Today world economic has become more dynamic in an every minute and it is complicated. This due to so many changes happen around the world, such as increase the inflation, exchange rates are devaluated against to other currencies, economic downturns and biggest economies are collapse downs suddenly and corporate entities reducing their investment or else takeovers and mergers happen. In the above scenario is highlighting that how economic changes affect on investment. Therefore most of the economies (Governments) corporate entities (Companies and semi government institutions, NGO and INGO's) and peoples are invest their monies are very carefully in the several ways based on their objectives. In the every economy can be identified three type of finance. Those are;
Personal finance
Corporate finance
Public finance
The above main three areas drive any economy to develop it or turn down it. Therefore need to be analyzing that thoroughly and different manner which finance is made main impact on the growth of economy. When we consider the personal finance that is basic of economic unit (called house hold) that is made huge impact on any econmy because of their people who pay direct and indirect tax, made savings, contribute retirement plans, creating demands in the economy, develop the economy via human capital. Therefore personal finance is hold strong and important position in terms of the economy development. This assignment is going to give wider analyze of the personal finance and assignment focused on the following areas;
What is the personal finance and it importance
Analyze major personal finance decisions and select out of available choices
Effect of portfolio theory on it and risk
Evaluate and analyze portfolio performance
Making conclusion regarding overall assignment
1. What is personal finance?
Personal finance is the application of the principles of finance for individual or family when they make their monitory or economic decision. This discipline is addressing the way individuals or families received monies or income and ways that received income is spend under different categories of expenses. Under this topic is focused personal budgeting, different financial risk which will face in the future and future events of the life. Components of personal finance might include the following area;
Checking (maintaining current account)
Savings and FD accounts
Credit cards
Consumer loans
Investment in the stock market, retirement plan, social security benefits and insurance policies
Income tax managements
1.1. Importance of the personal financial planning
Its help to manage day today expenses
To increase physical assets such as lands, building, businesses
Grow the financial assets such as savings, stocks, unit trust, treasury bills and bonds
Building financial safety arising for future arising risk such as accident, disability, critical illness, death of family members.
1.2. Major personal financial decisions made by individuals
Majority of individual made the following finance decision in their day to day life
How much of amount of money spent on food
How much of amount of money spent on dress
Amount of money spent essential services health care, education, traveling, telephones, etc.
How much of amount of money on savings, insurances and investment
How much of amount of money spent on parties, weddings, funerals, etc.
1.3. Selection of the portfolio
For individuals and corporate sector is having different type of portfolio to invest and get return. These investments can be classified;
Based on the time - short term & long term
Based on Risk - Risk free and risk attached
The following types of investments are classified based on the risk that has organized from least risk up to highest risk of those investments.
Investment Type
Objective of the investment
Maximum Loss
Savings
Security and interest payment
Secure
Fixed Interest Bonds & Gilts
Rising bond markets, fixed interest payments
Initial Investment
Investment Trusts, Unit Trusts & OEICs
Rising investment prices, income from dividends
Initial Investment
Exchange Traded Funds (ETFs)
Rising index or sector prices
Initial Investment
UK & International stock
Rising share prices or dividends
Initial Investment
Securitized Derivatives including Covered Warrants
Rising or falling prices of the underlying financial investment
Initial Investment
Contracts for Difference
Rising or falling prices of the underlying financial investment
Initial Investment
By considering future growth, risk and return as well as top ten buys & sells (Note 1) decided to invest the following way;
Portfolio Choice - Stock
Price of shares
No of share
Value of shares
% Portfolio Mix
BP
£4.48
20,000
89,600
90%
Royal bank
£0.41
25,366
10,400.06
10%
Total
100%
Note 1
Portfolio Selection justification
BP represents Oil & gas industry that is having more growth possibility in the future because in future energy will be increased and they are looking & investing alternative energy sources.
Royal bank is attached with diversified group business therefore their future growth potential is very high because of synergies and strategic alliances can be align based on the market demand
Top ten equities buys and sells as at 02.11.2010
Rank
Top Ten Buys
Top Ten Sells
s1
DESIRE PETROLEUM
DESIRE PETROLEUM
2
LLOYDS BANKING GP
LLOYDS BANKING GP
3
BARCLAYS
GULF KEYSTONE PETR
4
XCITE ENERGY LTD
MAX PETROLEUM
5
GULF KEYSTONE PETR
ROYAL BK SCOT GRP
6
MAX PETROLEUM
BP
7
ROYAL BK SCOT GRP
BARCLAYS
8
BP
ENCORE OIL
9
XSTRATA PLC
XCITE ENERGY LTD
10
BERKELEY MINERAL R
VODAFONE GROUP
British Petroleum
Last Trade:
447.90 p
Day's Range:
447.05 - 452.80
Trade Time:
8:59AM
52wk Range:
296.00 - 639.60
Change:
6.55 (1.44%)
Volume:
5,776,611
Prev Close:
454.45
Avg Vol (3m):
35,315,300
Open:
449.10
Market Cap:
84.85B
Bid:
447.85
P/E (ttm):
7.96 x
Ask:
448.00
EPS (ttm):
56.70 p
1y Target Est:
508.00 p
Div & Yield:
8.68 (1.91%)
Royal Bank
Last Trade:
41.02 p
Day's Range:
39.82 - 42.99
Trade Time:
4:35pm
52wk Range:
38.80 - 58.10
Change:
2.73 (6.24%)
Volume:
261,792,592
Prev Close:
43.75
Avg Vol (3m):
75,270,600
Open:
42.73
Market Cap:
23.78B
Bid:
41.01
P/E (ttm):
N/A
Ask:
41.03
EPS (ttm):
N/A
1y Target Est:
54.03 p
Div & Yield:
N/A (N/A
1 GBP = 100 pence
1.4. Portfolio theory, risk & return
This theory is an investment approach that was introduced by Henry M. Markowitz who works for University of Chicago. This theory says the ways and facts that how investor needs take into account when he or she does an investment. This means need to consider risk & return of the investment. That theory further described risk can be reduced by using diversified portfolio strategy (Investor must invest their money on various portfolios rather than investing on one particular sector or business) .There are two types of Portfolio Strategies:
1.4. (A). Passive Portfolio Strategy:
A strategy that involves minimal expectation input, and instead relies on diversification to match the performance of some market index. A passive strategy assumes that the marketplace will reflect all available information in the price paid for securities.
1.4. (B). Active Portfolio Strategy:
A strategy that uses available information and forecasting techniques to seek a better performance than a portfolio that is simply diversified broadly. Moreover, there are three more types of Portfolios:
1.4. (B). 1. The Patient Portfolio:
This type invests in well-known stocks. Most pay dividends and are candidates to buy and hold for long periods. The vast majority of the stocks in this portfolio represent classic growth companies, those that can be expected to deliver higher earnings on a regular basis regardless of economic conditions.
1.4. (B). 2. The Aggressive Portfolio:
This portfolio invests in "expensive stocks" (in terms of such measurements as price-earnings ratios) that offer big rewards but also carry big risks. This portfolio "collects" stocks of rapidly growing companies of all sizes, that over the next few years are expected to deliver rapid annual earnings growth.
Because many of these stocks are on the less-established side, this portfolio is the likeliest to experience big turnovers over time, as winners and losers become apparent.
1.4. (B). 3. The Conservative Portfolio:
They choose stocks with an eye on yield, as well as earnings growth and a steady dividend history.
Based the above strategies selected active strategy under which aggressive strategy has been selected as a final decision.
1.5. Risk analysis
There two type of risk can be identified, those are;
Industry or company specific risk (Unsystematic risk)
The following major risk can be identified when analyze selected industry
Oil & gas industry risk
Financial service industry risk
Operational risk
Technical risk
Environmental & climate changes risk
Safety & health risk
Operational risk
Technical risk
Legal risk
Execution risk
Human skill risk (errors, collution, fraud)
Market risk (Systematic risk) - Market risk associated with the economic environment in which all the entities operates, so changes in interest rates, exchange rates, prices, taxation, etc. Market risk is measured by using the "beta value" of the investment. this risk is divided into two categories
Business risk - risk that with particular business activities undertaken by entity.
Financial risk - risk that resulting from existence of debt in the finance structure of the entity.
BP risk analysis
Alpha:
-0.0075
Beta:
0.8839
R2:
0.1968
Relative Performance:
-35.2791%
Relative Strength:
1.182
Retractment from maximum:
-30.9556%
Quarterly Volatility:
23.694%
Distance to 20 days moving average:
2.7903%
Distance to 200 days moving average:
-8.0015%
Royal bank risk analysis
Alpha:
-0.0002
Beta:
1.5402
R2:
0.3823
Relative Performance:
44.4388%
Relative Strength:
-0.3814
Retractment from maximum:
-28.4818%
Quarterly Volatility:
32.0762%
Distance to 20 days moving average:
-3.8715%
Distance to 200 days moving average:
-2.205%
Investment
Proportion
Beta
Weighted average
BP
0.90
0.8839
0.796
Royal bank
0.10
1.5402
0.154
Total weighted average beta
0.950
1>Beta value considers as less risky investment; Therefore according to situation portfolio weighted average risk (0.950 <1) has been reduced by using diversification
1.6. Consideration of efficient market hypothesis
Under this part is assumed that market information are available whenever investors. When we consider the current scenario most of the time information can be gathered freely or by paying subscription for any investor. Most of the time stock brokers or agents are having required information, as well as they are having wider experience in dealing with stock market activities. The following information sources are available to make decision to buy or sell shares;
Web sites
London stock exchange - www.londonstockexchange.com
Financial times - www.ftse.com
Yahoo finance - http://uk.finance.yahoo.com
Google finance - http://google.lk
London business school of risk analysis service (need pay subscription to get information's)
2. Portfolio performance Evaluating
2.1. Basic calculations
BP
Performance
Since Dec. 31st: growth of share price
445.45
Last Month: growth of share price
-25.7583%
Last Week: growth of share price
2.2026%
Reference Index:
1.4%
Correlation
FTSE100
Support
0.4475
Resistance
418.25
Since Dec. 31st: growth of share price
Bull market
Royal Bank
Performance
Last Price:
0.4216
Since Dec. 31st: growth of share price
44.3836%
Last Month: growth of share price
-11.4472%
Last Week: growth of share price
-6.6637%
Reference Index:
FTSE 100
Correlation
0.5518
Support
0.4238
Resistance
0.482
Since Dec. 31st: growth of share price
Bear
2.2. Tax consideration & calculation
The following tax affected on the investment
Stamp duty is apply when stocks transferring & applying rate is 0.5%
Brokers compliance levy
When the share are selling and if there is capital gain on investment apply 18%
Tax on dividend is apply 10%
2.3. Evaluate the impact of taxation upon personal investment choices
As decided to short term gained can be investing on shares therefore the base cost of shares can be calculated the following way;
Calculation of base cost
GBP
Cost of shares
xxx
Stamp duty 0.5%
xxx
Broker commission 1.65%
xxx
Broker compliance levy
xxx
Total base cost of shares
xxx
2.4. Comparative analysis (Calculation & Evaluation)
Base cost calculation
Description
BP
Royal bank
Cost of shares
89,600.00
10,400.06
Stamp duty (0.5%)
448.00
52.00
Brokers commission (1.65% per transaction )
1,478.40
171.60
Brokers compliance levy
5.00
5.00
base cost of shares
91,531.40
10,628.66
2.5. Evaluate personal portfolio performance
Portfolio performance is evaluated based on the market price. When the market prices up at that time sell the entire share within given time duration and expect to capital gain.
3. Portfolio Evaluation
3.1. Evaluate personal portfolio performance
In light of the subject's importance to fund sponsors and investment managers alike, we want to consider the primary questions that performance evaluation seeks to address. In discussing performance evaluation we shall use the term "account" to refer generically to one or more portfolios of securities, managed by one or more investment management organizations. Thus, a tone end of the spectrum; an account might indicate a single portfolio invested by a single manager. At the other end, an account could mean a fund sponsor's total fund, which might involve numerous portfolios invested by many different managers across multiple asset categories. In between, it might include all of a fund sponsor's assets in a particular asset category or the aggregate of all of the portfolios managed by an investment manager according to a particular mandate. The basic performance evaluation concepts are the same, regardless of the account's composition. With the definition of an account in mind, three questions naturally arise in examining the investment performance of an account:
1. What was the account's performance?
2. Why did the account produce the observed performance?
3. is the account's performance due to luck or skill?
In somewhat simplistic terms, these questions constitute the three primary issues of Performance evaluation. The first issue is addressed by performance measurement, which calculates rates of return based on investment-related changes in an account's value over specified time periods. Performance attribution deals with the second issue. It extends the results of performance measurement to investigate both the sources of the account's performance relative to a specific investment benchmark and the importance of those sources. Finally, performance appraisal tackles the third question. It attempts to draw conclusions concerning.
To many investors, performance measurement and performance evaluation are synonymous. However, according to our classification, performance measurement is a component of performance evaluation. Performance measurement is the relatively simple procedure of calculating returns for an account. Performance evaluation, on the other hand, encompasses the broader and much more complex task of placing those investment results in the context of the account's investment objectives. Performance measurement is the first step in the performance evaluation process. Yet it is a critical step, because to be of value, performance evaluation requires accurate and timely rate 7 of-return information. Therefore, we must fully understand how to compute an account's returns before advancing to more involved performance evaluation issues.
3.1.1. Performance measured without intra period external cash flows
The rate of return on an account is the percentage change in the account's market value over some defined period of time (the evaluation period), after accounting for all external cash flows. (External cash flows refer to contributions and withdrawals made to and from an account, as opposed to internal cash flows such as dividends and interest payments.) Therefore, a rate of return measures the relative change in the account's value due solely to investment-related sources, namely capital appreciation or depreciation and income. The mere addition or subtraction of assets to or from the account by the account's owner should not affect the rate of return. Of course, in the simplest case, the account would experience no external cash flows. In that situation, the account's rate of return during evaluation period t equals the market value (MV1) at the end of the period less the market value at the beginning of the period (MV0), divided by the beginning market value.2 That is,
Rt = (MV 1 - MV0)/ MV0
External cash flows are a fact of investment management. Fund sponsors occasionally
(and in some cases frequently) add and subtract cash to and from their managers' accounts. These external cash flows complicate rate-of-return calculations. The rate-of-return algorithm must deal not only with the investment earnings on the initial assets in the account, but also with the earnings on any additional assets added to or subtracted from the account during the evaluation period. At the same time, the algorithm must exclude the direct impact of the external cash flows on the account's value. An account's rate of return may still be computed in a straightforward fashion if the external cash flows occur at the beginning or the end of the measurement period when the account is valued. If a contribution is received at the start of the period, it should be added to (or, in the case of a withdrawal, subtracted from) the account's beginning value when calculating the account's rate of return for that period. The external cash flow will be invested alongside the rest of the account for the full length of the evaluation period and will have the same investment related impact on the account's ending market value and, hence, should receive a full weighting. Thus, the account's return in the presence of an external cash flow at the beginning of the evaluation period should be calculated as
Rt = MV 1 - (MV0 +CF)/ MV0 + CF
If a contribution is received at the end of the evaluation period, it should be subtracted from (or, in the case of a withdrawal, added to) the account's ending value. The external cash flow had no opportunity to affect the investment-related value of the account, and hence, it should be ignored;
Rt = (MV 1 - CF) - MV0 / MV0
The ease and accuracy of calculating returns when external cash flows occur, if those flows take place at the beginning or end of an evaluation period, lead to an important practical recommendation: Whenever possible, a fund sponsor should make contributions to, or withdrawals from, an account at the end of an evaluation period (or equivalently, the beginning of the next evaluation period) when the account is valued. In the case of accounts that are valued on a daily basis, the issue is trivial. However, despite the increasing prevalence of daily valued accounts, many accounts are still valued on an audited basis once a month (or possibly less frequently), and the owners of those accounts should be aware of the potential for rate-of-return distortions caused by intra period external cash flows. What does happen when external cash flows occur between the beginning and the end of an evaluation period? The simple comparison of the account's value relative to the account's beginning value must be abandoned in favour of more intricate methods
3.1.2 Total Rate of Return
Interestingly, widely accepted solutions to the problem of measuring returns in the presence of intra period external cash flows are relatively recent developments. Prior to the 1960s, the issue received little attention, largely because the prevailing performance measures were unaffected by such flows. Performance was typically measured on an income-only basis, thus excluding the impact of capital appreciation. For example, current yield (income-to-price) and yield-to-maturity were commonly quoted return measures. The emphasis on income-related return measures was due to several factors:
Portfolio management emphasis on fixed-income assets
Particularly in the low-volatility interest rate environment that existed prior to the late 1970s, bond prices tended to be stable. Generally high allocations to fixed-income assets made income the primary source of investment-related wealth production for many investors.
Limited computing power
Accurately accounting for external cash flows when calculating rates of return that include capital appreciation requires the use of computers. Access to the necessary computing resources was not readily available. The income-related return measures were simpler and could be performed by hand.
Less competitive investment environment
Investors, as a whole, were less sophisticated and less demanding of accurate performance measures. As portfolio allocations to equity securities increased, as computing costs declined, and as investors (particularly larger institutional investors) came to focus more intently on the performance of their portfolios, the demand grew for rate-of-return measures that correctly incorporated all aspects of an account's investment-related increase in wealth. This demand led to the adoption of total rate of return as the generally accepted measure of investment performance.
Total rate of return measures the increase in the investor's wealth due to both investment income (for example, dividends and interest) and capital gains (both realized and unrealized). The total rate of return implies that a dollar of wealth is equally meaningful to the investor whether that wealth is generated by the secure income from a 90-day Treasury bill or by the unrealized appreciation in the price of a share of common stock. Acceptance of the total rate of return as the primary measure of investment performance was assured by a seminal study performed in 1968 by the Bank Administration Institute (BAI). The BAI study (which we refer to again shortly) was the first comprehensive research conducted on the issue of performance measurement. Among its many important contributions, the study strongly endorsed the use of the total rate of return as the only valid measure of investment performance. For our purposes, henceforth, it will be assumed that rate of return refers to the total rate of return, unless otherwise specified
3.1.3 The Time-Weighted Rate of Return
We now return to considering the calculation of rates of return in the context of intra period external cash flows. To fully appreciate the issue at hand, we must think clearly about the meaning of "rate of return." In essence, the rate of return on an account is the investment-related growth rate in the account's value over the evaluation period. However, we can envision this growth rate being applied to a single dollar invested in the account at the start of the evaluation period or to an "average" amount of dollars invested in the account over the evaluation period. This subtle but important distinction leads to two different measures: the time-weighted and the money-weighted rates of return. The time-weighted rate of return (TWR) reflects the compound rate of growth over a stated evaluation period of one unit of money initially invested in the account. Its calculation requires that the account be valued every time an external cash flow occurs. If no such flows take place, then the calculation of the TWR is trivial; it is simply the application of Equation 12-1, in which the change in the account's value is expressed relative to its beginning value. If external cash flows do occur, then the TWR requires computing a set of sub period returns (with the number of sub periods equaling one plus the number of dates on which external cash flows occur). These sub period returns must then be linked together in computing the TWR for the entire evaluation period.
3.2. Evaluate the impact of taxation upon personal investment choices
Disposal proceeds
xxx
Brokers commissions - 1.65%
xx
Compliance charge
xx
(xx)
Net proceeds
xxx
Deduct Base cost
(xxx)
Capital gain
xxx
Tax on capital gain
xxx * 18%
Deduct - Monthly PAYE
(4,083)
Net tax payable on capital gains
xxx
Note: PAYE can offset with capital gain. Last 7 months PAYE £4,083 (583.33 * 7)
