Assignment

Submitted To:

Mr. Morshed Mokhdum

Investment Analysis and Markets (Fin-724)

BRAC Business School
Executive MBA Program

Submitted By:

Md. Alamgir Badsha

ID-17374004

Date of Submission: 21 April, 2019

Question Answer 1 (a)

Difference between Markowitz Portfolio theory and Single Index model are given below:
Markowitz Portfolio theory
In 1950, Harry Markowitz invented modern
portfolio theory.
According to Markowitz, securities or asset are
not independent that means return of securities
create movement of other securities.
Each asset or security could be affected by
another asset; it is depend on their previous
relation.
Huge number of variance and covariance’s are
required to calculate.
According to Markowitz, Number of combination
for a variance and covariance’s calculated by
n(n−1)
, if number of asset 50 the combination
2 are, (3*50) + 2=152.
50(50−1)
is = 1225.
2
Covariance are calculated by
ꭃVab = ab ρab
Risk is calculated by,
 ρab = (wa2a 2+ wb2b 2 + 2wawbabρab)1/2
Consists with Variance and covariance risk
Single Index model
Single Index Model which was invented by
William sharp in 1963.
According to this theory asset is unique
and their relation depends on market
which is common relation in to the market.
According to him, market is only index,
which affecting securities risk and return.
No other factor affecting securities risk and
return in the market
Small number of variance and covariance’s
are required to calculate.
According to William sharp variance and
covariance’s are calculated by (3*n)+2. If
there are 50 asset then total combination
Covariance are calculated by
ꭃVij = βi βj M 2
Risk is calculated by,
p2 = βp2 M 2 + ep2
Consists with market risk and asset specific
risk
 Question Answer 1 (b)

The Capital Asset Pricing Model (CAPM) and means Arbitrage Pricing Theory (APT) are two of
the most popular asset pricing model used by analysis and investors. There are some
differences between them:

CAPM
CAPM depicts the relevant risk for a new security
is the amount of risk which is added to a well-
diversified portfolio.
CAPM means Capital Asset Pricing Model for
Single Asset
CAPM consider single factor which is the
sensitivity of the asset to changes in the market.
CAPM is easy to calculate
In CAPM, there are no company specific factor
and different betas for each factor have to be
calculated individually empirically
Equation for CAPM is:
Ri = R F + β i ¿ ¿)
CAPM assume that, all investors are in single
investment period
CAPM assume that, investors borrowing and
lending at a risk free rate.
CAPM assume that, no taxation
APT
APT is based on Law of One Price that
means two identical assets or security
should not be traded as different prices.
APT means Arbitrage Pricing Theory which
is alternative to CAPM model.
According to APT, return of a single asset is
subject to N factors.
APT is calculate and difficult to calculate
In APT, there are company specific factor
and different betas for each factor have to
be calculated individually empirically.
Equation for APT is:
Ri = E(Ri) + βi1fi1 + βi2fi2 +…+ βinfin + ei
Whereas APT, does not assume that.
Whereas APT, does not assume that.
Whereas APT, where is no such
assumption.

Question Answer 2

An investment is the process which held for some time less than one year or more than one
year, get some return and associate with risk. For investing in security we need to know what
the investment process is, where to invest? In which security we should invest? Where it is risky
or not? How long we invest? This course (FIN-724) helps us to taking investment decision to
which security we should invest?

For investment decision we need to know about asset or security types. There are different
types of asset. For example:
 Debt Security: The most common is a bond, including government bonds, corporate
bonds, municipal bonds, collateralized bonds, zero coupon bonds and debentures.

Equity Securities: Common Stock, Preferred Stock.

Hybrid Securities: It is a single financial security that combines two or more different
financial instruments. It is a combination of debt and equity. Example: Convertible bond.

In this course we know about Asset backed securities, any security which is issued backed by an
asset that is called Asset backed securities. Here we know about financial market is a forum
where demanders of fund and suppliers of fund are transacting with each other. Also we know
about financial derivatives: Options, Forward Contract and Futures. Options create a right to
exercise but Future create obligation.

In this course we get concept about Investment companies. Investment Company is a financial
service provider which is issuing securities in the market and then raised capital is issued to
form a diversified portfolio of securities. Investment companies are registered under security
and exchange commission. Investment companies are: Unit Investment Trust(UIT), Close-end
Investment company, Open-end Investment company, Exchange Traded Fund(ETF). Some are
traded all day long and some are traded in end of the day. Also they are traded in market price
or Net Asset Value. Therefore, the concept of Investment Company’s helps us to in which
company we should invest.

This course told us to high risk for high return. A person can invest in single asset or in portfolio.
Then selection of asset is the first things for investment. This course told us to how to select
asset and allocation of asset in an asset class? Help us to manage a portfolio by passive
investment strategy and active investment strategy as well as factor affecting investment
decision like risk, return, type of investor, global nature of investment etc.

There are direct and indirect investments are possible. Direct investment includes Non-
negotiable Financial Assets, Money Market Securities, and Capital Market Securities. Most
common direct investment includes Savings Account, Non-Negotiable CD (Certificate of
Deposit), Money Market Deposit Account (MMDA), Govt. Bond, Commercial Paper, Bankers’
Acceptance, Re-purchase Agreement, Debenture, Municipal Bond, Taxable Bond, Tax Exempted
Bond, Common Stock, and Preferred Stock.

Investment in investment company’s securities is known as indirect investment. Like, Lanka

Bangla’s securities, IDLC’s securities. Mutual fund is an example of indirect investment security.

According to this course Capital Market is two types: Primary market and Secondary market.
Before investing in securities or asset one should know about difference of primary and
secondary market. Primary market is a place where new share is issued or issue IPO’s and
secondary market is a market where already issued share is traded. Then we should in which
market first we invest?

Also there are two ways of issuing IPO’s in financial market. Private placement where does not
need to register with Security Exchange Commission and does not need to under writing fee or
issue fee. Public placement where need to register with Security Exchange Commission and
need to under writing fee or issue fee.

For investing in security this course helps us to choose the broker who helps us to process
investment in security market. There are Broker and Dealer. A broker is a person or a company
who act as an intermediary between buyers and sellers. A dealer is a person or a company who
buys or sells securities from their own account. There are many stock exchanges company in the
world. NYSE (New York Stock Exchange) is the oldest. DSE (Dhaka Stock Exchange) is a
Bangladeshi stock exchange company. Some are trading online as well as manual trading exists.

This course told us how to calculate risk and return for a single asset as well as for portfolio.
Return would be benefit and consists with Yield and Capital gain. Risk is calculated by Standard
Deviation and variance. Variance is better for identifying risk.

There are different theory exists for calculating risk and return which is help us to selecting
security to invest. Henry Markowitz formula invented modern portfolio theory. But his theory
has some limitation like, huge number of variance and covariance’s are required to calculate
and it is only two parameter model. William Sharp invented alternative portfolio theory, which
is Single Index Model or Single Factor Model and Mult-index model. By the help of William
sharp the main limitation of Markowitz is overcome. According to their theory there is an
efficient frontier line which identifies the optimal sets of portfolio as well as risky and risk free
portfolio. Therefore, investors decide in which portfolio should he/she invest? It is depend on
their preferences.

There is asset pricing theory:

1. Capital Market Theory which helps us to taking investing decision in which risky
portfolio we should invest and financial decision that means allocating fund in risky and
risk free portfolio.
2. Capital asset pricing model which helps us to calculate expected return. Also there is an
alternative theory of capital asset pricing model named Arbitrage Pricing Theory (APT)
and according to APT, return of single asset is subject to no. of N factors.

All the above issues which we learnt from our FIN-724 course help us to selecting security to
invest in the market where it is capital market or money market.