Finance Essay Example | Topics and Well Written Essays - 1500 words - 1

Finance - Essay Example investment in diversified portfolio like equity, bond, preference share, different securities etc in domestic as well as international stock market. A number of companies are attached with this investment process where the finance managers and the fund managers of the investment companies are responsible for the whole process of investment by taking into consideration the associated risk factor (Kimmel, 2008 p.145). Risk and Return In case of investment, risk is associated with the financial operation and transaction of securities and stocks (Correia, 2007 p.111). So, the risk of the financial operation is determined by calculating the difference between the expected return and the actual return of the stocks. On the other hand the return on the investment designates the total earnings of the investment. Here the return of the investment may be positive or negative. Rate of return is the fundamental expectation of the investors. If the portfolio manager decides to invest in the euro denominated bonds, the return on investment would be around 11.5%, whereas, the US denominated bonds would provide a return of around 9.9%. Thus there would be a difference in return when comparing these two bonds. Therefore, the portfolio manager should aim at maximizing the portfolio returns (wealth maximisation) by making the entire foreign bond allocation in euro denominated bonds, to fetch more returns for his investment. Frequent changes in the economic condition and currency value of US affects the US bonds. So, euro bonds hold a strong position than US bonds. Portfolio managers should also take into consideration that higher returns are associated with higher risks. However, the European currency in comparison to the US currency is quite stable in nature. Therefore, the euro-denominated bonds do not get much affected by the volatility in the market (Kieso, 2010 p.169). Portfolio Theory The main theme of the portfolio theory is to minimise the risk by allocating the financial securities into different portfolio i.e. by diversifying the portfolio. This theory is introduced by Harry Markowitz in 1952 to maximise the wealth of the investor by mitigating the risk. Hedging strategy is a part of portfolio theory and it involves with the reduction of risk of the investments domestically as well as international markets. But companies can invest in appropriate proportions in different stocks by framing proper hedging strategy. Mainly, there are two types of hedging strategies followed by the corporate sectors like financial hedging and operational heading. The financial heading strategy is mainly applied in the derivative instruments, foreign currency borrowings and loan related matters. However, operational hedging is applicable in the cases where investment is diversified internationally. Most of the investment companies invest in different countries to control the foreign exchange market and to maximise the return from investment. This is also a part of the portfolio strategy. Thus investing in a portfolio reduces the risk of investment as compared to the risk involved in 100% investment on a certain stock.