Equity Stock Investments Analysis

This assignment delves into the world of equity stock investments. It analyzes the benefits of investing in equity stocks, highlighting their high liquidity, ease of diversification across industries, and potential for returns. However, it also acknowledges the inherent risks associated with equity investments and encourages a balanced approach to portfolio construction.

HIGH-RISK INVESTMENT
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1. Investors’ attraction towards high risk investment:
Risks stand for the chance that the actual return of the investment would differ from the
anticipated return. It is the possibility of losing the potential investment and in certain cases loses
the capital as well (Dorfman & Cather, 2012). Higher returns are related with higher risks and
vice versa. So the risk/return trade-off would strike for a balance between the desires for the
lowest possible risk and the highest plausible return. The scenario has been depicted below by
the risk/return trade-off presented in the figure below showing a higher standard deviation
indicates for a higher risk along with higher plausible return.
Figure 1: Relation between risk and return
Source: (Jacque, 2013)
It is a misconception that higher risk would yield higher returns. According to the risk/return
trade-off higher risk has bearings with the possibility of higher returns but there is no such
guarantee. This is because higher potential returns would implicate higher potential losses
(Jacque, 2013). The risk-free rate of return is depicted by the US Government Securities as the
instrument stands little chance of default. If the government securities offer a return of 6%, it
indicates that there are no such risks and the instrument could yield a return of 6%. It is noted
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that the index fund which generally gives a return for 12% contains substantial risk as it return
varies every year. It is supposed the investors in this case are exposed to a greater risk owing to
financial volatility though it carries a comparative higher return than the government securities
(Oikonomou, et al., 2012). The additional return out of the risk premium has been 6% (12% -
6%). So the risk appetite of the investors varies from individual to individual based on his goals,
income and background.
There are certain factors that determine the preferences of the investors such as:
 Market trends–The market is supposed to repeat its performance and the investors need
to understand the implications of the different asset classes that has left its impression in
the past.
 Risk appetite – The risk taking capability of the investors varies from person to person.
It is very much influenced by the financial responsibilities, goals in life and personality
of the individual investors to make a suitable investment decision (Kimyagarov &
Shivdasani, 2013).
 Investment duration –It depends on the nature of the investor that how long he would be
keeping the investment in the market. It seems longer the duration of the investment the
better would be the return as the risk element reduces substantially.
 Surplus of investments –The investible surpluses are supposed to play a crucial factor in
selection of the different asset classes because of the differentiation of the minimum
investment amount along with its risk and return (Erkens, et al., 2012).
 Needs of investment –It is unto the desire of the investor to fulfil on his goals in life and
invest in a systematic way to achieve the same.
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 Returns –The expected return is a crucial factor and is directly related to the investment
choice (Lins, et al., 2011). For instance, a young investor would be opting for risky
investments like equities as he has the risk taking ability and longer duration to
neutralise the market risks. Again an aged investor on the verge of retirement would
avoid equity and look for debt instruments like government securities which would offer
a safe haven to his investment for a shorter period.
2. Risks associated with exchange-traded derivatives:
Exchange traded investments like futures and options as an investment asset are considered to be
riskier on likes with other instruments like equities and currencies. The US Treasury bond
futures contract are considered to be one of the most traded investment across the globe but the
prices of the futures contract are volatile. In lines with equities, the futures and options too, carry
more risks than the fixed income investments. The trading futures are considered to be quite
riskier due to the leverages associated to it. Leverages are the ability to margin investments on
the basis of fraction of its total value (Arnold, 2014).In case of stocks the maximum leverage
could go unto 50% while that of futures it might raise unto 90%-95%. It implies that the investor
can invest in the futures contract by investing 10% of the actual value of the contract.
The leverages intensify the consequences of the changes in prices in respect to relatively smaller
changes in prices to represent considerable profits or losses (Coles, et al., 2012). The
involvement of the leverages in future trading has possibility to sustain greater losses than the
initial investment. Contrarily, the futures could also come up with substantial returns as the risks
involved with it depends on the process in which the futures contract are being traded. The
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futures traders could handle the additional leverage quite wisely with the relevance of the
superior level of financial management. This could be done by using the prudent stop-loss orders
by limiting the potential losses (Lins, et al., 2011). The futures trader does not over-margin
themselves but tries to maintain uncommitted investment capital for the protection of the
investments.
3. Challenges and suggestions to regulate a complex global financial firm:
Globalisation has made the financial market more complex. The global financial firms are facing
different political as well as geographical and economic diversity. The availability of versatile
financial products into the global financial market is demanding a stricter and dynamic
regulatory environment to protect the interest of the stakeholders of the financial market
(Chandra, 2011). In absence of global government followings are the key challenges to regulate a
global financial firm in this era of globalisation:
Transparency – The financial products must be bringing into the regime of the monitoring and
being regulated. The contracts of financial products shall not escape standardization and should
be bring into the regulatory net. Over-the-Counter (OTC) contracts needs to be brought into the
line of technical trading platform so that the systematic risk can be avoided (Hill, et al., 2013).
Macro-prudential regulation – The financial firms should be regulated as a whole; the risk
shall be handled and managed taking into consideration of the aggregate adverse consequences.
The financial firms should be governed at the systematic level rather than taking care of an
individual institution (Erkens, et al., 2012). The different financial institutions should be bringing
into an identical reporting requirements and governing system.
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Co-ordination – with the rise of globalisation the financial institutions are now operating into
the different geographical regions and abide to the different regulatory systems. The Co-
ordination between the different regulators is the key to mitigate the systematic risk of the
financial market (Kramer, 2012). The uniform reporting requirements and sharing of information
between the regulatory authorities is necessary to identify the risk at the earliest and to manage it
at the aggregate level.
4. Analysis the Ethical Violation by JPMorgan Chase:
The JP Morgan Chase is one of the biggest names in the financial market of US. The company is
engaged not only into the ordinary consumer banking operation but also offering various
financial services. Before 2008 crisis in the US the large banks like JP Morgan Chase were
engaged into the business of “Mortgage Securitization”. The banks then sold those Mortgages in
the form of underlying securities to the investors (Brigham & Houston, 2011).
JPMorgan Chase has sold these mortgage backed securities, many of which were bad loans. The
investors have purchased those mortgage backed securities considering that they are investing
into a lower risk securities. However, the JPMorgan Chase has cheated the investors by showing
them the high value of the backed mortgage security. The company has been fined $13 billion by
the US government.
The act of JPMorgan Chase has affected the US economy adversely. As the investors thought
that they are investing into AAA rating securities which were turned out junk. The various
investors have suffered huge losses (Coles, et al., 2012). The faith of the investors into the US
financial market has declined. Over statement of the value of the mortgages not only affected
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the investors by huge losses but also it is an eye opener for the regulatory authority as well. The
placement of a rigid law is necessary to avoid such practices. The “due diligence” has to be
conducted in the manner that should be independent and qualified enough to mitigate such
situations of crisis (Titman, et al., 2015).
5. Implications for trading in high risk investments:
In 2013, a federal jury in New York returned a prosecution of two senior executives from JP
Morgan, Javier Martin-Artajo and Julien Grout. They were held responsible for the valuation of
the credit derivatives that the financial institution bought resulting in a loss for $6 billion. Both
of them were charged with conspiracy, false entries in the banking records and false statement to
the Securities and Exchange Commission. The public notion goes along with the verdict as it is
admitted of a violation, the aspect of corporate criminal investigation brought up in the scenario
is totally justified (Jacque, 2013). The charges filed in this case would supposedly cause a
significant damage to the reputation of the executive withholding his lucrative career from the
financial glamour of the banking industry.
The management of the organisation also suffered a huge blow as most of its senior management
got removed or charged with criminal conspiracies for contemplating financial misconducts. The
ratings of the institution fell drastically and it was charged with a hefty fine worth $2 billion for
engaging in financial scandal. The implications were also felt on the brokers of JP Morgan Chase
involved in high risk investments. The organisation expelled its head of the government debt
trading desk and other employees intensifying the complexity of the banking compliance as the
management entered into disagreement with such parties. The traders wanted to enhance the size
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of the reserves which the management opposed owing to violation of the internal banking
processes (Coles, et al., 2012). These steps were to be followed as the crisis engulfed the
scenario totally and the institution was not in a mood to endanger its brand reputation and stake
in the financial market.
6. Scenario where high risk Investment would be beneficial:
Investment in high risk investment could be beneficial if an investor ready to hold the investment
in long run. The holding period of an investment is crucial. The equity stocks are termed to be
the more risky than the other form of securities, although has more liquidity. An investor desired
to take high risk can opt for the equity stock investment (Moyer, et al., 2011). A perfect diverse
portfolio of the equity stock not only provides the good return on investment but also it is
proving out to be the wealth creation in long run. The risk associated with the equity stocks can
also be mitigated in long run. Some of the benefits of investing in equity stocks are:
Increase wealth - The history the stock market is suggested that the equity shares have increased
in value in long run, even though the stock market crashes various times. The equity stock may
fluctuate but it is prove to be beneficial in long term (Lasher, 2013).
Regular Income - Equity shares generally generate income in the form of dividends. Holding
the equity in long run can out to be more beneficial than any other form of investment. A regular
income and wealth creation both are achievable (Titman, et al., 2015).
High Liquidity - The equity stock is highly liquid investment tool. The equity stock can be
termed to be the next cash option in the hand of investors. The equity stock can be easily buy,
sell and lien.
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Diversification – An investor can achieve diversification by investing into the equity stock. A
portfolio of investment in different industry can be easily achieved by the investor (Madura,
2012). The industry specific risk can be mitigated through well diversify investment.
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