Investment discussions - Free Essay Example

GENERAL INVESTMENTS DISCUSSIONS 1 All investors must make a decision whether to use hybrid, active or passive portfolio management system while investing in stocks and securities. The type of management system that an individual chooses can determine the success or failure of the person making the investments. Active and passive strategies have their own advantages and disadvantages. One main advantage of passive strategy is that little work is required, and the fees charged are low. This is because an investor does not have the need to pay portfolio managers and security analysts to carry out a research on the stocks, and make decisions for the investor (Barnes, 2009). Wieland (2010) denotes that a passive investment strategy has a rate of return of 7% per annum. This, Wieland (2010) denotes that is the main disadvantage of a passive investment strategy. That is, an investor will not get a high return for his or her investments. Barnes (2009) denotes that an active strategy will incorporate a method in which an investor seeks to buy bonds or stocks expecting a high return. On this basis, its main advantage over passive strategy is that an investor can acquire unlimited return. However, this method is very expensive, and there is no guarantee of success. It is important to denote that approximately 80% of actively managed stocks usually underperform (Barnes, 2009). Those that perform well are not consistent over the years. On this basis, the best form of portfolio management is the hybrid system. This is because it is a combination of the passive and active investments strategies (Wieland, 2010). On this note, the hybrid system combines the advantages of these two investments strategies, as well as mitigating their disadvantages. Question Number Two: Toporowski (2010) denotes that one major strength of a projected P/E is its ability to explain the degree of confidence upon which investors have on a company. Toporowski (2010) further denotes that a P/E which is low in value will imply that investors do not have confidence with the company. On the other hand, a P/E which is high will denote that investors have confidence with the company. Investors will therefore purchase the various securities and stocks of these companies. On this note, the projected P/E ratio provides a guideline in which investors will know a company that performs well or not. However, the P/E ration has limitations. This is because the P/E ratio uses earnings as its indicator. It is important to denote it is possible to manipulate the earnings of a company. On this note, it is therefore possible to distort the P/E ratio of a company (Toporowski, 2010). However, one disadvantage of P/E is that it does not factor in the debts of the company; in fact, it only puts an emphasis on the price and market capitalization of the company under consideration. CAPE on the other hand is a technique which has the capability of predicting long term returns of a financial investment/security. However, it is unable to predict short term returns on a financial investment (Madura, 2012). Question Number Three: Grannum (2012) denotes that high frequency market leads to an increase in volatility. This in turn leads to a high liquidity in the securities market (Grannum, 2012). An increase in liquidity that is brought forth by high volatility is not a good thing for the securities market. This is because it increases speculations, which in turn will either reduce or increase the prices of the stocks or financial securities. It is important to denote that an increase in volatility increases the levels of changes of a stock. This is a conducive atmosphere for speculative trading to take place (Lee, 2011). This unpredictable change is therefore not conducive for an investor, therefore adding volatility by adding liquidity is not justified. This unpredictable change in the stock prices are brought about by speculative investor (Grannum, 2012) . It is also important to denote that fast-paced trading at the market is disadvantageous to other participants. This is because an order can be bought or sold before these people make a bid or request for the order under consideration. Flash orders on the other hand involves sending a certain stocks to certain investors such as banks, or even hedge funds before those shares are rolled out at the securities market. However, this service is controversial, with some investors accusing the stock exchanges of creating two markets, and being biased to another. They also denote that flash orders promote the trading ahead of orders by a small number of selected investors (Lee, 2011). However, it is important to denote that flash orders help to create liquidity, and they are in no means upfront trading. This is because they only last a matter of seconds, and this is enough for firms using a high frequency trading technique to respond. Flash orders are also small in number, and they cannot make any significant change in the market (Lee, 2011). Even though controversial, this technique of trading is legal under regulation 602 of stock market rules. Question Number Four: Greater openness by the Fed is a good issue, and this is because by communicating, the Fed is giving guidance to investors on how to invest, and the performance of the economy. Through better communication, the Federal Reserve will help the actors of the market to make good investments decisions, ensuring a return to their investments. Take for example when the Federal Reserve denotes that it is going to keep interests at a very low rate for a long period of time. By giving out this information, monetary organizations will be willing to lend money to people at a very lower rate (Hens and Rieger, 2010). It is important to denote that the Federal Reserve will always create some market waves through the information that they provide. This is because such kind of information will always affect the future of the countryà ¢Ã¢â€š ¬Ã¢â€ž ¢s monetary market. But, it is also important to denote that failing to provide the information under consideration will lead to uncertainties amongst investors. On this note, they will try to make their investment decisions through guesswork (Kaeppel, 2009). Hen and Rieger (2010) observe that these traders will not like it if the Federal Reserve fails to provide relevant information concerning the performance of the economy. This is because they depend on the information provided to make investment decisions (Hens and Rieger, 2010). To balance the various concerns regarding recession and inflation, the Federal Reserve should create policies that will help them monitor how people are spending their money, at the same time creating a policy that will encourage people to save some of their monies. Question Number Five: In my own opinion, the use of derivative is beneficial to the market. This is because if they are used effectively, derivatives can help investors to make profits from rate shifts in the currency exchange, changes in equity markets, and interest rates, and from changes in the international supply and demand of agricultural commodities and industrial metals. It is important to denote that there are two major benefits of derivatives, namely risk management and price discovery (Kawai and Prasad, 2011). Under price discovery, it is important to denote that the market prices of various stocks depend on the continuous movement of information. Information on factors such as debt default, refugee displacement, climatic conditions, environmental factors and political situations play a role in influencing the future prices of stocks. Information concerning these factors and the manner in which people absorb this type of information constantly affects the future price of the commodity under consideration (Sabalot, 2012). This is an aspect referred to as price discovery. It is important to denote that some derivative contracts are always based on these stocks. Another important function of the derivative market is the risk management role. Risk management refers to the process of identifying the desired and actual levels of risks, and altering the actual level of risk, to be equal to the desired level of risks. This process of risk management can fall under the categories of speculation and hedging. Hedging is referred to as a strategy or reducing risks by holding a market position. Speculation on the other hand refers to predicting the manner in which a market will move. Speculation, hedging and derivatives are an effective methods of managing risks by investors. References: Barnes, P. (2009). Stock market efficiency, insider dealing and market abuse. Farnham, Surrey, England: Gower. Grannum, S. D. (2012). Securities arbitration 2012. New York, NY: Practising Law Institute. Hens, T., Rieger, M. O. (2010). Financial economics. Berlin: Springer. Kaeppel, J. (2009). Seasonal stock market trends the definitive guide to calendar-based stock market trading. Hoboken, N.J.: John Wiley Sons. Kawai, M., Prasad, E. (2011). Financial market regulation and reforms in emerging markets. Washington, D.C.: Brookings Institution Press. Lee, R. (2011). Running the worlds markets the governance of financial infrastructure. Princeton, N.J.: Princeton University Press. Madura, J. (2012). International financial management (11th ed.). Mason, OH: South-Western, Cengage Learning. Sabalot, D. A. (2012). Butterworths securities financial services law handbook (13th ed.). London: LexisNexis. Toporowski, J. (2010). Why the world economy needs a financial crash and other critical essays on finance and financial economics. London: Anthem Press. Wieland, V. (2010). The science and practice of monetary policy today the Deutsche Bank Prize in Financial Economics 2007. New York: Springer.