Archive for the ‘Investment & Finance’ Category

What is an investment?

Monday, December 21st, 2009

Some people like to give up immediate possession of savings expect to receive in the future a greater amount than they gave up.  What they do with the savings to make them increase over time is investment.

Specially, an investment is the current commitment of dollars for a period of time in order to derive future payments that will compensate the invester for (1) the time the funds are committed,(2) the expected rate of inflaiton,and (3) the uncertainty of the future payments. The “investor” can be an individual, a government, a pension fund, or a corporation. This definition includes all types of investment, including investment by corporations in plant and equipment and investments by individuals in stocks, bonds, commodities, or real estate. In all cases, the investor is trading a known dollar amount today for some expected future stream of payments that will be greater than the current outlay.

A central question is how investors select investments that will give them their required rates of return, that is, how to choose among alternative investment assets. This selection process requires that you must understand how to measure the rate of return and the risk involved in an investment accurately.

Measures of Historical Rates of Return

The period during which you own an investment is called its holding period, and the return for that period is the holding period return (HPR). It is caculated as follows:

HPR = Ending value of investment / Beginning value of investment

This value will always be zero or greater. A value greater than 1.0 reflects an increase in your wealth. A value less than 1.0 means that you suffered an decline in wealth. A HPR of zero indicates that you lost all you money.

Investors generally evaluate returns in percentage terms on an annual basis. The percentage return is referred to as the holding period yield (HPY). The HPY is equal to the HPR minus 1.

HPY = HPR – 1

To derive an annual HPY, you compute an annual HPR and subtract 1. Annual HPR is found by:
Annual HPR = HPR exponent(1/n)
n = number of years the investment is held

Note that we made some implicit assumptions when converting the HPY to an annual basis. This annualized holding period yield computation assumes a constant annual yield for each year.

Best Tips to do an Analysis of Mutual Funds

Sunday, December 20th, 2009

Before investing in mutual funds a proper analysis is required. While all analyses’ efforts are aimed at maximizing returns and minimizing risks, it is the latter that gains importance as the single most fundamental criterion to compare mutual funds. This article makes you aware of:

  • How can you do a mutual fund analysis?
  • important is the risk factor analysis?
  • Why is it important to track the record of mutual fund companies?

Investing in mutual funds is not a child’s play unless one does a mutual funds’ analysis. At least it is not as easy as picking top performers going by indices and investing in them. While all analyses’ efforts are aimed at maximizing returns and minimizing risks, it is the latter that gains importance as the single most fundamental criterion to compare mutual funds.

Fundamental Objectives of Investment

To begin with mutual funds’ analysis you need to be clear about the investment objectives you have, that is whether the objective is growth of capital or regular income. Whatsoever be the case, the basics of

Tips To Do Mutual Fund Analysis

It is needless to say that you need to have some rudimentary knowledge of investing in stocks and securities apart from street smartness to research mutual funds. Here are a few tips for analysis before investing mutual funds. We will begin our exercise from the point you have collected all the relevant information about competing funds.

Look At The Portfolio of Your Pick of Funds

Most of the plans will have invested in multiple stocks or securities for diversification. Critical point here is in what proportion they have invested in different stocks. Giving a higher weight age to a high returning stock leaves less opportunity for broader allocation and may back fire when market is bearish (plummeting steadily). Also higher returning stocks carry high element of risk.

The Optimum Portfolio Size

What should be the optimum portfolio size (assortment investments under one plan) for your pick of fund? Well, opinions are divided about this, but it is crucial to look into the specifics of stock bets and sectors you will be exposed to. Higher exposure to specific sectors may see you loosing out on broad based rallies in the bourses (stock markets). Optimally 65 % to 85% may be allocated in stocks from different sectors for diversification plus growth and the balance being in typical bond and money market instruments.

Is Your Pick of Funds Really Diversified

Notice that the competing plans, though from different fund companies, perform almost on par as if they have a correlation. They indeed have. So, does it mean you have diversified by spreading your money amongst them? Well, think again. Similar plans have similar pattern of their holdings of stocks and with a similar portfolio. This means, in actual effect you are not diversifying. They all go up and down almost as if they do it in tandem. For clear diversification, pick those with different portfolios though they are similar plans (ex: growth, index or dividend paying etc).

What Is Bear Call Spread

Saturday, December 19th, 2009

The Bear Call Spread is an intermediate strategy that can be profitable for stocks that are either rangebound or falling. The concept is to protect the downside of a Naked Call by buying a higher strike call to insure the one you sold. Both call strikes should be higher than the current stock price so as to ensure a profit even if the stock doesn’t move at all.

The higher strke call that you buy is further OTM than the lower strike call that you sell. Therefore, you receive a net credit because you buy a cheaper option than the one you sell. If the stock falls, both calls will expire worthless, and you simply retain the net credit. If the stock rises, then your breakeven is the lower strike plus the net credit you receive. Provided the stock remains below that level, then you’ll make a profit. Otherwise you could make a loss.

Sell lower strike call + Buy OTM call = Bear call spread

Maximum Risk: [Difference in strikes - net credit]

Maximum Reward:  [Net credit received]

Breakeven:  [Lower strike net credit]

With bear calls, you outlook is bearish or neutral to bearish. It’s safest to trade this strategy on a short-term basis, preferably with one month or less to expiration.

Advantages

1. Short-term income strategy not necessarily requiring any movement of the stock.

2. Capped downside protection compared to a Naked Call.

Disadvantages

1. Maximum loss is typically greater than the maximum gain, despite the capped downside.

2. High yielding trades tend to mean less protective cushion and are therefore riskier.

3. Capped upside if the stock falls.

Example

ABCD is trading at $28.00 on May 12, 2004. Sell the June 2004 $30 strike call for 1.00. Buy the June 2004 $35 strike call for 0.50.

Net Credit:  Premium sold – premium bought
                 1.00 – 0.50 = 0.50
Maximum Risk:  Difference in strikes – net credit
                 5.00 – 0.50 = 4.50   Maximum risk is greater than your net credit
Maximum Reward:  Net credit
                    0.50
Breakeven:  Lower strike + net credit
                30.00 + 0.50 = 30.50
Max ROI:  11.11%
Cushion:  $2.50 or 8.93% from breakeven

Tips of Using Moving Averages

Saturday, December 19th, 2009

The moving average is one of the most versatile and widely used of all technical indicators. It is the basis for many mechanical trend-following systems in use today. There are many questions to be considered when using moving averages. Here we address some of the more common usages of the moving average.

The moving average is a smoonthing device with a time lag.

The moving average is essentially a trend following device. Its purpose is to identify or signal that a new trend has begun or that an old trend has ended or reversed. Its purpose is to track the progress of the trend. It does not, however, predict market action. It never anticipates; it onlyreacts. The moving average follows a market and tells us that a trend has begun, but only after the fact.

The moving average is a smoothing device. By its very nature, however, the moving average line also lags the market action. A short moving average, such as a 20 day average, would hug the price action more closely than a 200 day average. The time lag is reduced with the shorter averages,but can never be completely eliminated. Shorter term averages are more sensitive to the price action, wheareas longer range averages are less sensitive.

The Use of One Moving average

Some traders use just one moving average to generate trend signals. The simple moving average is the one most commonly used by technicians. The moving avearage is plotted on the bar chart in its appropriate trading day along with that day’s price action. When the closing pirce moves above the moving average, a buy signal is generated. A sell signal is given when prices move below the moving avearge.

A shorter average gives earlier signals. While the longer average is slower, but more reliable.

For added confirmation, some technicians also like to see the moving average line itself turn in the direction of the price crossing. If a very short term average is employed, the average tracks prices very closely and several crossing occur. The use of a very sensitive average produces more trades and results in many false signals, but it has the advantage of giving trend signals earlier in the move. The more sensitive the average, the earlier the signals will be. The longer averages work better as long as the trend remains in force, but a shorter average is better when the trend is in the process of reversing.

Use Two Averages to Generate Signals

It becomes clearer that the use of one moving average alone has several disadvantages. It is usually more advantageous to employ two moving averages. This technique is called the double crossover method. This means that a buy signal is produced when the shorter average crosses above the longer. This technique of using two averages together lags the market a bit more than the use of a single average but produces fewer whipsaws.

Moving Average Envelopes

The usefulness of a single moving average can be enhanced by surrounding it with envelopes. Percentage envelopes can be used to help determine when a market has gotten overextended in either direction. The envelopes are placed at fixed percentages above and below the average. Shorter term traders often use 3% envelopes around a simple 21 day moving average. When prices reach one of the envelopes, the short term trend is considered to be overextended. For long range analysis, some possible combiantions includes 5% envelopes around a 10 week average or a 10% envelope around a 40 week average.