‫المملكة العربية السعودية‬

Kingdom of Saudi Arabia ‫وزارة التعليم‬

Ministry of Education ‫الجامعة السعودية اإللكترونية‬
Saudi Electronic University

College of Administrative and Financial Sciences

Assignment 2
INVESTMENTS (FIN403)

Course Name: Investments Student’s Name:

Course Code: FIN403 Student’s ID Number:
Semester: 1st CRN: 11752
Academic Year:2023-24-Ist

For Instructor’s Use only

Instructor’s Name: Dr. Muath Alolayan
Students’ Grade: 00 / 10 Level of Marks: High/Middle/Low

General Instructions – PLEASE READ THEM CAREFULLY

 The Assignment must be submitted on Blackboard (WORD format only) via the
allocated folder.
 The due date for Assignment 1 is 30/10/2023.
 Assignments submitted through email will not be accepted.
 Students are advised to make their work clear and well-presented, marks may be
reduced for poor presentation. This includes filling in your information on the
cover page.
 Students must mention the question number clearly in their answers.
 Late submissions will NOT be accepted.
 Avoid plagiarism, the work should be in your own words, copying from students
or other resources without proper referencing will result in ZERO marks. No
exceptions.
 All answers must be typed using Times New Roman (size 12, double-spaced)
font. No pictures containing text will be accepted and will be considered
plagiarism).
 Submissions without this cover page will NOT be accepted.
 Assignment 2 Questions: Week 5,6 and 7

Assignment 2
Submission Date by students: 30/10/2023
Place of Submission: Students Grade Centre via blackboard.
Weight: 10 Marks

Assignment Purposes/Learning Outcomes:

CLO-3. Demonstrate investment arrangements as part of the process for implementing an

investment strategy. ( PLO-2.2)
CLO-4. Demonstrate the valuation methods used for valuation of the common forms of debt,
equity, property and derivative securities.( PLO-2.3).
Assignment Question(s): (Marks 10 )

Q-1. Explain the efficient market hypothesis and the different forms it can take. Relate the
efficient market hypothesis to fundamental and technical analyses. ( 2.5 Marks )

Q-2. Explain the relationship between the income statement, balance sheet, and statement of cash
flows. Break down and analyse ratios in six major categories. Explain how the ratios can be
applied to a specific company. ( 2.5 Marks )

Q-3. Describe the characteristics of other forms of fixed-income securities such as preferred stock,
money market funds, etc. Develop an investment strategy for investing in bonds. ( 2.5 Marks )

Q-4. Explain the differences among various concepts of yield such as yield to maturity, yield to
call, and anticipated realized yield. Describe the techniques for anticipating changes in interest
rates. ( 2.5 Marks )

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Answer:

Q1

According to the Efficient Market Hypothesis (EMH), it is difficult to consistently generate

above-average profits via research or trading methods since financial markets effectively integrate and

reflect all relevant information. The fundamental presumption is that all investors have rational

responses to the same information and have access to it. The foundation of the efficient market

hypothesis (EMH) is the notion that investors cannot easily get an advantage by examining past price

data or fundamental knowledge if information has already been included into asset prices.

There are three variations of EMH: mild, semi-strong, and powerful. The theory, in its weak

version, asserts that all prior trading data, including prices and quantities traded, is already included into

current pricing. This is expanded to encompass all public information in semi-strong form, which covers

both historical data and publicly accessible basic information (Ţiţan, 2015). Finally, robust shape

According to EMH, asset prices properly represent all available information, including insider

knowledge, hence it is impossible for insider knowledge to provide an advantage.

Evaluating a security's underlying worth via a review of financial statements, economic

variables, and industry trends is known as fundamental analysis. The Efficient Market Hypothesis

(EMH) states that in a semi-strong form efficient market, prices already represent all available

information, hence fundamental research should not consistently result in gains. However, in order to

forecast future price fluctuations, technical analysis looks at past trade volumes and price patterns.

Technical analysis is deemed ineffective under the Efficient Market Hypothesis (EMH), especially in a
strong form efficient market where past price patterns and trade signals are presumed to have already

been factored into current prices (Hamid et al., 2017). Essentially, the Efficient Market Hypothesis

(EMH) posits that in completely efficient markets, it may be difficult for both fundamental and technical

studies to continuously beat the market in the long run.

Q2

Together, the income statement, balance sheet, and statement of cash flows are the three essential

financial statements that provide a thorough picture of the condition and performance of a company's

finances. These claims are related to one another and provide distinct perspectives on various facets of

the industry. The income statement provides a breakdown of a business's earnings for a certain time

frame. To calculate net income, certain expenses are subtracted from revenues at the beginning. The

balance sheet shows the company's assets, liabilities, and shareholders' equity and gives a moment in

time view of its financial situation (Hasanaj, P., & Kuqi, 2019). The cash movement into and out of the

business is monitored by the statement of cash flows, which divides operations, investments, and finance

into three categories.

Ratios are invaluable tools for financial analysis, allowing stakeholders to gain deeper insights

into a company's performance. Here are six major categories of ratios:

1. Liquidity Ratios: These assess a company's short-term ability to meet its obligations. The

current ratio, calculated by dividing current assets by current liabilities, and the quick ratio,

which considers only the most liquid assets, are common examples.

2. Profitability Ratios: These evaluate a company's ability to generate profits. The net profit

margin, calculated by dividing net income by revenue, and Return on Equity (ROE),

computed by dividing net income by shareholders' equity, are key indicators.

 3. Solvency Ratios: These measure a company's long-term financial viability and its ability to

cover long-term obligations. The debt-to-equity ratio, which gauges the proportion of debt to

equity, and the interest coverage ratio, which assesses the company's ability to meet interest

payments, fall into this category.

4. Efficiency Ratios: These assess how efficiently a company uses its assets and manages

resources. Examples include the inventory turnover ratio, calculated by dividing the cost of

goods sold by average inventory, and the accounts receivable turnover ratio, which gauges

how quickly a company collects its receivables.

5. Market Ratios: These relate a company's stock price to its earnings or other financial metrics.

The price-to-earnings (P/E) ratio, obtained by dividing the market price per share by earnings

per share, and earnings per share (EPS) are commonly used market ratios.

6. Cash Flow Ratios: These evaluate a company's cash generation and management. The

operating cash flow ratio, computed by dividing cash flows from operating activities by current

liabilities, and the free cash flow to equity, which assesses cash available to equity shareholders,

are examples.

Utilizing financial information from the company's accounts, these ratios must be applied to a

particular business. To compute net profit, for example, you would use Apple Inc.'s income statement;

for total assets and liabilities, you would use the balance sheet; and for cash flow information, you

would use the statement of cash flows. You may learn more about the company's efficiency, competitive

position, and financial health by comparing these numbers and doing ratio calculations. To get useful

insights into the success of the firm, these ratios should be interpreted in light of the economic and

industrial environment.
Q3

Beyond conventional securities, fixed-income instruments provide a wide range of investment

opportunities. Preferred stock is one such substitute; it symbolizes a share of ownership in a business but

usually comes with a predetermined dividend. There is some protection since preferred investors have a

larger claim on assets than ordinary stockholders (Swammy, 2017). They do not, however, have the

same voting rights as ordinary stock. These securities are appealing to income-seeking investors because

of their constant dividend characteristic, which is consistent with their fixed-income nature.

Another kind of fixed-income product that offers a reasonably secure and liquid investing choice

is money market funds. These funds make investments in short-term financial instruments that provide

stability and liquidity, such commercial paper and Treasury bills (Ashford, 2023). The net asset value

(NAV) of money market funds is intended to remain constant at $1 per share; nonetheless, the returns

are often lower than those of other fixed-income instruments. Money market funds are often used by

investors as a short-term holding option for cash while they look for other investment possibilities or to

preserve capital.

An investor's financial objectives, time horizon, and risk tolerance should all be taken into

consideration when developing an investing plan for fixed-income instruments, including bonds. To

disperse risk, one popular strategy is to build a diversified bond portfolio with a mix of corporate,

municipal, and government bonds (Fabozzi & Fabozzi, 2021). An essential component of a bond

investing strategy is duration management. Bond duration is a measure of how sensitive a bond is to

changes in interest rates. Investors may modify the duration of their bond portfolios to reflect their view

for interest rates. Investing in bonds with higher yields, such corporate bonds or debt from developing

markets, might be a strategy for income seekers, but there may be more risk involved.
 The state of the economy should be taken into account by investors when developing a fixed-

income investing plan. Investors may need to be more cautious and even take on more risk in an

environment with low interest rates, like the one that has prevailed internationally in recent years, in

order to generate acceptable returns (Fabozzi & Fabozzi, 2021). Additionally, investors may make well-

informed judgments about whether to purchase or sell fixed-income assets by keeping up to date on

macroeconomic developments, central bank policies, and market circumstances. Creating a robust fixed-

income portfolio requires, all things considered, taking a well-rounded and diversified strategy that takes

into account the nature of the fixed-income securities as well as the economic environment.

Q4

In the realm of fixed-income instruments, yield is a crucial idea as it denotes the investor's return

on investment. There are several definitions of yield, each with unique attributes. A popular indicator

called yield to maturity (YTM) shows the overall return an investor might anticipate if they hold a bond

until it matures, taking into account both interest income and any possible capital gains or losses

(Kalotay, 2017). YTM makes the assumption that the bond will be kept until it matures and that all

principal and coupon payments will be paid on time.

On the other hand, bonds with a callable feature—which enables the issuer to redeem the bonds

before to their planned maturity date—should be considered in relation to Yield to Call (YTC). The

yield that an investor would get if the bond's issuer called it before it matures is determined by YTC

(Smith, 2005). This measure takes into account the possibility of an early redemption and the related call

premium or penalty.

An investor's expectations on changes in interest rates are included into the idea of Anticipated

Realized Yield (ARY). It entails calculating the yield using projected shifts in interest rates as well as
the possibility of reinvesting coupon payments (Kalotay, 2017). By taking into account the investor's

expectations for future market circumstances, ARY seeks to produce a more accurate estimate of a

bond's return while acknowledging the dynamic nature of interest rates.

Bond investors must anticipate interest rate changes since they have an effect on the value of

their current bonds. Investors may manage interest rate risk by using a variety of strategies. One popular

tactic is duration management, which is modifying a bond portfolio's term to correspond with an

investor's anticipated interest rate changes. The duration of a bond indicates how sensitive its price is to

changes in interest rates (Smith, 2005). An investor may shorten the length of the portfolio in order to

minimize possible losses if they anticipate an increase in interest rates. On the other hand, if interest

rates are dropping, an investor may decide to lengthen the portfolio's duration in order to take advantage

of future capital gains.

Furthermore, being up to date on market sentiment, central bank policies, and economic data

may provide important insights into where interest rates are headed. Another method is to keep an eye

on the yield curve, which shows the yields of bonds of comparable quality plotted against their

maturities. Shifts in the market expectations for interest rates may be indicated by changes in the yield

curve. Investors may better position themselves to predict and manage fluctuations in interest rates by

combining these tactics and being aware of economic issues.

 References

Ţiţan, A. G. (2015). The efficient market hypothesis: Review of specialized literature and empirical

research. Procedia Economics and Finance, 32, 442-449.

Hamid, K., Suleman, M. T., Ali Shah, S. Z., & Imdad Akash, R. S. (2017). Testing the weak form of

efficient market hypothesis: Empirical evidence from Asia-Pacific markets. Available at SSRN

2912908.

Hasanaj, P., & Kuqi, B. (2019). Analysis of financial statements. Humanities and Social Science

Research, 2(2), p17-p17.

Swammy, S. (2017). Preferred Stock. The Capital Markets: Evolution of the Financial Ecosystem, 286-

295.

Ashford, K. (2023, June 1). What is a money market fund? Forbes

Advisor. https://www.forbes.com/advisor/investing/what-is-money-market-fund/

Fabozzi, F. J., & Fabozzi, F. A. (2021). Bond markets, analysis, and strategies. MIT Press.

Kalotay, A. (2017). Creating a live yield curve in the illiquid muni market. The Journal of Fixed

Income, 27(1), 84-91.

Smith, W. S. (2005). Bond Selection for Managed Portfolios. Journal of Business Finance &

Accounting, 32(1‐2), 389-413.