Introduction
Diversification of portfolios attempts to reduce systemic risks. However, even with the best portfolio diversification, these risks can only be reduced at best. The main risks that affect stocks are the general market risks, which have a direct bearing on the output, while the individual stock risks can be significantly reduced by wise investment (Beach, 2006, p. 17). To ensure that the risks are reduced, investors need to diversify not only between the different classes of assets, but also on the respective industries that are potentially rewarding. To ensure that the reduction of risks is achieved through diversification, the returns that are anticipated must be weighed against the probable risks. This paper provides an example of portfolio diversification. It will achieve this goal using different classes of securities. The investments will be in different industries to allow more diversification in addition to the different securities used. The initial investment stake is $50,000. The closing prices used will be for 31st of December 2012 with a settlement date of 10 September 2013. The major assumption is that there are no transaction costs in the portfolio creation. Where they exist, they will be ignored.
Investment Strategy
As stated above, the investment strategy to allow minimum risk bearing will involve investment in more than one field. The fields will be the banking sector, the motor manufacturing sector, and the software development sector. The classes of securities to be incorporated in the portfolio to achieve a minimum risk bearing include the acquisition of stocks or shares and investment in the United States treasury bonds. The maximum amount to be spent in the setting up of the portfolios is $50,000. At least 95% of this will be incorporated into the portfolio.
The stock acquisition will be the main type of security, with the buying of shares in Apple Smartphone Company, The Bank of America, and General Motors. The next type of security will be the investment in the United States Government Bonds. The choice of the above variations in securities was informed by the desire to establish a portfolio that is relatively free of risks and that can guarantee the maximum output from the least of the inputs. The assessment of the willingness to bear risk is also carried out in the portfolio, with all the investment securities being scrutinized for the same before the decision to proceed with the investment. Risk bearing was assessed via a number of ways such as using the previous fortunes of the respective companies.
Description of Securities
Bank of America Corporation is one of the securities in which a fraction of the $50,000 will be invested. The corporation is one of the most successful of the American banks, as it is ranked second in terms of the banks holding assets in the US (Ahn, Denis, & Denis, 2006, p. 328). The company has also been ranked among the largest companies in the US, with the past few years seeing it make the top five companies in terms of revenue and among the top five largest companies in the world (Ahn, Denis, & Denis, 2006, p. 328). In last few years, the corporation has also embarked on the acquisition of other smaller institutions, thus increasing its market dominance and growing its asset base.
The Bank of America Corporation serves over 80% of the American residents, with branches being distributed all over the US and other countries around the world. Customers can also access the financial services from a series of automated teller machines, which are also spread out in the countries that the bank can be found. The Bank of America has a significant history, with the name changing a number of times from the original ‘Bank of Italy’ to the current name. The bank has also seen a number of mergers and acquisition of smaller banks over the years. The bank has a history of withstanding hard financial times to emerge stronger. The corporation grew from the original branch in San Francisco to the present-day multinational organization with profits also growing constantly over the years. The choice of the corporation was based on the significant success in its field and the little risk that would be incurred with the acquisition of shares from the corporation (Jordan, Miller, & Dolvin, 2012).
The other security investment that is to be undertaken is the buying of shares in the electronic company, Apple Inc. The company is an American corporation that has made a name for itself in the design, sale, and development of electronic goods. The bulk of the company’s output is in the form of computers and software among other state-of-the-art communication devices. Founded in the year 1976, the company is relatively younger that the Bank of America. It has performed at a surprisingly compatible level. Some of the achievements that the company has include being listed as the second largest IT Company and the third largest mobile phone manufacturer in the world (Willis, 2003).
The company has recognitions in other fields, winning honors, and criticism alike. The company has branches in over fifteen countries, with subsidiaries managing the distribution and manufacturing of her products. The company also performs well on the stock market, with a number of retailers exhibiting interest in the stocks based on this aspect. The company has a significant revenue base exceeding 150 billion dollars worldwide. It has risen in the fortune magazine list of 500 greatest companies in the world. The shares are also easy to acquire. The company has reported significant dividends for the shareholders. The choice of investing in this company was based on the significantly low risks that investing with it carries and the potential benefits.
The above companies represent the Information Technology sector and the Banking industry. For complete diversity, the next sector that was included in the securities is the car manufacturing industry. In this sector, General Motors (GM) was chosen (Willis, 2003). GM is an American company with branches in many parts of the world and business ventures in over 150 states. The main activities in the company include the manufacture, sale, and marketing of vehicles and vehicle parts. The automaker has a record of manufacturing and sale of classic vehicles. It held the record of the most units made and sold for over 70 years since the early 30s. It continues to rank among the largest and most profitable automakers in the world with employees all over the world and operations everywhere.
Some of the remarkable points in the history of GM include its landmark Initial Public Offer that opened in 2010 to ensure that the corporation was back to profitability after a period of misfortunes. The IPO was among the greatest ever, with the finance raised used to ensure the sustainability that it required. The company is also a dominant force in the auto manufacturing industry, with over a hundred years of running the industry in the front seat (Chen, & Chen, 2012, 405). This has placed the company among the most respectable brads in the world. In the current global situation, the brand stands to gain from diversification of the car-making industry to incorporate technology in the units. The risk assessment for the company produced positive results. The security is worth the investment.
The next class of securities apart from the stocks included above is the treasury bonds. The last sector that was considered based on this security is the US treasury bonds. The treasury bonds are marketable debts that the federal government issues through the Department of treasury (Jordan, Miller, & Dolvin, 2012). The choice of the bonds was based on the guaranteed returns that they hold over a given period and the relatively low risks that they pose. The other reason for the choice of treasury bonds is the maturity period that coincides with the period of the investment return expected.
Calculation of the quarterly and annualized return on the portfolio
In this section, a calculation of the quarterly and annualized return on the portfolio is carried out. The settlement dates used are those of September 10, 2013. The same date of 10 September 2013 will be used in the calculation of the gains made for the above companies and treasury bonds while the first day of class (27 August 2013) will be used as the reference date for the closing prices. For the treasury bills, the amount that was invested is $15,000. With the rate of 5.125% that averages on 10 September 2013, the interest earned would be $ 768.75.Thisfigure is based on an investment for the cumulative six months that the bonds are expected to mature. With the share price of the Bank of America being 13.349 dollars at the time of investment, 898 shares were bought at a total price of approximately 12000 dollars. The share price at the time of selling was 14.25 dollars per share, with an overall profit of $ 796.50. This makes the investment very beneficial, well informed, and hence an example of wise spending.
The next piece of investment was in Apple Inc. with the closing date being August 27th and the settlement date being September 10th; a total of $12,000 of the original amount was also invested in the shares here. With the shares in this company trading at $467.90 at the time of investment, they had grown to$471.60 at the time of exit. This finding was a total growth of $ 3.7 with the amount gotten from the growth standing at $44,400. This was a positive one for the portfolio. The last investment was in general motors, with the closing date being August 27 and the settlement date being September 10 as in the other transactions. In this company, the remaining amount of approximately $10,000 was invested in the stocks that traded at a price of $37.10. At the time of exit, the shares traded at $37.95, with an increase of only $ 85 cents. This means that the amount generated from the investment was only $850. This constituted one of the lowest amounts that were gotten from all securities. In total, $49,000 of the original $50,000 was used in the portfolios, with a profit of $46,815.25.
The results indicate that the investment portfolio was more balanced with the risks exposed in the various securities covered by the other more profitable securities. The investment in the US federal Bonds was more risky with little of the profits in the portfolio coming from it. This meant that the amount that was available for the other portfolios had to be supplemented by the other profits in the other securities. The above case serves to prove that portfolio diversification is an apt method of ensuring increased returns in an environment where the investment in one company or security may prove detrimental and unrewarding.
Portfolio Betas
The beta calculation of the portfolios enables investors to establish the returns from the portfolios to estimate the best of securities for future investment (Jordan, Miller, & Dolvin, 2012). In the above portfolios, the beta calculation proves that the best companies to invest in were among those selected. Beta value is described as being 1, 0, above 1, or between 0 and 1. These values have specific meanings to the investor. They advise on the likely decisions for future investment. Values above 1 are characteristic of stocks that are highly volatile (being influenced by daily events). Such stocks are exemplified by Apple Inc., which produced the largest returns of the investments.
The poorest performer in terms of beta value was the investment in treasury bills, with an only little of the investment returns coming from the security. The beta value was below zero. This finding was a reflection of the performance that was recorded over the period of investment. The next investment that performed exemplarily well and had a higher beta value for the dame is the investment in the Bank of America. The beta value was at above 1, which means that it performed better on average than most shares in its class. The last beta value established was that of the company General Motors. This had a beta value between 0 and 1. The implication of this is that the shares in this company are a bit less flexible and less influenced by the daily activities as compared to the shares in Apple Inc. and/or other companies with a beta value greater than 1.
Summary
In summary, the portfolios invested in were in different sectors including banking, telecommunication and information technology, and manufacturing. These fields provided the best risk reduction strategy. They provided a more informed method of ensuring more returns from the investment. The other type of security that was featured is the treasury bonds. Although these were not as profitable as the initial stock, the investment here provided a risk minimization procedure. The investment in the treasury bonds alone would have resulted in overall poor returns on investment. There was no predicting of how the stock market could behave before the investment. Investing purely in this area would have proved more risky.
Therefore, based on the returns from the two types of securities, several deductions can be made on the chances of investing on the portfolios. The returns may be invested in both Apple Inc. and the Bank of America, both of which proved profitable in the above portfolio. There is also a reduced risk in investing in the corporations based on the nature of their beta values and the volatility of their respective markets. In conclusion, investment in a diversified portfolio is effective in reducing risks associated with one field investment. It also increases chances for greater returns.
Reference List
Ahn, S., Denis, J., & Denis, K. (2006).Leverage and investment in diversified firms. Journal Of Financial Economics, 79(2), 317-337.
Beach, L. (2006). Why Emerging Market Equities Belong in a Diversified Investment Portfolio. Journal Of Investing, 15(4), 12-18.
Chen, S., & Chen, I. (2012).Corporate governance and capital allocations of diversified firms. Journal Of Banking & Finance, 36(2), 395-409.
Jordan, B., Miller, T., &Dolvin, S. (2012). Fundamentals of investments, valuation and management (6th ed.). New York, NY: McGraw-Hill.
Willis, A.(2003).The Role of the Global Reporting Initiative’s Sustainability Reporting Guidelines in the Social Screening of Investments. Journal Of Business Ethics, 43(3), 233-137.