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TỔNG QUAN VỀ RỦI RO VÀ RỦI RO TRONG KINH DOANH

TỔNG QUAN VỀ RỦI RO VÀ RỦI RO TRONG KINH DOANH

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Investment Analysis & Portfolio Management. MBA II. Lahore School of Economics. Spring 2014. Dr. Sohail Zafar.

LECTURE 1 2 3

Since the word “investment” is used in different contexts and in each context it has a different

meaning therefore it is deemed important that right from the beginning it is clarified as to

what is meant by “investment” in this course. This course is about investment in securities

market. It is not a course about investment in corporate assets such as NWC and FA; as

typically these decisions are called investing decisions in corporate finance. This course is

not about investment in an a country’s or province’s infrastructure such as roads, bridges,

schools, hospitals, etc; as this is the meaning attached to the word investment by economists.

This course is not about foreign direct investments as depicted by foreign entities building

factories in this country. The course may have some relevance for foreign portfolio

investment by foreigners who may be contemplating investing in securities markets in

Pakistan. Both individual Investors as well as professional money managers in Pakistan

working for institutional investors such as mutual funds, commercial banks, insurance

companies, investment banks, pension funds, etc, are expected to benefit most from this

course.

THREE QUESTIONS FACED BY INVESTORS

Any person or institution contemplating investments in securities markets must face three

questions:

1. What to buy?

2. What combination to buy?

3. When to buy?

Let us treat these questions in some detail in this lecturer; the rest of the course is also about

the further details, derivations, and analytical skills needed to answer these 3 questions.

Question One: What to Buy (or Sell):

Common sense answer to the question “what to buy or what to sell” is: buy those (or sell

those) securities that would make you wealthier. But more correctly the answer depends on

your position in the market. If you want to take long position in a security then answer is :

buy those securities that would give positive rate of return (ROR), and thus would increase

your wealth. In other word buy those shares whose price is likely to increase. But if you

want to take short position then answer is short sell those securities that are expected to give

negative rate of return; that is , if (ending price – beginning price) / beginning price gives

negative answer. Or in other words whose price is likely to fall, doing so would increase your

wealth. Wealth after one year = Wealth now (1 + ROR). This can be written as:

= Wo (1 + ROR). Note: ROR is written in fraction, say 10% is written as 0.1

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Investment Analysis & Portfolio Management. MBA II. Lahore School of Economics. Spring 2014. Dr. Sohail Zafar.

Selling is the flip side of buying; you are in the market as investor as long as you have bought

some shares or other securities and have not sold them as yet. It is called having a long

position in that security. On other hand if the shares you had bought earlier have now been

sold then you have “closed your long position”, or simply you are out of the market. Also if

you initiated your entry in the market by selling some shares which you did not have but you

had borrowed the shares from a broker to sell them, then it is called short selling , or simply

you have short position in the market. You have an open short position as long as you do not

close your short position by buying the same shares and returning them to the lending broker.

It is necessary that short position is ultimately closed, called short covering, because the

share you initially sold were not owned by you, in fact you had borrowed those shares from

the broker and sold them in the market in the hope of making profit by buying these shares

when share price would go down in future. So in short selling you borrow shares and sell

them first and buy later; and you have an open short position in the market until you buy

the shares and return them to the broker from whom you had borrowed them.

Long Position

For example you bought share of a company at Rs 100 and it is expected to give 10% ROR

in one year so your wealth after one year is going to be :

= 100 (1 + 0.1). Please note 10% ROR was written as 0.1 in decimal points.

= 110 Rs. In this case 10% positive ROR has increased your wealth from 100 to 110 Rs.

Similarly if its current price is 100 and after one year expected price is 93, then expected

ROR = (ending price – beginning price)/ beginning price

= (93 - 100) / 100 = -0.07 or - 7%

As expected ROR from this share is negative 7% and if you took long position in it, then

after one year your wealth would be:

= 100 ( 1 + -0.07)

= 93 Rs. Negative ROR would decrease your wealth from 100 to 93 Rs.

Short Position

It is possible to increase your wealth as investor by investing in a share which is expected to

give negative ROR and whose price is expected to fall during the next year. It can be done by

short selling such a share. In short selling you borrow the share and sell it in the market at

current high price; and then hope its price would fall and you would buy it at that low price

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LECTURE 1 2 3 Since the word "investment" is used in different contexts and in each context it has a different meaning therefore it is deemed important that right from the beginning it is clarified as to what is meant by "investment" in this course. This course is about investment in securities market. It is not a course about investment in corporate assets such as NWC and FA; as typically these decisions are called investing decisions in corporate finance. This course is not about investment in an a country's or province's infrastructure such as roads, bridges, schools, hospitals, etc; as this is the meaning attached to the word investment by economists. This course is not about foreign direct investments as depicted by foreign entities building factories in this country. The course may have some relevance for foreign portfolio investment by foreigners who may be contemplating investing in securities markets in Pakistan. Both individual Investors as well as professional money managers in Pakistan working for institutional investors such as mutual funds, commercial banks, insurance companies, investment banks, pension funds, etc, are expected to benefit most from this course. THREE QUESTIONS FACED BY INVESTORS Any person or institution contemplating investments in securities markets must face three questions: 1. What to buy? 2. What combination to buy? 3. When to buy? Let us treat these questions in some detail in this lecturer; the rest of the course is also about the f ...
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