Capital Market & Portfolio Management

1) Net income = ₹3, 00,000/- preferred dividend = ₹30,000/- during the year. In addition
it also had ₹30, 00,000 total shares outstanding during the year and ₹5, 00,000/-
preferred stock. Calculate ROE of the organization.

Ans :

Introduction

Return on equity (ROE) is a critical financial metric that assesses a company's profitability
and efficiency in producing income for its shareholders. It measures the go-back generated on
shareholders' equity invested within the business. For buyers and analysts, ROE is a critical
indicator of an organization's overall economic performance and is frequently used to
evaluate its overall fitness and attractiveness as an investment.

Understanding ROE entails analyzing the net income because of common shareholders
concerning the equity to be had to the one's shareholders. It answers the fundamental
question: "How successfully is a company utilizing its equity to generate profits?"

In this discussion, we can delve into the concept and alertness of ROE, exploring its
importance in financial assessment and a way to compute it. We can use a hypothetical
scenario to illustrate the calculation system, considering internet earnings, preferred
dividends, outstanding shares, and stock.

Concept & Application

Return on equity (ROE) is an essential financial ratio used to assess the profitability and
performance of an agency from the perspective of its shareholders. It measures how correctly
an employer generates profit from its shareholders' equity.

Understanding the Components of ROE:

1. Net Income: net profits are an organization's profit after deducting all prices, taxes,
and preferred dividend payments. It represents the profits to both favoured and not unusual
shareholders.

2. Preferred Dividends: preferred dividends are the payments made to desired

shareholders, generally at a set fee. It's essential to subtract these from internet income to
decide the earnings for common shareholders.

3. Total Shares Outstanding: the number of corporation shares traders hold, including
popular and favoured shares.

4. Preferred Stock Value: preferred stock represents an agency's equity type. The value
of the favoured stock is usually provided in the financial statements.

The Formula for ROE:

ROE=(Net Income−Preferred Dividends Total Equity)×100ROE=(Total Equity Net
Income−Preferred Dividends)×100

Interpreting ROE:

• High ROE: A high ROE indicates that the company correctly uses its fairness to
generate profits. It has usually been visible as a positive sign, suggesting correct financial
health and robust control.
• Low or Negative ROE: A low or terrible ROE may additionally imply inadequate
profitability or inefficient use of equity. This will be because of high debt levels, low net
profits, or extensive favoured dividend payments.

Application of ROE:

1. Comparative Analysis: buyers use ROE to compare an employer's performance with

its industry peers or historical data. A higher ROE than competitors should signal an extra
attractive investment.

2. Investment Decision-making: ROE is a crucial component in investment selections.

Traders often try to find corporations with regular and high ROE, showing sturdy financial
performance and ability returns.

3. Management Evaluation: ROE displays the effectiveness of control in utilizing

equity to generate profits. Shareholders and forums use it to assess managerial overall
performance.

4. Financial Health Assessment: Analysts use ROE to assess a company's financial

health and to determine capability risks associated with the company's capital structure.

Understanding and computing ROE is crucial for stakeholders because it aids in informed
selection-making, presenting insights into the company's capacity to generate shareholder
returns.

To calculate the go back on equity (ROE) for the organization, we can use the method:

ROE = Net Income – Preferred Dividends

Total Equity

Total equity includes common equity (equity attributable to common shareholders) and
preferred equity. The preferred equity is the preferred stock.
Given information:
- Net income: 3, 00,000/-
- Preferred dividends: 30,000/-
- Total shares outstanding: 30, 00,000 (common equity)
- Preferred stock: 5, 00,000/-

First, let us calculate the common equity:

Common Equity = Total Shares Outstanding - Preferred Stock

Common Equity = 30, 00,000 - 5, 00,000
Common Equity = 25, 00,000

Now, let us calculate the ROE:

ROE = Net Income – Preferred Dividends

Total Equity

ROE = 3, 00,000 - 30,000

25, 00,000

ROE = 0.11 or 11%

The organization’s Return on Equity (ROE) is approximately 11%

Conclusion:

The organization's return on equity (ROE) is approximately 11%. This means that the
organization generated an approximate return of 11% in net income for every rupee of
common equity invested by the shareholders after accounting for preferred dividends. A
higher ROE generally indicates better profitability and efficiency in utilizing equity for
generating profits.
2) Your collogue is interested to invest in derivative market. But he doesn’t have a good
knowledge about it. He wants some information about different types of derivatives.
Explain him different types of derivatives.

Ans :

Introduction

Derivatives are financial devices whose value is derived from the value of an underlying
asset, index, or charge. They are essential in modern finance, allowing investors to manage
risk, speculate on fee movements, and decorate investment returns. Derivatives have gained
tremendous popularity in financial markets due to their versatility and ability to cater to
various threat management strategies.

In essence, derivatives function contracts between parties, the client (long position) and the
seller (short work), and their price is related to the anticipated future fee movements of the
underlying asset. Those instruments are traded on various platforms, including futures
exchanges and over-the-counter markets.

Concept & Application

The core concept of derivatives revolves around leveraging price movements of underlying
assets. Let us delve into every kind of concept and application briefly:

Types of Derivatives
Derivatives can be broadly categorized into four main types:

Futures Contracts:
Futures contracts are standardized agreements to shop for or sell a particular amount of an
underlying asset at a predetermined fee (the futures rate) on a specific future date. These
contracts are widely used in commodities, currencies, and economic instruments like stock
indices.

Buyers regularly use futures to hedge in opposition to capability losses from negative charge
moves within the underlying asset. For instance, a farmer might use a futures contract to
fasten in a price for their plants before the harvest to mitigate the risk of fee fluctuations.

• Concept: Futures contracts are standardized economic agreements obligating the

buyer to purchase and the vendor to sell a particular asset at a predetermined fee and date
within the destiny. The contract's price is derived from the expected future rate of the
underlying asset.

• Application:

• Hedging: buyers use futures contracts to hedge against adverse price actions. For
instance, a production company might hedge in opposition to rising steel fees by taking a
protracted function in metallic futures.

• Speculation: traders speculate on destiny charge actions to make income. For

example, a trader might take an extended function in crude oil futures if they anticipate a
growth in oil prices.

Options:

Options provide the buyer with the right, but not the responsibility, to buy (call choice) or sell
(positioned alternative) a specific amount of the underlying asset at a predetermined price
(strike charge) earlier than or at the expiry date. The customer pays a premium to collect this
properly.
Alternatives can be used for hedging towards ability fee volatility or for hypothesis. Hedgers
use options to protect in opposition to unfavourable price movements, whilst speculators
employ options to make the most of charge changes within the underlying asset.

• Concept: options are contracts granting the client the right (but now not the
obligation) to shop for (name option) or promote (put option) a specific asset at a
predetermined fee within a particular time frame.

• Application:

• Hedging: investors use alternatives to hedge towards potential losses. A portfolio

manager may purchase options to hedge against a possible downturn inside the inventory
market.

• Income Generation: buyers can sell (write) options to generate profits through the
premiums acquired. This strategy is called writing protected calls.

Swaps:

Swaps are contracts in which parties agree to exchange cash flows or other financial
instruments over a defined period. Common swaps include interest charge swaps, currency
swaps, and commodity swaps. Swaps manage dangers related to interest fee fluctuations,
currency exposure, and commodity price actions.

Swaps control cash flows and risks associated with interest rates, currencies, or commodities.
For instance, a company with a variable interest rate debt may enter into an interest rate swap
to convert it into a hard and fast charge, offering a balance in interest payments.

• Concept: Swaps are contracts where parties agree to exchange financial units or cash
flows based totally on an agreed-upon notional amount.
• Application:

• Interest Rate Swaps: corporations may use interest rate swaps to convert variable
interest rate debt to fixed prices, managing interest price risk effectively.

• Currency Swaps: Multinational corporations use currency swaps to hedge against

fluctuations in exchange rates whilst dealing with international transactions.

Forwards:

Forwards are just like futures contracts but are customizable concerning contract length,
expiration date, and contract terms. They are privately negotiated agreements between two
parties to shop for or promote an asset at a destiny date for a price agreed upon these days.

Forwards are, in particular, used for hedging functions, mainly in foreign exchange markets
where groups want to lock in an exchange fee for future transactions to minimize currency
risk.

• Concept: Forwards are customizable agreements between two parties to shop for or
promote an asset at a future date for a fee agreed upon these days.

• Application:

• Customization: Forwards are tailor-made to satisfy the parties' unique desires,

making them ideal for special conditions that popular contracts won't cover.

• Commodity Hedging: Farmers may also use forward contracts to lock in crop costs,
ensuring a predictable sales movement no matter market rate fluctuations.

Conclusion
Derivatives are crucial in contemporary financial markets, presenting various risk control,
speculation, and portfolio diversification tools. But, it's vital to use products prudently,
knowing their inherent complexities and associated risks. Education and a stable know-how
of the underlying property and market dynamics are crucial for a hit spinoff trading and
investment. Whilst used judiciously, derivatives can substantially enhance portfolio
performance and offer precious risk management solutions for marketplace participants.

3) a) Your friend wanted to invest in stock market. But he is confused how much
amount to invest in different stocks. With the help of sharpe ratio, help your friend to
prepare optimum portfolio.

Stock Sharpe Ratio

S1 1.5

S2 2

S3 2.5

Total 6

Ans ;

Introduction to the Sharpe Ratio:

The Sharpe Ratio is a widely used measure in finance to assess the chance-adjusted go-back
of a funding or portfolio. It was advanced by way of Nobel laureate William F. Sharpe. The
ratio helps traders examine the trade-off between threats and go back and make informed
selections about their investments.
Concept & Application of the Sharpe Ratio:

The Sharpe Ratio is calculated by subtracting the chance-free rate of return from the expected
portfolio return and then dividing this by the portfolio's standard deviation (a measure of
risk). The system for the Sharpe Ratio is as follows:

Where:
R_p\ is the expected portfolio return.
R_f\ is the risk-free rate of return.
sigma_p\ is the standard deviation of the portfolio's return.

Here's how to use the Sharpe Ratio to prepare the best portfolio with your friend's stock
options:

1. Calculate the Expected Portfolio Return:

To calculate the expected portfolio return R_p, you must decide how much of every
inventory to include inside the portfolio. You can use the proportion of each stock's Sharpe
Ratio in the overall Sharpe Ratio to allocate investments. In this case, you could use the
following method:

2. Determine the Risk-Free Rate:

 The threat-free fee R_f is the return expected from a danger-free investment, such as a
central authority bond. It would help if you used a contemporary, appropriate, risk-free
charge based on your investments' currency and time horizon. Permits assume a danger-free
fee of 1% for this example.

3. Calculate the Portfolio Standard Deviation sigma_p

You may want historical statistics or estimates of the man or woman inventory returns and
their correlations to calculate the portfolio's fashionable deviation. This calculation may be
complex and often requires economic software or tools.

4. Calculate the Sharpe Ratio:

Plug the values you've calculated into the Sharpe Ratio formula:

5. Evaluate and Compare:

Calculate the Sharpe Ratio for different portfolio mixtures to locate the one with the best
Sharpe Ratio. This portfolio will offer a first-rate chance-adjusted return.

Conclusion:
In conclusion, the Sharpe Ratio is a valuable tool for constructing an optimal portfolio that
balances risk and return. With the aid of the use of this ratio, your friend can allocate their
investments among specific stocks to maximise their risk-adjusted returns. It is critical to
remember that the accuracy of the Sharpe Ratio calculation depends on the great of facts used
for expected returns and preferred deviation, as well as the choice of an appropriate risk-
unfastened price. Moreover, standard monitoring and modifications to the portfolio are
critical to preserving its optimality through the years.

b) If you have Rs.10, 000/- & decides to invest 40% in mutual fund and rest in shares.
Expected return from mutual fund is 8% & from shares is 12%. How will you calculate
total expected return?

Ans :

Introduction:

Investing is a crucial factor in financial planning and wealth creation. It involves allocating
funds in various financial contraptions to generate ability returns. One common approach is
diversifying investments in mutual budgets and shares. This approach allows for publicity to
both marketplace diversity and potential growth. In this scenario, we have Rs. 10,000 to
invest, with 40% allotted to the mutual price range and the relaxation of shares. We can
calculate the overall expected go-back based on the expected returns from those investment
options.

Concept & Application:

Mutual Fund Investment:

Mutual finances are professionally managed funding pools that aggregate funds from
numerous investors to invest in a varied portfolio of stocks, bonds, or other securities. The
predicted return from the mutual fund in this situation is 8%. To calculate the expected return
from the Rs. 4,000 invested in mutual funds:

Expected return from Mutual Fund = 40% of Rs. 10,000 * expected return rate (8%) = 0.40 *
Rs. 10,000 * 0.08 = Rs. 320

Shares investment:

Shares, or stocks, represent ownership in a company and offer ability returns through capital
appreciation and dividends. The expected return from shares in this state of affairs is 12%. To
calculate the expected return from the Rs. 6,000 invested in shares:

Expected return from shares = 60% of Rs. 10,000 * expected return rate (12%) = 0.60 * Rs.
10,000 * 0.12 = Rs. 720

Total Expected Return:

The total expected return is the sum of the expected returns from mutual funds and shares:

Total expected return = expected return from Mutual Fund + expected return from shares =
Rs. 320 + Rs. 720 = Rs. 1,040

Conclusion:

Diversifying investments through allocating budget to mutual finances and shares is a prudent
approach to maximize returns while handling risks. In this hypothetical state of affairs, with
Rs. 10,000 to invest, a 40% allocation to mutual funds and a 60% allocation to shares, the
total predicted go back is Rs. 1,040. It is critical to notice that actual returns also vary based
on market situations, financial factors, and the overall performance of particular investment
gadgets. Regular tracking and periodic adjustments to the investment portfolio are essential
for optimizing returns and reaching long-term financial goals.