Introduction
Although a crucial element in the development of commerce over the last several years, the investment banking process can be, for those who are not continually involved in it, a rather mystifying ordeal. Analyzing a business’s financial performance and operations is the start of the investment banking process, in addition, the external market conditions are also taken into account. It is obvious that the important outcome and final stages of this process is to invest funds and raise capital.
Investment banks help their clients through each step of the process, leading to corporate mergers and takeovers or simply trading on the stock market. The process helps to understand how to invest and be successful while investing. In this paper I will analyze the investment banking process by describing this process including portfolio construction, describing the factors to consider when selecting among asset classes for an investment portfolio, describing the capital market instruments used in investment portfolio construction and lastly I will make general recommendations for the composition of an investment portfolio.
PORTFOLIO CONSTRUCTION
A portfolio must meet the future needs of the investor for capital. A well-maintained portfolio is vital to the investor giving him or her peace of mind. An investor can construct a portfolio to align to the investment strategies and goals. “Among the weakest sectors in the literature of investing are the elements involved in the structuring of a portfolio and the methods of implementing portfolio strategy” (Block, 1969, para. 1).
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Portfolio construction involve the following elements:
Return
Risk
Diversification
Volatility
Time horizon
The aforementioned terms are used regularly in portfolio strategy discussions. “For a basic theory of portfolio structuring, such elements must be rigorously defined, but at present they are used loosely and have different earnings to different users. Without the disciplines of both definition and quantification, they are too vague to be assembled into a formal, logical structure” (Block, 1969, para. 2).
In portfolio construction, diversification, investment performance, and asset allocation should be examined to achieve increase return.
ASSET CLASSES
“Don’t put all you eggs in one basket” is the principle behind asset allocation. An investor constructs a portfolio that is customized from several asset classes that will reflect the risk tolerance, objectives, and resources of the investor. Asset classes have individual risk and return profiles and react differently during a variety of economic events and cycles (Petroff, 2007, para. 3).
The basis for constructing a diversified portfolio is to combine a variety of asset classes (Petroff, 2007, para. 3).
“Investors make two types of decisions in constructing their portfolios. The asset allocation decision is the choice among these broad asset classes, while the security selection decision is the choice of which particular securities to hold within each asset class” (Bodie, Kane, & Marcus, 2008, p. 10).
The asset classes that should be considered in constructing a well diverse portfolio are:
(1) Cash – “Money market or savings accounts, which should consist of three to six months of living expenses” (Savage, 2007).
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(2) Fixed income – “Municipal bonds, corporate debt securities, U.S. Treasury securities, U.S. Government securities, and mortgage and asset-backed securities. These investments can provide the investor cash flow and may help take the edge off potential investment risk in the portfolio” (Savage, 2007).
(3) Equities – “Common stocks, convertible preferred stocks, and other equity investments, both domestic and international, that have potential for growth in capital and/or income. These securities may improve the long term return of the portfolio and provide reasonable liquidity” (Savage, 2007).
(4) Real estate – “Direct or indirect ownership of real property, real estate partnerships, REITs, and real-estate-based exchange-traded funds. Real estate typically has a low association with other types of asset classes and can diversify your overall portfolio allocation” (Savage, 2007).
(5) Alternative investments – “Hedge funds, private equity, and commodities. These investments provide a small connection with other traditional asset classes, which can diversify portfolio holdings” (Savage, 2007).
CAPITAL MARKET INSTRUMENTS
There are several capital market instruments used by investors to make a profit. These capital market instruments include: debentures, bonds, stocks, fixed deposits, T-bills, foreign exchange and many others. The aforementioned capital market instruments are responsible for producing funds for firms and sometimes national governments. Two basic capital market instruments are stocks and bonds. Stocks are used in three different markets as the capital market instrument: the virtual, the physical, and auction markets. Bonds are traded in a separate bond market, also known as a credit, debt or fixed income market (Mapsofworld.com, 2009).
In this market is also trade in debt securities, T-bills and debentures, which are more secured than others, however, they provide less return also.
“The capital market is the market for the issue and trading of long-term securities” (van den Berg, 2003).
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... to the investment portfolio. A portfolio consists of such investment, which can be marketed and traded. Suppose, if your portfolio contains ... Security Portfolio Management: Portfolio is a group of financial assets such as shares, stocks, bonds, debt instruments, mutual ... of the funds invested. Capital Growth: Portfolio management guarantees the growth of capital by reinvesting in growth ...
Risk factors are different for each capital market instrument. These instruments are intended to make a return on investment available for the investor which is the decision maker on the selection of the instrument. An investor should select these instruments once the proper research has been done. “The risk tolerance factor and the expected returns from the investment play a decisive role in the selection by an investor of a capital market instrument” (Mapsofworld.com, 2009).
CONCLUSION – GENERAL RECOMMENDATIONS
The investment strategy that can help to effectively target an investor’s objective would be to select asset categories instead of individual securities. With asset allocation, one would basically choose a combination of asset categories. An investor can decrease his or her dependence on the performance of any one class, by dividing his or her portfolio among various investment classes (New York Life, 2010).
Some assets experience declines and some assets experience growth.
“Age, family composition, marital status, children, tax bracket and employment status are all part of your investment profile” (Ventre, 2007).
For instance, a person aged 30 will have a longer investment timeline than a person aged 60. One who is a senior citizen would not be able to afford the long-term risk as a younger employee who is new to the working environment. “Older investors nearing retirement age should not risk the loss of capital associated with a high risk investment portfolio structure” (Ventre, 2007).
Tax planning and current income should also be taken into consideration. “The main thing to keep in mind when restructuring an investment portfolio is that it is an opportunity, not a punishment” (Ventre, 2007).
References
Block, F. (1969).
Elements of Portfolio Construction. _Financial Analysts Journal_,
_25_(3), 123-129. Retrieved from Business Source Complete database.
Bodie, Z., Kane, A., & Marcus, A.J. (2008).
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My sincere thanks to Mr. DEEPAK, Manager and Ms. SWATHI BASA, Assistant Manager for permitting me to pursue this project and for providing their valuable time, suggestions and support for completing my project work successfully. Their patience and invaluable guidance have proved to be very precious without which this project would not be completed. Acknowledgements are also due to all the other ...
_Essentials of Investments_ (7th ed.).
New
York, NY: McGraw-Hill, a business unit of the McGraw-Hill Companies, Inc.
Maps of World. (2009).
_Capital Market Instruments_. Retrieved from
http://finance.mapsofworld.com/capital-market/instruments.html
New York Life. (2010).
_Asset Allocation_. Retrieved from
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Better Portfolio Construction. _Forbes.com,_
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Savage, J. (2007, October 23).
The five asset classes to consider for a diversified
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van den Berg, B. (2003-2009).
_Understanding Financial Markets & Instruments_.
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