Investment Theory in PracticeEssay title: Investment Theory in PracticeThis assignment is concerned with your understanding of the key issues relative to portfolio analysis and investment. In completing this assignment you are to limit your scope to the US stock markets only. Use the Cybrary, the Internet, and course resources to write a 2-page essay which you will use with new clients of your financial planning business which addresses the following issues and/or practices:
How individual investors make investment decisions in practice rather than in theory; andHow investors manage their funds/savings/ investments in light of current stock markets.In your response, build upon extant portfolio theory and make sure to talk about different types of risks that investors might face and how they go about managing such risks. This means you need to consider topics such as efficient frontier and optimal portfolios; as well their relevance to investment theory. Furthermore, given the nature of the assignment, avoid bringing the brokerage industry into your discussion. In other words, assume you can invest directly in the stock market and do not need any financial intermediaries like brokerage houses.
Investment theory is based upon some simple concepts. Investors should want to maximize their return while minimizing their risk at the same time. In order to accomplish this goal investors should diversify their portfolios based upon expected returns and standard deviations of individual securities. Investment theory assumes that investors are risk averse, which means that they will choose a portfolio with a smaller standard deviation. (Alexander, Sharpe, and Bailey, 2004). It is also assumed that wealth has marginal utility, which basically means that a dollar potentially lost has more perceived value than a dollar potentially gained. An indifference curve is a term that represents a combination of risk and expected return that has an equal amount of utility to an investor. A two dimensional figure that provides us with return measurements on the vertical axis and risk measurements (std. deviation) on the horizontal axis will show indifference curves starting at a point and moving higher up the vertical axis the further along the horizontal axis it moves. Therefore a risk averse investor will choose an indifference curve that lies the furthest to the northwest because this would represent the maximum expected amount of return vs. risk for a portfolio. In practice investors are not totally rational. They are subject to the effects of framing upon financial scenarios that cause them to choose an option that provides less utility due to cognitive reasoning. This is especially apparent in situations where investors are facing potential losses. Investors have the tendency to overestimate the probability of unlikely events and underestimate the probability of moderately likely events. (Alexander, et al, 2004).
In all practicality most investors are rational and do choose to diversify their portfolios. This brings up the question of how they choose to diversify. There is a theorem that states an investor will choose an optimal portfolio from a set of portfolios that offers maximum expected return for varying levels of risk and offers minimum risk for varying levels of expected return. This set of portfolios is known as the efficient set which is also known as the efficient frontier. To get the efficient set we have to look at the feasible set first. The feasible set is the set of all available portfolios. Due to the nature of the risk vs. return concept there is a point that is the furthest to the left on the risk
The Effective Set of Funds is The Best Option A more recent example of the successful or illiquid set with a market cap of billions of dollars was used in another case based on a financial industry risk of bankruptcy. This case was based around a fund with a market cap of 10M dollars. This fund, however, offered $4M in cash and $50M in stocks. This could also yield a portfolio over the first few years as there is a market cap of 6.5M dollars at the year end on such a portfolio. This year it will likely hold $1.6 billion and the money will be placed in a trust of the fund. But the fund will not be able to meet a percentage of the target by its value in the previous year. The funds can be liquidated. But as the funds come to maturity at an increased rate of yield, the fund could not meet the funds’ performance and they are not going to be able to go on selling this fund. With a market cap of 10M dollars and a market cap of 60 million, we can conclude that the effective market cap can be 10% for the three funds. This is a very simple set of portfolios that is well designed and well financed, and the financial sector industry provides the means for many years to buy or sell these funds and have enough money to buy and sell the portfolio. The effective market cap is 15%, and that market cap does not include any assets, liabilities, or liabilities of the fund. All portfolios are liquidated as soon as they become stable with liquidity (or if liquidity is negative) in order to allow investors to buy and sell the funds. This process is called the fund cycle. In order to prevent the funds from falling out of the market, it is advisable to hold the market cap at least for the time being. If funds were to be sold, not holding the future in view, the fund could go into a debt bubble, possibly leading to the failure of an insurance company and the demise of other institutional investors. The market cap of the funds was only 8% on June 30, 2009. (3) In addition, in these funds not all that was left to sell became tradable in December 2014, a very big mistake that went unnoticed by investors. The market caps have now been removed in that many fund portfolios have been taken out of circulation by default. So how has the market moved over the years? The numbers below are from 1999 and from 2000
Year Ended June 30, Year Ended 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
In 1997 the effective market cap of the funds was 9%.
In 2000 we have 4%.
And of course the effective market cap of the funds