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Corporate finance is the vast field that encompass lots of things. In the current report portfolio are evaluated in terms of their performance. Percentage return that is earned on each security is computed and same is used to evaluate the performance of the portfolio. In the middle part of the report, difficulty that one face in measuring performance of the portfolio is identified and probable solution of same is identified. At end of the report, portfolio theories are explained in terms of diversification. Along with this, features and attributes of investment alternatives are also explained in the report.
Results indicate that in the portfolio of the Steve Quinn portfolio return is 4.24% and same for the Peter Walker is -0.12%. Results are clearly indicating that high amount of return is earned in the portfolio of the mentioned person relative to other one. Minor difference exist in the portfolio of both entities. In the portfolio of Steve Quinn basically securities are bond and mutual funds. On other hand, in case of Peter Walker there is shares of single company and junk bonds which are related to the firms that are not so financially sound. It can be said that due to shares in the portfolio and junk bond less return are earned on same.
There are number of questions that must be asked to the advisors in order to ensure that in upcoming time period better return will be earned on the invested amount. Asked questions will be classified in to two categories namely questions in respect to past and probable performance.
In order to ensure that financial advisor have some forecasting power and outlook about future time period some questions will be asked to them. Same are given below.
On comparison of the performance of the portfolio it can be said that on both portfolio less return is earned. It can be observed that on the portfolio of Steve Quinn only return of 4% is earned and on portfolio of other one negative return is observed -0.12%. In case of portfolio of Steven Quinn higher return is earned on the single security in case of Blackmore bond PLC which is equivalent to 17%. In other securities in the portfolio less return are earned on average 7%. In the portfolio of Peter Walker average return is 5-7%. Thus, very low return is earned on securities because stock does not perform well and other are junk bonds which give less return. Thus, on comparison it can be said that portfolio of Steve Quinn is more balanced then Peter Walker.
There are lots of difficulties that one face in measuring the performance of the portfolio. There are number of techniques that can be used to measure the performance of the portfolio. One of the main difficult task is to determine the minimum return that must be earned on the portfolio. One can make estimation about the return that must be earned on the portfolio but same may be wrong (Zhang, Fuehres. and Gloor, 2011). This is because one cannot by thinking about conditions can estimate about the return that must be earned on the portfolio in order to ensure that minimum return is earned on the investment amount. In order to solve this problem CAPM model which is also known as capital asset pricing model can be used. Under this model required rate of return is computed for the risk that is taken by the investor on the investment amount. It must be noted that there are different level of risks on different securities and due to this reason it is very important to apply CAPM model separately on all securities. In this model risk free rate of return is and risk premium is used to compute minimum return that an investor must earn for the risk same is taken on the investment amount. By using CAPM model problem can be solved.
While measuring the performance of the portfolio one must also know the return that is earned on the every unit of risk that is taken on the portfolio. It is well known fact that there is close connection between risk and return. It is assumed that if high risk is taken then return on same will also be high. However, many times it happened that one make investment by taking heavy risk but return does not received at same rate (Edmans, 2011). Thus, it is very difficult task to measure the performance of the portfolio in terms of return that is earned for taking every unit of risk. This problem is solved by using Sharpe ratio under which return is divided from the standard deviation. Under this formula from return, risk free rate of return is deduced and then computed value is divided by the standard deviation. In this way return that is earned on unit risk is computed.
Analysis of content of portfolio in terms of diversification and explanation on theory and practice of diversification and its relation to risk as well as techniques to optimize the risk return relationship in investment portfolios
On analysis of content of both portfolios it can be said that it is not possible to do diversification in proper manner by following same portfolio. This is because it can be observed that in the portfolio of Steve there is single unit of mutual fund and there are only two bonds. This clearly reflects that portfolio is not diversified in the systematic way. It was possible to allocate 50 to 60% of invested amount in equity, 20% in the mutual funds and remaining in the bonds. Apart from this in the equity investment can be made in the different firm’s shares as much as possible by considering beta value and other factors. By doing so it was possible to do allocation in better manner. In case of portfolio of Peter it can be observed that there is single bond and remain is mutual fund and shares (Wachter, 2013). It can be observed that entire amount that was allocated for bond is not invested in different bonds and same thing is observed in other securities. It can be said that both portfolios are not diversified as there are only few securities in both and it can be said that portfolio is not diversified in nature. There are number of theories of the diversification and same are explained below.
Modern portfolio theory: This theory was stated by the Markowitz under which it state that allocation of asset must be done in the portfolio on the basis of correlation of the asset to the total value of the portfolio. By using covariance and correlation relationship between different securities is identified and on that basis portfolio of securities is designed where risk is minimized and return is maximized.
Post modern portfolio theory: Under this theory some limitations of the modern portfolio theory was removed. Under this theory risk is measured by using internal rate of return which refers to the minimum return that is needed on the portfolio. Those assets that have high return are included in the portfolio.
Risk parity theory: Risk parity theory state that volatility that is associated with each asset must be considered for the formation of the portfolio (Kazem and et.al., 2013). One must consider the risk that it intends to take on the investment. According to the risk assessed one must determine the securities that it must take in the portfolio. By doing so portfolio can be prepared in better manner.
There is a close association between risk and diversification that is associated with the portfolio. This happened because risk is associated with each unit that is included in the portfolio. If there will be few units then loss in value of the portfolio will be high. On other hand , in case there will be lots of securities in the portfolio then in that case high risk that is associated with the specific securities will have little impact on the portfolio. Thus, diversification and risk have high level of correlation.
There are number of techniques that can be used to optimize the risk and return. Under this specific proportion of equity and other securities in the portfolio is determined. Under this specific method is used and expected return is estimated. On the basis of expected return allocation of different securities is done in the portfolio. It can be said that if any security have higher expected return then higher allocation must be given to same in the portfolio. In this regard CAPM model can be used and expected return for the assessed risk can be determined.
Equity: Equity is the one of the major investment avenue that can be considered for the investment by the business firm. In the portfolio it can be observed that there is a single company. Thus, there is a need to make investment in equity (Ferreira. and Santa-Clara, 2011). There are the number of features of equity as it is considered as one of the best return generating asset in comparison to other alternative. In the equity most of the mutual fund houses make huge investment in order to ensure that higher return will be earned on the investment. Usually, it is observed that there is a high beta value of the FTSE components. Due to high beta value stocks become highly volatile and higher amount of profit and loss are made on the invested amount. Thus, in case market will gone up then in that case huge amount of return can be earned on the invested amount. On other hand, if beta value is high and market decline then in that case share price will be decline sharply (Chi, Liu and Lau, 2010). Hence, it can be said that high profit making opportunity is the one of the main revenue generating opportunity for the investor.
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Commodity: Commodity is another investment alternative that is huge return asset and from same good amount of profit can be earned. It is observed that profit and loss are also huge on commodity. Inclusion of commodity in the portfolio will elevate return on same and by doing so huge amount of return can be earned on the invested amount. One of the main attribute of commodity is that under same amount can be invested in multiple alternatives like Nickel, copper, aluminum and other metals etc. Investment can be made in the future and option contract of the metals and by making investment in the multiple lots greater amount of profit can be earned. It can be said that investment can be made in the commodity.
Gold ETF: Gold ETF is also known by name gold exchange traded fund. Under this physical delivery of gold is not taken and investment is made in the specific scheme. Business firm makes investment in gold on behalf of client. One of the main benefit of gold ETF is that one by making less investment can purchase gold units. Thus, every type of investor can make investment in gold ETF and by doing so better return can be earned on the gold ETF.
Real estate: Investment can also be made on the real estate and under this small premises that owners have can be given on rent. It can be said that good return can be earned by making investment in real estate (Lim and Brooks, 2011). It is another alternative on which investment can be made by the business firm. In case if value of the property will increase then in that case on sale of same huge return can be earned. Usually when economy is on growth track demand of real estate increased. It is expected that in the upcoming time period demand for property will increase and due to this reason real estate is the one of the best option that is available to the investors.
Quality of service that is provided to the Steve and Peter is not excellent as it can be observed that low return are generated by the financial advisors on both portfolios. In case of portfolio of Steve only return of 4% is generated and return on other portfolio is negative and on this basis it can be said that quality of service that is provided by the advisors is not good. There are number of improvements that can be demanded from the advisors. Under this, both persons can order to the advisors to reallocate asset in the portfolio and they can ask the advisors to reallocate the fund in proper manner. Apart from this clients must ask reason behind allocation of assets in the portfolio. This approach will ensure that advisors are after thinking prudently on the investment and current economic conditions of the nation are making investment decisions and asset allocation decisions. It is recommended that investors must demand some of the improvement from the investors (Dougal and et.al., 2012). In this regard clients can advised advisors to compute varied statistics and provide same to them. Clients can discuss the computed values with the advisors and can seek advice from them in respect to allocation of assets in the portfolio. Apart from this, as part of improvement clients can demand proper tracking of portfolio from the advisors and can demand weekly data about the performance of the portfolio. In this regard clients can demand from the advisors to develop specific excel template under which weekly price of security can be entered and performance of the specific stock can be tracked in terms of growth rate. By doing so on time it can be identified whether specific security value increase or decrease. On this basis advisors can take decision on time in respect to sale of asset. Clients can also recommended the advisors to follow active investment strategy and under this frequently securities can be changed in the portfolio and by doing so loss on holding security in the portfolio can be reduced.
On the basis of above discussion it is concluded that it is not wise decision to lay down entire profit making responsibility on the financial advisors. This is because advisors handle multiple clients portfolio and due to this reason same cannot pay due attention on the portfolio of the investors. Thus, it is the liability of an investor to keep track of its portfolio and take decision and communicate same to the advisor. It is also concluded that advisors must make use of advanced tools and techniques to evaluate the securities and to make investment decisions. By doing so better investment decisions can be made by the managers.
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