produced at all stages. Research report is the main document on the basis of which the contribution of the research is judged. A research report is a formal, official statement that contains facts, is a record documentation of findings and/or is perhaps the result of a survey or investigation(Booth 1991). According to the Oxford English Dictionary, a report is a statement of the results of an investigation or of any matter on which definite information is required. The research report contains four main areas: 8 ABSTRACT OR SUMMARY ✓ The abstract or summary tells the reader very briefly what the main points and findings of the paper are. ✓ This allows the reader to decide whether the paper id useful to them. ✓ Get into the habit of reading only abstracts while searching for papers that are relevant to your research. Introduction– What is the issue? What is known? What is not known? What are you trying to find out? This section ends with the purpose and specific aims of the study. REVIEW OF LITERATURE ✓ A literature review should shape the way readers think about a topic, it educates readers about what the community of scholars says about a topic and its surrounding issues. ✓ Along the way it states facts and ideas about the social world and supports those facts and ideas with credit for where they came from. ✓ The literature review has its own voice. The sources of information are not extensively quoted or copied and pasted. Methods– The recipe for the study. If someone wanted to perform the same study, what information would they need? How will you answer your research question? This part usually contains subheadings: Participants, Instruments, Procedures, Data Analysis, Results– What was found? This is organized by specific aims and provides the results of the statistical analysis. Discussion– How do the results fit in with the existing literature? What were the limitations and areas of future research? REFERENCES ✓ The references are just as important as any other part of your paper. ✓ They are the link to the community of scholars that will permit your reader to assess the worthiness of the claims you make in your paper. ✓ References also make the research process much more efficient because they make it very easy to look up sources of facts and ideas. Efficient Market Hypothesis(EMH) The Efficient Market Hypothesis (EMH) is a theory that suggests financial markets are efficient and incorporate all available information into asset prices. According to the EMH, it is impossible to consistently outperform the market by employing strategies such as technical analysis or fundamental analysis. 9 The hypothesis argues that since all relevant information is already reflected in stock prices, it is not possible to gain an advantage and generate abnormal returns through stock picking or market timing. The EMH comes in three forms: weak, semi-strong, and strong, each representing different levels of market efficiency. While the EMH has faced criticisms and challenges, it remains a prominent theory in finance that has significant implications for investors and market participants. Types of Efficient Market Hypothesis Weak Form - reflects all past market prices and data in current stock prices Semi-strong form - Incorporates all publicly available information in addition to past prices Strong form- accounts for all information public and private, in stock prices Implications of the Efficient Market Hypothesis Individual Investors  Beating the MarketConsistently is virtually impossible  Focus on well-diversified portfolios Portfolio Managers  Active Management Strategies unlikely to outperform passive strategies consistently Corporate Finance  companys stock is always fairly priced; indifference between issuing debt and equity no impact on company value from financial decisions Government Regulation  support for policies promoting transparency and information dissemination  Justification for prohibiting insider training The Efficient Market Hypothesis is a crucial financial theory positing that all available information is reflected in market prices, making it impossible to consistently outperform the market. It manifests in three forms, each with distinct implications. 10 The weak form asserts that all historical market information is accounted for in current prices, suggesting technical analysis is futile. The semi-strong form extends this to all publicly available information, rendering both technical and fundamental analysisineffective. The strongest form includes even insider information, making all efforts to beat the market futile. EMH's implications are profound, affecting individual investors, portfolio managers, corporate finance decisions, and government regulations. Despite criticisms and evidence of market inefficiencies, EMH remains a cornerstone of modern finance, shaping investment strategies and financial policies. V. Conclusion In conclusion, understanding the differences between technical and fundamental analysis is essential for navigating the financial market. Technical analysis relies on historical price data and chart patterns to forecast future price movements while fundamental analysis focuses on assessing a company's inherent value through financial statements, economic indicators, and general economic conditions. Economic indicators are important because they can provide insights into market trends and economic health, influencing investment decisions. Research reports are essential because they provide in-depth evaluations that advise investors and direct tactics. Furthermore, the efficient market hypothesis (EMH) contends that asset prices already take into account all available information that is already reflected in asset prices, which has implications for the effectiveness of both fundamental and technical analysis in achieving superior investment returns. Overall, integrating insights from fundamental and technical analyses, understanding economic indicators and leveraging research reports can enhance investment strategies. Even though the EMH provides a framework for comprehending market efficiency, while making investment decisions, it's critical to take its limitations and implications into account. VI. REFERENCES Investopedia. (n.d.). What is the difference between fundamental and technical analysis? https://www.investopedia.com/ask/answers/difference-between-fundamental-and- technical-analysis/ Finance Strategists. (n.d.). Efficient market hypothesis (EMH). https://www.financestrategists.com/wealth-management/investment- management/efficient-market-hypothesis-emh/ INFLIBNET. (n.d.). Components of a research report. In Research report writing (Chapter 5). https://ebooks.inflibnet.ac.in/socp3/chapter/components-of-a-research-report/ Ohio State University Libraries. (n.d.). Components of a research report. In Research report writing (Chapter 6). https://ohiostate.pressbooks.pub/formalizedcuriosity/chapter/chapter- 6-components-of-a-research-report/ 11  MODULE 9 RISK AND RETURN CAPITAL MARKET M/W/F : 5:00PM - 6:00PM TEAM TRIPLETS CABRAL, ERICA M. ESCALONA, JENNY ROSE M. VEGA, KATRINA LEIDEN P. 1  TABLE OF CONTENTS Learning Objectives.......................................................................................................................... 3 Introduction......................................................................................................................................... 3 Discussion of Main Topics and Subtopics................................................................................. 4 Understanding the risk and its type................................................................................. 4 Sources of risk.............................................................................................................4 Systematic and unsystematic risk............................................................................5 Types of systematic and unsystematic risk............................................................ 6 Difference between systematic and unsystematic risk.........................................7 Relationship between risk and return.............................................................................7 Risk and return............................................................................................................7 Calculating the expected return and standard deviation......................................8 Capital Asset Pricing Model............................................................................................. 10 Formula and calculation.........................................................................................11 How does it works?.................................................................................................13 Modern Portfolio Theory and the efficient frontier.....................................................14 Benefits of MPT.......................................................................................................15 Efficient Frontier...................................................................................................... 16 Significance of Efficient frontier............................................................................ 17 Conclusion....................................................................................................................................... 17 References........................................................................................................................................ 18 2 Learning Objectives  Explain the various kinds of unsystematic and systematic risks, as well as how they affects portfolio performance and investment choices.  Determine the expected return on investment by determining the trade-off between risk and return.  Evaluate the expected return on an asset along with its importance in portfolio management using the Capital Asset Pricing Model (CAPM).  Define the basic ideas behind Modern Portfolio Theory (MPT), such as diversification, the benefits it brings, the efficient frontier, and its importance. Introduction Risk and return are fundamental concepts in finance that are closely intertwined. They represent the two sides of the investment coin—where there is potential for return, there is also an associated level of risk. These concepts are the building blocks of financial decision-making, guiding investors in balancing their portfolios, optimizing their returns, and achieving their long-term financial goals. Risk refers to the uncertainty or potential variability in the returns of an investment. Return is the profit or loss derived from an investment over a certain period. Returns can come in various forms, such as capital gains, dividends, or interest income. It is essential to comprehend the ideas of risk and return since these factors directly influence investment decisions, strategies, and outcomes. Understanding these ideas will enable you to communicate effectively about financial topics and contribute valuable insights to discussions on investing. Let’s say you’re considering three different investment options: Stock X, Government Bonds, and Real Estate. Each option comes with its own risk and return profile. In this scenario, each investment offers a different balance of risk and return. Stock X offers high returns but with significant market and specific risks. Government Bonds provide lower, safer returns with interest rate and inflation risks. Real Estate sits in the middle, offering moderate returns with some risk related to liquidity and market conditions. As an investor, understanding these risks helps you choose investments that align with your financial goals and risk tolerance. The Capital Asset Pricing Model (CAPM) is a key financial theory that links the expected return of an investment to its market risk, measured by beta. Developed by William Sharpe, CAPM asserts that investors should earn returns based on the risk-free rate plus a premium for taking on additional market risk. It's widely used to determine the required return on assets and guide investment decisions. 3  Modern Portfolio Theory (MPT) is a framework for constructing an investment portfolio that maximizes return for a given level of risk. The theory emphasizes diversification, suggesting that by combining assets with varying levels of risk and return, investors can reduce the overall risk of their portfolio without sacrificing returns. The Efficient Frontier is a key concept within MPT, representing the set of optimal portfolios that offer the highest expected return for a given level of risk. Portfolios on the Efficient Frontier are considered the most efficient, as they provide the best possible returns for their level of risk, helping investors make informed decisions about where to allocate their assets Discussion of Main Topics and Subtopics UNDERSTANDING THE RISK AND ITS TYPE SOURCES OF RISK Business Risk - The risk that the company's profit margin may be lower than expected due to inefficient management, bad trading policies and changes affecting that industry. Financial Risk - The risk of partial or complete loss of invested capital in the event of the failure of a company or scheme due to an unsound financial structure. Market Risk/Volatility - The risk of capital loss and instability of invested capital, as well as variations in the return from that capital. - It is caused by market cycles and movements in the market. - It can mean the value of capital can vary, both positively and negatively. - They can be sudden and unexpected or it can be slow and predicted Market Timing Risk - Economists often use economic cycles - To try and predict when a market will rise or fall - However, this is extremely difficult, as economic cycles are never exactly the same 4  - - with the same timing. Economic Risk - Risk relating to changes in inflation rates, interest rates, etc. Political Risk - Changes in government and government policies Interest rate risk/Re-investment risk - Some investors attempt to avoid volatility by investing in fixed rate investments. - Than they face the risk that when the investment matures the money may have to be reinvested and interest rates could be significantly lower - Thus, relying on interest as income - this income could dramatically decrease Liquidity Risk - Considerable problems can occur if money is required for unforeseen expenses and the investments cannot be turned into cash quickly or without costs Credit Risk - When money is places with banks and companies through term deposits and debentures they use it in their businesses and pay an interest rate for doing so. - The risk here is the financial ability of those institutions to be able to pay the interest and/or repay the capital on the due date Inflation risk - Whether inflation is high or low, the cost of goods has always increased over time. - If the chosen investment does not at least grow at the same rate then the real purchasing power of the money is being eroded. SYSTEMATIC AND UNSYSTEMATIC Systematic risks affect the financial market as a whole, whereas unsystematic risks are unique to a specific company or investment. What are systematic risks? Systematic risks are inherent risks that exist in the stock market. They’re also called “diversification risks” or “market risks” since they impact the entire asset class. Non- diversification means that an organization can’t control, minimize, or avoid systematic risks. 5 These risks are typically due to external factors like ongoing geopolitical situations, monetary policies, and natural disasters. For example, the COVID-19 pandemic was a systematic risk because it impacted the entire stock market. Types of systematic risks Consider a few types of systematic risks:  Interest rate risk. Interest rate risk results from a change in the market interest rate. It mainly impacts fixed-income securities like bond prices and asset-backed securities. The yield on these securities is inversely related to the interest rate. As interest rates go up, investors find it more attractive to pull their money out of fixed-income securities.‍  Market risk. Market risk results from the general tendency of investors to behave as per the market. For example, investors avoid investing in even the best-performing companies during a financial crisis. ‍  Purchasing power risk. Also called inflation risk, purchasing power risk results from the decline in the purchasing power of money due to inflation. For example, if inflation is 5% per year, you’d need $10.50 to buy the pack of pens next year that cost $10 today. What are unsystematic risks? Unsystematic risks, also known as “non-systematic risks,” “specific risks,” “diversifiable risks,” or “residual risks,” are unique to a specific company or industry. These risks arise due to various internal and external factors that affect only the particular organization but not the entire market. Some examples of unsystematic risk include labor unrest at a factory, regulatory changes, and shortages of raw materials. Unlike systematic risks, an organization can control, minimize, and possibly even avoid unsystematic risks. Types of unsystematic risks Unsystematic risks occur as two types:  Business risk. Business risk includes the internal factors that affect a company’s revenue and performance. Business risks can also result from company-specific external factors, such as the government banning a raw material that a company uses. 6   Financial risk. Financial risk relates to a company’s debt and equity. If a company takes on too much debt, its debt-to-equity ratio may suffer. A negative debt-to-equity ratio indicates that a company might be on the verge of bankruptcy. The 6 main differences between systematic vs. unsystematic risk  Impact. Systematic risks can potentially affect the entire industry and the overall economy, whereas unsystematic risks generally affect an organization. Systematic risks are non-diversifiable, whereas unsystematic risks are diversifiable.  Nature. Systematic risks are unavoidable and uncontrollable, whereas unsystematic risks are avoidable and controllable.  Factors. Systematic risks result from external factors that occur at a macroeconomic level, which is why they’re unavoidable and uncontrollable. In contrast, unsystematic risks result from internal factors occurring within an organization or externally but in a closely related manner to the organization. They’re linked to micro-economic factors and are avoidable and controllable.  Protection. The effects of systematic risk can be mitigated through proper asset allocation, whereas mitigating unsystematic risk relies on portfolio diversification.  Avoidability. Systematic risks can’t be avoided; however, unsystematic risks can be mitigated or avoided.  Types. Systematic risks include interest, inflation, purchasing power, and market risk, whereas unsystematic risks are financial and business-specific risks. RELATIONSHIP BETWEEN RETURN AND RISK Risk an unwanted event which may or may not occur. It is also a situation involving exposure to danger. Risk can be defined in lots of ways. But when it comes to investing and financial management, it can be defined as the unpredictable return of an investment over a specific time period or as the possibility of losing "X" amount of an investment. Return is the typical object of investment is to make current income from investment in the form of dividends and interest income. The investment should earn a reasonable and expected rate of return on investment. Usually, standard deviation is used to describe return volatility. The square root of the variance is used to compute this statistical measure, which shows how spread a dataset is in relation to its mean. In terms of finance, the standard deviation can assist investors in assessing the degree of risk associated with an investment and figuring out the minimal return necessary. 7  The principle between risk and return is relatively straightforward: the higher the risk, the higher the potential return. Conversely, lower risk typically means lower potential returns. This principle is rooted in the fundamental trade-off investors must consider when evaluating investment opportunities. High-risk investments, such as stocks, offer the potential for high returns but come with the volatility and uncertainty of market fluctuations. On the other hand, low-risk investments, like government bonds, provide more stable and predictable returns. Since a government may generate money to pay off its debts, asset class #1, risk- free bonds are typically regarded as "risk-free" securities. They are issued by governments. As a result, risk-free bonds have the lowest investment return and are the safest asset. It is evident that as we move along the risk-return continuum, each asset type becomes riskier. But each asset class also has an increased potential return on investment. The fifth asset type is private equity, which consists of investments in privately held businesses that aren't listed on a public market. Generally speaking, these investments carry more risk than publicly traded stocks and come with extra risks including liquidity risk. However, because of these additional risks, private equity also offers investors the highest potential investment returns. Determining Expected Return (Discrete Distribution) We can find the expected return by using the following formula: 8 Where: Pi = Probability of outcome i n = number of possible states Ri = rate of return on the asset in the state i E(R) = expected return on R By using the formula above, we are also calculating Variance, which is the square of the standard deviation. The equation for calculating variance is the same as the one provided above, except that we don’t take the square root. Example: What is the expected rate of return? E(R) = (.20)(-15%) + (.50)(10%) + (.30)(35%) E(R) = - 3% + 5% + 10.5% E(R) = 12.5% Standard Deviation This measures the variability of possible return and represented by the lowercase Greek symbol sigma (δ). Formula: 9 Where: δ² = variance of returns Pi = Probability of outcome i n = number of possible states Ri = rate of return on the asset in the state i E(R) = expected return on R Interpretation: - the smaller the standard deviation, the more likely we are going to earn something “close” to our expected return. - the greater the standard deviation, the greater the chance that we may earn something far more (good) or far less (bad) than our expected return.