Question One
Investment involves some level of risk, which can either be systematic, that is not under control by investors or unsystematic, which are specific to a particular industry or company. Examples of unsystematic risks may include market risk, which is the risk of investment associated with a decline in value as a result of economic developments. It provides equity risk, interest risk, and currency risk. Such risks can be reduced or eliminated through diversification of investments, whereby investors are advised to invest in different investments to spread uncertainties.
Question Two
In recent years, unethical behavior in the financial industry has been considerably destructive. It goes beyond the crisis that triggered the bank bailout to other sectors. Unethical behavior does not only affect global finance but it is also costly in terms of reputation and brand, which may cause a downturn in profitability. However, firms have taken the knee-jerk approach in solving ethical issues through the introduction of more rules and rewarding external behaviors. In financial services, there is no lack of rules and regulations but the unspoken rules often carry more weight and such laws can conflict with ethical behavior. Furthermore, financial service companies often incentives to employees in a bid to wan off unethical practices.
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Question Three
Modern portfolio theory is a model that elucidates how risk-averse investors can develop a portfolio to optimize investment returns at a given level of market risk with an emphasis on the uncertainty. Despite MPT importance, critics question whether it a vital investment tool as it does not match the real world in many aspects. The risks, returns, and the correlation values are based on expected values. The theory has also been criticized because of the assumption that return follow Gaussian distribution, which was shown by Benoit Mandelbrot and Eungine Fama who showed the adequacy of the model and proposed the use of stable distribution
Question Four
An index is a mutual fund where the portfolio is constructed to match or track the component of the financial market index. An index mutual fund is said to avail abroad market exposure, low market exposures, low operating expenses, low portfolio turnover, and it has actively managed funds. Active and passively managed funds differ in how the account manager handles the investment portfolio over time. Actively managed fund occurs when management actively picks investments to outperform the market index and tends to charge high fees. Conversely, passive management occurs when the management attempts to copy some benchmark and replicate its holdings. Likely the performance and the costs are usually lower than active management funds.
Question Five
Treasury bonds are essential loans to the government stemming from the purchase of the bonds by domestic consumers. The bonds affect the economy by allowing the government to have more money at its disposal. Also, it impacts the economy through the determination of interest rates that affect the amount of liquidity. As a result, bonds yield determines the cost of buying items on credit, request car financing loans, and the availability of houses or education loans. Also, the treasury bonds express how businesses can expand.
Question Six
Amazon Inc. and Nike Inc. deal in designs and clothing. However, they are trading at different earning multiples; Amazon is trading at higher exchange multiple than Nike Inc. The difference is as a result of several factors that may include fundamental factors, technical factors and market sentiments. The amazon price is higher because it has a larger market share, and the price-earnings ratio, which is the deciding factors for investors, does attract more demand that generally raises rates. Also, technical factors favor amazon Inc.; such factors include inflation, the strength of the market and pears, substitutes, related transactions, and demography.
Question Seven
Harry Markowitz was born in 1927; he is a Nobel Prize-winning economist who developed the modern portfolio theory. He introduced the theory to the academic circle in an article that appeared in the journal of finance in 1952. Markowitz's approach emphasized the benefits of a portfolio, risk, and the correlation between investments and diversification. Markowitz is currently a professor at the University of California at Santiago. The theoretical framework explores how investors can develop a portfolio that maximizes expected return at a given market risk with an emphasis on the risk as an inherent part of high reward. The theory has helped investors to develop the portfolio that is diversified with non-correlated investments to manage risks. Diversification helps reduce risks and thus optimizing the return potential.
Question Eight
Derivatives are financial instruments whose values are derived from the underlying financial asset, index, or security. Derivatives can be used to either mitigate risk or assume risk with speculation of commensurate reward. An example of a derivative is a future contract, which is the legal agreement to sell or buy a particular commodity or asset at a given price at a specified time in the future. Principally, because derivatives involve the agreement between two or more people, one has to communicate the features of the contract to the other parties. However, they may face challenges in conveying such features. One problem is the interconnection risk, which is how the interconnection between derivatives and dealers affects the trade of the futures contracts in the market. Also, expertise and language barriers are other challenges as one party may not understand some technical language used in the contract.
