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Wirtschaft & Finanzen

MBA 3rd semester FM01 Notes

Paritosh chaudharyFolgen

- 2. Introduction Technical analysis is the attempt to forecast stock prices on the basis of market-derived data. Technicians (also known as quantitative analysts or chartists) usually look at price, volume and psychological indicators over time. They are looking for trends and patterns in the data that indicate future price movements.
- 3. Charting the Market Chartists use bar charts, candlestick, or point and figure charts to look for patterns which may indicate future price movements. They also analyze volume and other psychological indicators (breadth, % of bulls vs % of bears, put/call ratio, etc.). Strict chartists don’t care about fundamentals at all.
- 4. Each bar is composed of 4 elements: Open High Low Close Note that the candlestick body is empty (white) on up days, and filled (some color) on down days Note: You should print the example charts (next two slides) to see them more clearly Open Close High Low Standard Bar Chart Japanese Candlestick Open Close High Low Standard Bar Chart Japanese Candlestick
- 5. Types of Charts: Bar Charts This is a bar (open, high, low, close or OHLC) chart of AMAT from early July to mid October 2001.
- 6. Types of Charts: Japanese Candlesticks This is a Japanese Candlestick (open, high, low, close) chart of AMAT from early July to mid October 2001
- 7. Trend Lines There are three basic kinds of trends: An Up trend where prices are generally increasing. A Down trend where prices are generally decreasing. A Trading Range.
- 8. Support & Resistance Support and resistance lines indicate likely ends of trends. Resistance results from the inability to surpass prior highs. Support results from the inability to break below to prior lows. What was support becomes resistance, and vice-versa. Support Resistance Breakout
- 9. Price Patterns Technicians look for many patterns in the historical time series of prices. These patterns are reputed to provide information regarding the size and timing of subsequent price moves. But don’t forget that the EMH says these patterns are illusions, and have no real meaning. In fact, they can be seen in a randomly generated price series.
- 10. Head and Shoulders This formation is characterized by two small peaks on either side of a larger peak. This is a reversal pattern, meaning that it signifies a change in the trend. Head Head Left Shoulder Left Shoulder Right Shoulder Right Shoulder Neckline Neckline H&S Top H&S Bottom
- 11. Head & Shoulders Example Sell Signal Minimum Target Price Based on measurement rule
- 12. Double Tops and Bottoms These formations are similar to the H&S formations, but there is no head. These are reversal patterns with the same measuring implications as the H&S. Target Double Top Double Bottom Target
- 14. Triangles Triangles are continuation formations. Three flavors: Ascending Descending Symmetrical Typically, triangles should break out about half to three-quarters of the way through the formation. Ascending Descending Symmetrical Symmetrical
- 15. Broadening Formations These formations are like reverse triangles. These formations usually signal a reversal of the trend. Broadening Tops Broadening Bottoms
- 16. Trend Lines There are three basic kinds of trends: An Up trend where prices are generally increasing. A Down trend where prices are generally decreasing. A Trading Range.
- 17. Dow Theory This theory was first stated by Charles Dow in a series of columns in the WSJ between 1900 and 1902. Dow (and later Hamilton and Rhea) believed that market trends forecast trends in the economy.
- 18. Dow Theory Trends (1) Primary Trend Called “the tide” by Dow, this is the trend that defines the long-term direction (up to several years). Others have called this a “secular” bull or bear market. Secondary Trend Called “the waves” by Dow, this is shorter-term departures from the primary trend (weeks to months) Day to day fluctuations Not significant in Dow Theory
- 19. Dow Theory Trends (2)
- 20. Gaps • Gaps are those points or price levels where the scrip has not changed hands. They are formed in rising or falling price level. • If the prices are moving upwards and the high of any day is lower than the next day’s low, a gap is said to have occurred. • Similarly, if the prices are falling, a gap is formed if the low price on a day is higher than the high price of next day.
- 21. Gap up
- 22. Gap Down
- 23. Elliott Wave Theory • • Ralph Nelson Elliott developed the Elliott Wave Theory in the late 1920s by discovering that stock markets, thought to behave in a somewhat chaotic manner, in fact traded in repetitive cycles. Elliott discovered that these market cycles resulted from investors' reactions to outside influences, or predominant psychology of the masses at the time. He found that the upward and downward swings of the mass psychology always showed up in the same repetitive patterns, which were then divided further into patterns he termed "waves"
- 24. Market Predictions Based on Wave Patterns • • Elliott made predictions based on unique characteristics he discovered in the wave patterns. An impulsive wave, which goes with the main trend, always shows five waves in its pattern. On a smaller scale, within each of the impulsive waves, five waves can again be found. In this smaller pattern, the same pattern repeats itself infinitely. These ever-smaller patterns are labeled as different wave degrees in the Elliott Wave Principle. In the financial markets we know that "every action creates an equal and opposite reaction" as a price movement up or down must be followed by a contrary movement. Price action is divided into trends and corrections or sideways movements. Trends show the main direction of prices while corrections move against the trend. Elliott labeled these "impulsive" and "corrective" waves
- 25. Theory Interpretation • • • • • • • The Elliott Wave Theory is interpreted as follows: Every action is followed by a reaction. Five waves move in the direction of the main trend followed by three corrective waves (a 5-3 move.) A 5-3 move completes a cycle. This 5-3 move then becomes two subdivisions of the next higher 5-3 wave. The underlying 5-3 pattern remains constant, though the time span of each may vary. Let's have a look at the following chart made up of eight waves (five up and three down) labeled 1, 2, 3, 4, 5, A, B and C. We can see that the three waves in the direction of the trend are impulses, so these waves also have five waves within them. The waves against the trend are corrections and are composed of three waves.
- 26. Relative Strength Index (RSI) • • RSI was developed by Wells Wilder. It identifies the inherent technical strength and weakness of a particular scrip or market. RSI can be calculated for a scrip by adopting the following formula. RSI can be calculated for 5,7,9 and 14 days. 100 RSI =100 1 Rs Rs = Average gain per day Average loss per day If RSI crosses 70 there may be down turn. If RSI falls below 30, there may be an uptrend. If the share price is falling and RSI is rising, a divergence is said to have occurred. Divergence indicates the turning point of the market. If RSI is rising in overbought zone, it indicates a fall in prices. If RSI is in oversold zone, it indicates a rise in prices.
- 28. Technical Analysis and Fundamental Analysis 1. Fundamental analysts analyses financial strength of corporate, growth of sales, earnings and profitability. The technical analysts mainly focus the attention on the past history of prices. 1. Fundamental analysts estimate the intrinsic value of the shares. Technical analysts mainly predict the short term price movement. 1. Fundamentalists are of the opinion that supply and demand for stocks depend on the underlying factors. Technicians opine that they can forecast supply and demand by studying the prices and volume of trading.
- 30. 2 The group of assets - such as stocks, bonds and mutual - held by an investor. The art and science of making decisions about investment mix and policy, matching investments to objectives, asset allocation for individuals and institutions, and balancing risk vs. performance Equity Debt Preference FD
- 31. 3 Defined Portfolio management is all about strengths, weaknesses, opportunities and threats-SWOT in the choice of debt vs. equity, domestic vs. international, growth vs. safety, and numerous other tradeoffs encountered in the attempt to maximize return at a given appetite for risk.
- 32. 4 Notions of Portfolio Management 1) Notion of Diversification 2) Notion of Negative Co-relation
- 33. 5 Functions/Advantages/objectives of Portfolio Management To frame an investment strategy and select an investment mix to achieve the desired investment objectives. To provide a balanced portfolio which not only can hedge against the inflation but can also optimize returns with the associated degree of risk To make timely buying and selling of securities To maximize the after tax return by investigating in various tax saving instruments. Portfolio Management provides marketability and liquidity to the investment
- 34. 6 Portfolio Manager Person who in pursuance of a contract with clients, advise/direct/undertake, the management/administration of portfolio of securities/funds of client on behalf of the latter Discretionary Portfolio Management Non-Discretionary Portfolio Management
- 35. 7 The Portfolio Manager’s Job Begins with a statement of investment policy, which outlines: • Return requirements • Investor’s risk tolerance • Constraints under which the portfolio must operate
- 36. 8 Deciding about investment Objectives Selection of Investment and the Timing of Investment Investment Strategy Portfolio Execution Alignment of Portfolio Performance evaluation of Portfolio The Process- Explained
- 37. 9 The Six Steps of Portfolio Management (cont’d) Learn the Basic Principles of Finance Set Portfolio Objectives And Constraints Formulate an Investment Strategy Have a Game Plan for Portfolio Revision Protect the Portfolio When Appropriate Evaluate Performance
- 38. 10 Portfolio Expected Return and Risk Expected Return Risk The Expected Returns of the Securities The Portfolio Weights The Risk of the Securities The Portfolio Weights The Correlation Coefficients
- 39. 11 Grouping Individual Assets into Portfolios The riskiness of a portfolio that is made of different risky assets is a function of three different factors: • the riskiness of the individual assets that make up the portfolio • the relative weights of the assets in the portfolio • the degree of comovement of returns of the assets making up the portfolio The standard deviation of a two-asset portfolio may be measured using the Markowitz model: BABABABBAAp wwww , 2222 2
- 40. 12 Risk of a Three-asset Portfolio The data requirements for a three-asset portfolio grows dramatically if we are using Markowitz Portfolio selection formulae. We need 3 (three) correlation coefficients between A and B; A and C; and B and C. A B C ρa,b ρa,c ρb,c CACACACBCBCBBABABACCBBAAp wwwwwwwww ,,, 222222 222
- 41. Computation of the Expected Return for a Portfolio of Risky Assets 13 0.20 0.10 0.0200 0.30 0.11 0.0330 0.30 0.12 0.0360 0.20 0.13 0.0260 E(Rpor i) = 0.1150 Expected Portfolio Return (Wi X Ri)(Percent of Portfolio) Expected Security Return (Ri) Weight (Wi) iassetforreturnofrateexpectedthe)E(R iassetinportfoliotheofpercenttheW :where RW)E(R i i 1 ipor n i ii
- 42. 14 Diversification Potential The potential of an asset to diversify a portfolio is dependent upon the degree of co-movement of returns of the asset with those other assets that make up the portfolio. In a simple, two-asset case, if the returns of the two assets are perfectly negatively correlated it is possible (depending on the relative weighting) to eliminate all portfolio risk. This is demonstrated through the following chart.
- 43. 15 Portfolio Programming in a Nut shell Welcome
- 44. 16 Various portfolio combinations may result in a given return The investor wants to choose the portfolio combination that provides the least amount of variance
- 45. 17 Example Assume the following statistics for Stocks A, B, and C: Stock A Stock B Stock C Expected return .20 .14 .10 Standard deviation .232 .136 .195
- 46. 18 Example (cont’d) The correlation coefficients between the three stocks are: Stock A Stock B Stock C Stock A 1.000 Stock B 0.286 1.000 Stock C 0.132 -0.605 1.000
- 47. 19 Example (cont’d) An investor seeks a portfolio return of 12%. Which combinations of the three stocks accomplish this objective? Which of those combinations achieves the least amount of risk?
- 48. 20 Example (cont’d) Solution: Two combinations achieve a 12% return: 1) 50% in B, 50% in C: (.5)(14%) + (.5)(10%) = 12% 2) 20% in A, 80% in C: (.2)(20%) + (.8)(10%) = 12%
- 49. 21 Example (cont’d) Solution (cont’d): Calculate the variance of the B/C combination: 2 2 2 2 2 2 2 2 (.50) (.0185) (.50) (.0380) 2(.50)(.50)( .605)(.136)(.195) .0046 .0095 .0080 .0061 p A A B B A B AB A Bx x x x
- 50. 22 Example (cont’d) Solution (cont’d): Calculate the variance of the A/C combination: 2 2 2 2 2 2 2 2 (.20) (.0538) (.80) (.0380) 2(.20)(.80)(.132)(.232)(.195) .0022 .0243 .0019 .0284 p A A B B A B AB A Bx x x x
- 51. 23 Example (cont’d) Solution (cont’d): Investing 50% in Stock B and 50% in Stock C achieves an expected return of 12% with the lower portfolio variance. Thus, the investor will likely prefer this combination to the alternative of investing 20% in Stock A and 80% in Stock C.
- 52. Markowitz Portfolio Theory • Quantifies risk • Derives the expected rate of return for a portfolio of assets and an expected risk measure • Shows that the variance of the rate of return is a meaningful measure of portfolio risk • Derives the formula for computing the variance of a portfolio, showing how to effectively diversify a portfolio 1
- 53. Assumptions of Markowitz Portfolio Theory 1. Investors consider each investment alternative as being presented by a probability distribution of expected returns over some holding period. 2. Investors minimize one-period expected utility, and their utility curves demonstrate diminishing marginal utility of wealth. 2
- 54. Assumptions of Markowitz Portfolio Theory 3. Investors estimate the risk of the portfolio on the basis of the variability of expected returns. 4. Investors base decisions solely on expected return and risk, so their utility curves are a function of expected return and the expected variance (or standard deviation) of returns only. 3
- 55. Assumptions of Markowitz Portfolio Theory 5. For a given risk level, investors prefer higher returns to lower returns. Similarly, for a given level of expected returns, investors prefer less risk to more risk. 4
- 56. Markowitz Portfolio Theory Using these assumptions, a single asset or portfolio of assets is considered to be efficient if no other asset or portfolio of assets offers higher expected return with the same (or lower) risk, or lower risk with the same (or higher) expected return. 5
- 57. Efficient Frontier • Every possible combination of assets that exists can be plotted on a graph, with the portfolio's risk on the X-axis and the expected return on the Y-axis. This plot reveals the most desirable portfolios. 6
- 58. Efficient Frontier • For example, assume Portfolio A has an expected return of 8.5% and a standard deviation of 8%, and that Portfolio B has an expected return of 8.5% and a standard deviation of 9.5%. Portfolio A would be deemed more "efficient" because it has the same expected return but a lower risk. It is possible to draw an upward sloping hyperbola to connect all of the most efficient portfolios, and this is known as the efficient frontier. Investing in any portfolio not on this curve is not desirable. 7
- 60. Single Index Model • Need for Sharpe Model(Single Index) In Markowitz model a number of co- variances have to be estimated. If a financial institution buys 150 stocks, it has to estimate 11,175 i.e., (N2 – N)/2 correlation co-efficients. Sharpe assumed that the return of a security is linearly related to a single index like the market index. 9
- 61. Single Index Model • To simplify analysis, the single-index model assumes that there is only 1 macroeconomic factor that causes the systematic risk affecting all stock returns and this factor can be represented by the rate of return on a market index, such as the S&P 500. 10
- 62. Single Index Model • According to this model, the return of any stock can be decomposed into the expected excess return of the individual stock due to firm-specific factors, commonly denoted by its alpha coefficient α , which is the return that exceeds the risk-free rate, the return due to macroeconomic events that affect the market, and the unexpected microeconomic events that affect only the firm. Specifically, the return of stock i is: 11
- 63. Single Index Model • ri = αi + βirm + ei • The term βirm represents the stock's return due to the movement of the market modified by the stock's beta βi), while ei represents the residual variance 12
- 65. Introduction An efficient capital market is a market that is efficient in processing information. In other words, the market quickly and correctly adjusts to new information. In an information of efficient market, the prices of securities observed at any time are based on “correct” evaluation of all information available at that time. Therefore, in an efficient market, prices immediately and fully reflect available information.
- 66. Definition • "In an efficient market, competition among the many intelligent participants leads to a situation where, at any point in time, actual prices of individual securities already reflect the effects of information based both on events that have already occurred and on events which, as of now, the market expects to take place in the future. In other words, in an efficient market at any point in time the actual price of a security will be a good estimate of its intrinsic value." - Professor Eugene Fama,
- 67. The Efficient Markets Hypothesis The Efficient Markets Hypothesis (EMH) is made up of three progressively stronger forms: Weak Form Semi-strong Form Strong Form
- 68. The EMH Graphically In this diagram, the circles represent the amount of information that each form of the EMH includes. Note that the weak form covers the least amount of information, and the strong form covers all information. Also note that each successive form includes the previous ones. Strong Form Semi-Strong Weak Form All information, public and private All public information All historical prices and returns
- 69. The Weak Form The weak form of the EMH says that past prices, volume, and other market statistics provide no information that can be used to predict future prices. If stock price changes are random, then past prices cannot be used to forecast future prices. Price changes should be random because it is information that drives these changes, and information arrives randomly. Prices should change very quickly and to the correct level when new information arrives (see next slide). This form of the EMH, if correct, repudiates technical analysis. Most research supports the notion that the markets are weak form efficient.
- 70. The Semi-strong Form The semi-strong form says that prices fully reflect all publicly available information and expectations about the future. This suggests that prices adjust very rapidly to new information, and that old information cannot be used to earn superior returns. The semi-strong form, if correct, repudiates fundamental analysis. Most studies find that the markets are reasonably efficient in this sense, but the evidence is somewhat mixed.
- 71. The Strong Form The strong form says that prices fully reflect all information, whether publicly available or not. Even the knowledge of material, non-public information cannot be used to earn superior results. Most studies have found that the markets are not efficient in this sense.
- 72. Summary of Tests of the EMH Weak form is supported, so technical analysis cannot consistently outperform the market. Semi-strong form is mostly supported , so fundamental analysis cannot consistently outperform the market. Strong form is generally not supported. If you have secret (“insider”) information, you CAN use it to earn excess returns on a consistent basis. Ultimately, most believe that the market is very efficient, though not perfectly efficient. It is unlikely that any system of analysis could consistently and significantly beat the market (adjusted for costs and risk) over the long run.
- 73. CAPM-Capital asset Pricing Model A model that describes the relationship between risk and expected return and that is used in the pricing of risky securities The CAPM says that the required return of a security or a portfolio equals the rate on a risk-free security plus a risk premium. If this expected market return does not meet or beat the required return, then the investment should not be undertaken. Risk Free rate-Yield on long term Govt Bonds Risk Premium-The reward for taking on additional Risk
- 74. CAPM
- 75. CAPM The general idea behind CAPM is that investors need to be compensated in two ways: time value of money and risk. The time value of money is represented by the risk-free (rf) rate in the formula and compensates the investors for placing money in any investment over a period of time. The other half of the formula represents risk and calculates the amount of compensation the investor needs for taking on additional risk. This is calculated by taking a risk measure (beta) which is a measure of the systematic risk. Unsystematic Risk need not be rewarded.
- 76. Application of CAPM Lets assume that a stock has a Beta of 1.2, the risk free rate is 4% and the market return is expected to be 12 %, the expected return of the stock considering the dividend and capital gain expectations is assumed to be 9 % Substituting in the CAPM formula we get the required return as 13.6 % As the Required return[ 13.6%] is more than the expected return of 9% the investment cannot be undertaken and if it has already been undertaken , needs to be disposed off/sold Thus for the non diversifiable risk [Beta of 1.2 , the required return is 13.6 %, if the Beta is increased to 1.5 , the required return comes to 16 %, thus higher the Beta [Risk] higher the return.