Trading Mechanism,

Portfolio Theory and

Fundamental Analysis
Ang, Cailing, Piodo, Resurreccion, Salvador, Sison

OBJECTIVES
Describe the mechanics of secondary
trading in the local stock market
Explain trading mechanisms: types of
orders, short selling, margin transactions
Differentiate between brokers and sellers
and describe their roles and costs
Discuss portfolio theory, diversification,
risks and returns

TRADING
MECHANISM
JEM ANG & MEL RESURRECCION

Why INVEST?

Investing is the most

effective way to
build personal wealth
and secure
financial future

INVESTMENT: STOCKS
https://www.youtube.com/watch?
v=Snsapamg8CU&list=PLFrErI4cWVHwU
4ORy5i2TuzQBvxqVbelH

2 Levels of Capital
Markets
Primary Market
It is where securities are created and businesses sell
new stocks and bonds to raise capital
New stocks and bond issues are directly purchased
from the issuing company

Secondary Market
Commonly referred as stock market
Investors buy and sell stocks among themselves
Trade existing securities without the
involvement of the issuing companies

Secondary Markets
Organized Securities Exchange
centralized institutions in which
transactions are made in already
2 former bourses: MSE and
outstanding securities

MKSE
June 1998, status of a SelfRegulatory Organization
(SRO)
Pre-opens at 9:00am; opens
at 9:30am; recess between
12:00 and 1:30pm; precloses at 3:15pm; run-off
from 3:20pm; closes at

Secondary Markets
Over-the Counter (OTC)
Market
decentralized market
without central physical location
communication modes are through
telephone, email, proprietary
electronic trading systems

BROKER VS DEALER Its Role

and Cost Associated in the
Market

BROKER
refers to an individual or firm that charges
clients a commission for assisting in the
buying and selling of products. In the
financial market, those products can include
stocks and bonds, insurance products and
real estate. Each industry has its own
brokers, and services can vary among
brokers
within
the
same
industry.

Brokers aid investors by collecting and transmitting

orders to the market, by bringing wiilling buyers and
sellers together,by negotiating prices,and by
executing order. The fee for these service is the
BROKERS COMMISSION.
DIFFERENT TYPES OF BROKERS
1. Full-Service Investment Broker
2. Discount Investment Broker
3. Insurance Broker
4. Real Estate Broker

DEALER
A person or business firm acting as a
middleman to facilitate distribution of
securities or goods. Typically, a dealer
buys for his or her own account and sells
to a customer from the dealer's
inventory. Thus a dealer acts as a
principal rather than as an agent.

Dealers perform 3 functions in markets;

1. They provide the opportunity for investors to
trade immediately rather than waiting for the
arrival of sufficient orders on the other side
of the trade(immediacy) and dealers do
this while maintaining short-run price
stability (contunity)
2. Dealers offer price information to market
participants
3. Incertain market structures, dealers serve as
auctioneers in bringing order and fairness to
a market.

Dealers as a Market Maker

Unmatched or unbalanced flow causes two
problems.
1. The securitys price may change abruptly
even if there has been no shift in either
supply or demand for the security.
2. Buyers may have to pay higher than
market-clearing prices if they want to
make their trade immediately.

Factor that determined price

dealer charged to the services
they provide?

One of the most important is the order

processing costs incurred by dealers.

Dealers have to be compensated for

bearing risk. A dealers position may
involve carrying inventory of a
security(a long position) or selling a
security that is not in inventory(a short
position).

TYPES OF COST
ASSOCIATED IN MARKET
1. TRANSACTION COSTS - Transaction costs consist of
commissions, fees, execution costs and opportunity costs.
Commissios are the fees paid to brokers to trade securities
2. EXECUTION COSTS -Execution costs represent the
difference between the execution price of a security and
the price that would have existed in the absence of the
trade.
3. OPPORTUNITY COSTS - The cost of not transacting
represents an opportunity cost. It may arise when a desired
trade fails to be executed. This component of costs
represents the difference in performance between an
investors desired investment and the same investors
actual investment after adjusting for execution
costs,commissions and fees.

SECONDARY
MARKET TRADING
MECHANICS

Order Types

(according to price)
refers to the type of price specified for an order

Limit
is a buy or a sell order to be executed at a specified
price limit or better; threshold for the execution of
trade
Market on Opening/Closing
is a buy or a sell order that must be executed at the
given instruments Indicative Opening/Closing Price
(IOP/ICP)
Market Order
is a buy or sell order for which all or a partial quantity
must be executed at the best price(s) available in the
market at the time the order is entered.

Order Types

(according to price)
refers to the type of price specified for an order

Stop Order
are triggered when a specified price limit is
reached. It becomes a market order as soon
as its trigger price limit is reached.

a.Stop Loss
An order placed with a broker to sell a
security when it reaches a certain price.
A stop-loss order is designed to limit an
investors loss on a position in a security.

Order Types

(according to price)
refers to the type of price specified for an order

b. Stop Limit
An order placed with a broker that
combines the features of stop order with
those of a limit order. A stop-limit order
will be executed at a specified price (or
better) after a given stop price has been
reached. Once the stop price is reached,
the stop-limit order becomes a limit order
to buy (or sell) at the limit price or better.

Order Types
(according to time/validity)

a.

Day Order (DAY)

is valid until the end of the trading day

only

b. Good Till Cancelled

(GTC)
is valid until cancelled by the investor
or trader or until it has reached the set
expiration date of the security

c.

Good Till Date (GTD)

Order Types
(according to time/validity)

d.

Good Till Week (GTW)

is valid for seven (7) calendar days

e. Sliding Validity
(SLIDING)
is valid for 360 calendar days from the
time it is posted

f.

Fill-and-Kill (FAK)

also referred to as Execute-andEliminate Order, is valid upon

Basic Types of
Securities Transactions
Long Purchase
Investor buys and holds
securities
Buy low and sell high
Make money when prices
go up

Basic Types of
Securities Transactions
Margin Trading
Uses borrowed funds to purchase
securities
Currently owned securities used as
collateral for margin loan from broker
Can be used for common stocks,
preferred stocks, bonds, mutual funds,
options, warrants and futures

Margin Trading
Margin requirements
The initial margin requirements is the
proportion of the total market value of
the securities that the investor must
pay for in cash.
Maintenance margin requirement is
the minimum amount of equity needed
in the investors margin account as
compared to the total market value.

Margin Trading
Advantages

Allows use of financial leverage

Magnifies profits

Disadvantages

Magnifies losses

Interest expense on margin loan

Margin calls

Basic Types of
Securities Transactions
Short Selling
Investor sells securities they dont own
Investor borrows securities from broker
Broker lends securities owned by other
investors that are held in street name
Sell high and buy low
Investors make money when stock
prices go down

Short Selling
Advantages
Chance to profit when stock price declines
Disadvantages
Limited return opportunities: stock price
cannot go below ZERO
Unlimited risks: stock price can go up an
unlimited amount. If stock price goes up, short
seller still needs to buy shares to pay back the
borrowed shares to the broker
Short sellers may not earn dividends

MARKET EFFICIENCY
Operationally efficient market

In an operationally efficient market investors can

obtain transaction services as cheaply as
possible given the costs associated with
furnishing those services.

Pricing efficient capital market

Pricing efficiency refers to a market where prices

at all times fully reflect all available
information that is relevant to the valuation of
securities

EXPECTED RETURN
The expected return =

EXAMPLE:
initial price of share is 10 TL.
The end of the year share price will be 12
TL.
Dividents of company is 1.50 TL.
The expected return = 1.50+2/10
3.5/10 = % 35 is rate of
expected return

In defining the relevant information set that

prices should reflect. Pricing efficiency of a
market was classified in three forms.
Weak efficiency
Semi-strong efficiency
Strong efficiency

PORTFOLIO
THEORY,
DIVERSIFICATIO
N, RISK AND
RETURN
DEBBIE PIODO & FEA SALVADOR

PORTFOLIO THEORY
This theory was developed
by Nobel Economist Harry
Markowitz in 1952
Dont put all your eggs in
one basket.

INSERT VIDEO (https://www.youtube.com/watch?

v=c5c_Zgn-Bjg)

PORTFOLIO THEORY
General assumption: Investors want to
maximize the returns from the total set
of investments for a given level of risk.
Portfolio theory also assumes that
investors are basically risk averse

RISK AND RETURN

RISK
The uncertainty of future
outcomes or the probability of an
adverse outcome.

RETURN
The gain or loss of a security in a
particular period. The return
consists of the income and the
capital gains relative on an
investment.

RISK ATTITUDES
RISK NEUTRAL
INVESTORS

RISK AVERSE
INVESTOR

in the middle of
the continuum
represented by
risk-seeking
investors at one
end, and riskaverse investors
at the other
extreme.

when faced with

two investments
with a similar
expected return
(but different
risks), will prefer
the one with the
lower risk.
typical investor
mentality

RISK
SEEKING/LOVER
INVESTOR
willing to take on
additional risk
for an
investment that
has a relatively
low expected
return.

PORTFOLIO THEORY
This portfolio variance formula not
only indicated the importance of
diversifying investments to reduce
the total risk of a portfolio but also
showed how to effectively diversify.

INSERT VIDEO (https://www.youtube.com/watch?

v=lPKtI90f_sE)

ALTERNATIVE MEASURES
OF RISK
Expected Value
Variance or Standard Deviation
Measure of spread of the outcomes around the
expected value.
MEASURING RISKS
Design probability distribution of anticipated
future outcomes
Establish
- Probability distribution
- Determine expected value
- Calculate dispersion around expected value

PORTFOLIO THEORY
THE EFFICIENT FRONTIER
Represents the set of
portfolios that has the
maximum rate of
return for every given
level of risk or the
minimum risk for
every level of return.

INSERT VIDEO (https://www.youtube.com/watch?

v=PiXrLGMZr1g)

ULTIMATE GOAL: OPTIMAL

PORTFOLIO
The optimal portfolio is the efficient portfolio
that has the highest utility for a given investor.
provides the highest return for a given level of risk
Given the choice between two equally risky
investments, an investor will chose the one with
the highest potential return.
Given the choice between two investments
offering the same return, an investor will choice
the one that has the least risk.

CORRELATION
Statistical measure of the relationship between
two series of numbers representing data
Positively Correlated items move in the
same direction.
Negatively Correlated items move in
opposite directions.
Correlation Coefficient is a measure of the
degree of correlation between two series of
numbers
representing data.

CORRELATION
Positively Correlated items move in
the same direction.
Negatively Correlated items move in
opposite directions.
Correlation Coefficient is a measure
of the degree of correlation between
two series of numbers representing
data.

CORRELATION
Perfectly Positively Correlated describes
two positively correlated series having a
correlation coefficient of +1
Perfectly Negatively Correlated describes
two negatively correlated series having a
correlation coefficient of -1
Uncorrelated describes two series that
lack any relationship and have a
correlation coefficient of nearly zero

PORTFOLIO THEORY
2 KINDS OF RISK:
Systematic Risk - These are market
risks that cannot be diversified away.
Unsystematic Risk - this risk is
specific to individual stocks and can be
diversified away as you increase the
number of stocks in your portfolio

INSERT VIDEO (https://www.youtube.com/watch?

v=lPKtI90f_sE)

FUNDAMENTAL
ANALYSIS
GENE CAILING & CERGE SISON

 What to Expect?
a.Introduction to Fundamental
Analysis
b.Aspects of Fundamental Analysis
c. Intrinsic Value
d.Financial Statements
e.Example (Use Yahoo Finance)

WHAT IS FUNDAMENTAL
ANALYSIS?
Fundamental analysis is a technique that attempts to
determine a securitys value by focusing on underlying
factors that affect a company's actual business and its future
prospects.
WHY FUNDAMENTAL ANALYSIS?
Fundamental analysis answers the following questions
1. Is the companys revenue growing?
2. Is it actually making a profit?
3. Is it in a position strong-enough to outrun its competitors
in the future?
4. Is it able to repay its debts?
5. Is management trying to "cook the books"?

WHAT IS FUNDAMENTAL
ANALYSIS?
Fundamental analysis can be composed of many different
aspects: the analysis of the economy as the whole, the
analysis of an industry or that of an individual company.

Industry
Analysis
Economic
Analysis

Company
Analysis

FUNDAMENTAL
ANALYSIS

ECONOMIC ANALYSIS
The performance of a company depends much on the
performance of the economy.
The first step to this type of analysis includes looking at the
macroeconomic situation.
GDP/growth
rate

Tax rates

Balance of
payments

Inflation

Domestic
savings rate

Infrastructure

Interest rates

FDI/FII

Political
stability

Exchange
rates

Agricultural
production/m
onsoon

Fiscal & Monetary Policies

Fiscal Policy (Keynesians)
Government expenditures (demand)
Tax & Debt policies
Monetary Policy (Monetarists M. Friedman)
Interest rates (discount, fed funds)
Money supply (Open market ops): M1, M2
Reserve requirements (commercial banks)

Goals of Policy
Full Employment
Interest Rates
Money Supply

Price Stability (control inflation)

Interest Rates
Money Supply

Economic Growth
Interest Rates
Money Supply

ECONOMIC INDICATORS AND THEIR

IMPACT ON THE STOCK MARKET
INDICATOR

FAVOURABLE UNFAVOURAB
IMPACT
LE IMAPACT

GDP/GROWTH RATE

HIGH GROWTH RATE SLOW GROWTH

RATE

DOMESTIC SAVINGS
RATE

HIGH

LOW

INTEREST RATES

LOW

HIGH

TAX RATES

LOW

HIGH

INFLATION

LOW

HIGH

IIP/INDUSTRIAL
PRODUCTION

HIGH

LOW

BALANCE OF TRADE POSITIVE

NEGATIVE

BALANCE OF
PAYMENTS

NEGATIVE

POSITIVE

ECONOMIC INDICATORS AND THEIR

IMPACT ON THE STOCK MARKET
INDICATOR

FAVOURABLE UNFAVOURAB
IMPACT
LE IMAPACT

FOREIGN
EXCHANGE
POSITION

HIGH

LOW

DEFICIT
FINANCING/FISCAL
DEFICIT

LOW

HIGH

AGRICULTURAL
PRODUCTION

HIGH

LOW

INFRASTRUCTURAL
FACILITIES

GOOD

NOT GOOD

Industry Analysis
An industry intelligence is a business
tool carried out to assess profit
potential and the complexity of a
particular industry.
Industry intelligence is assessed based of
key factors relating to the industry such as
the history of the industry,
industry life cycle,
a review of how differing trends such as
seasonal fluctuations affect the industry,
external influences on the industry such as
government laws and
a review of levels of competition both
present and future for the specific industry.

Porters Five Forces- Industry Analysis:

1. Industry rivalry: Indicates degree of competition

2.
3.
4.
5.

among existing firms, cut throat competition leads

to reduced profit potential for companies in the
same industry
Threat of substitutes: Availability of substitute
products or services will limit a firms ability to raise
prices
Bargaining power of buyers: It represents
powerful buyers have a significant impact on prices
Bargaining power of suppliers: It highlights
powerful suppliers can demand premium prices and
limit your profit
Barriers to entry: it includes threats of new
entrants that can act as a deterrent against new
competitors

Competitors intelligence
Competitors intelligence in international business is an assessment of
the strengths and weaknesses of current and potential competitors.

It involves primarily two activities:

1. obtaining information about important competitors and
2. using that information to predict competitor behavior.
Most firms face four basic types of Competition:
Identif
Identif
ying
ying
compet
compet
itors
itors
Profilin
Profilin
g
g
Compe
Compe
titors
titors
Competit
Competit
ors
ors
Analysis
Analysis

Develo
Develo
ping
ping
Marketi
Marketi
ng
ng
Strateg
Strateg
y
y

Compa
Compa
rison of
rison
of
your
your
potenti
potenti
als
als
with
with
compet
compet
itors
itors

1. Brand competitors, refers to competition with

different brands offering with similar features, prices
and benefits to the same potential customers.
2. Product competitors, offer same product class but
with offer different benefits, features, and prices.
3. Generic
products
satisfying
benefit or

competitors, are rival firms offering

which are different but are capable of
the same basic want or provide the same
utility to the prospective customer.

4. Total budget competitors, primarily focus on

prices, they compete for the limited financial
resources of the same customers.

Various types of competition

Produ
ct

Sedans
(Large
Cars)

Soft
Drinks

Movies

Colleges

Transportation

Total
Generic
Brand
Product
Budget
Competito
Competitors
Competitors Rental cars,
Competitor
Maruti
Suzuki, Ford Jeeps,
car-sharing,
riders
Hyundai, Toyota
Hatchbacks, SUVs, Bikes, BMTC,
sharing,sliftHonda, Nissan

Minivans, MUVs

Metro.

sharing

Refreshment

Coca-Cola, Pepsi,
Tropicana, Frooti
Minute Maid, Appy

Tea, Coffee,
Badam Milk, Fruit
Juice, Lime soda,
Butter milk.

Tap water,
Prasadam
(given in
religious places)

Candy, Pani puri,

Pop corn, Vada
pav, Pakoda.

Avengers,
Cable TV, Pay-perSpiderman, Ice
view on DTH, DVD
age, Shrek,
rentals
Batman, Immortals,
Mission Impossible.

Sporting events
like IPL, Music
Concerts,
Exhibitions,
Melas.

Relative and
friends house,
reading, Parks,
Museum.

St. Josephs, Christ,

Jain, Jyoti Nivas,
Mounts, Kristu
Jayanti

Books, Internet,
Apprenticeship,
Seminars.

Public Colleges

Need

Entertainment

Education

Distance
Education,
Community
college.

Company Analysis
It involves a close investigative scrutiny of the
companies financial and non financial aspects with
a view to identifying its strength, weaknesses and
future business prospects.
Company
Analysis

financial

non financial
Non Financial Factors
Marketing success
Business Model
Competitive Advantage
Management
Corporate Governance

Company Analysis-Non
Financial
Sales Revenue (growth)
Profitability (trend)
Product line (turnover, age)
Output rate of new products
Product innovation strategies
R&D budgets

Pricing Strategy
Patents and technology

Company Analysis-Non
Financial
Organizational performance
Effective application of company resources
Efficient accomplishment of company
goals

Management functions
Planning - setting goals/resources
Organizing - assigning tasks/resources
Leading - motivating achievement
Controlling - monitoring performance

Company Analysis-Non
Financial
Evaluating Management Quality
Age and experience of management
Strategic planning
Understanding of the global environment
Adaptability to external changes
Marketing strategy
Track record of the competitive position
Sustainable growth
Public image
Finance Strategy - adequate and appropriate
Employee/union relations
Effectiveness of board of directors

Strengths
Latest Technology

SWOT
ANALYSI
S

Lower delivered Cost

Established products

Committed manpower

Advantageous location

Weaknesses

Untrained labour force

Strained cash flows

Poor product quality

Strong finances

Well- known brand names

Opportunities

Loose controls

Family funds

Poor public image

Weaknesses

Growing domestic
demand

Price War

Expanding export
markets

Undependable component

Cheap labour
Booming capital markets
Low interest rates

Intensive competition
Suppliers
Infrastructure bottlenecks
Power cuts

Company Analysis-Financial
Operating efficiency
Productivity
Production function

Financial Ratio Analysis

Past financial ratios
With industry, competitors, and

Regression analysis
Forecast Revenues, Expenses, Net Income
Forecast Assets, Liabilities, External
Capital Requirements

Company Analysis-Financial
Balance Sheet
Snapshot of companys Assets,
Liabilities and Equity.
Income statement
Sales, expenses, and taxes incurred
to operate
Earnings per share
Cash flow statement
Sources and Uses of funds

Company Analysis-Financial
Financial Ratio Analysis
Liquidity (ability to pay bills)
Debt (financial leverage)
Profitability (cost controls)
Efficiency (asset management)
DuPont Analysis
Top-down analysis of company
operations
Objective: increase ROE

Company Analysis-Financial
Liquidity Ratios
Measure ability to pay maturing obligations
Current ratio
Current assets / current liabilities
Quick ratio
(Current assets less inventories) / current
liabilities

Company Analysis-Financial
Debt Ratios
Measure extent to which firm uses debt to
finance asset investment (risk attribute)
Debt-equity ratio
Total long-term debt / total equity

Total debt - total assets ratio

(Current liabilities + long-term debt) / total assets

Times interest earned

EBIT / interest charges

Company Analysis-Financial
Profitability Ratios
Measure profits relative to sales
Gross profit margin ( % ) = Gross profit / sales
Operating Profit Margin = Operating profits /
sales
Net profit margin = Net profit after taxes / sales
ROA = Net Profit / Total Assets
ROE = Net Profit / Stockholder Equity*
* Excludes preferred stock balances

Company Analysis-Financial
Profitability Ratios
Measure effectiveness of asset management
Average collection period (in days)
Average receivables / Sales per day

Inventory turnover (times per year)

Cost of Goods Sold / average inventory

Total asset turnover

Sales / average total assets

Fixed asset turnover

Sales / average net fixed assets

Company Analysis-Financial
Other Ratios
Earnings per share (EPS): (Net income after
taxes preferred dividends)/ number of shares
Price-earnings (P/E): Price per share/expected
EPS
Dividend yield: Indicated annual dividend/price
per share
Dividend payout: Dividends per share/EPS
Cash flow per share: (After-tax profits +
depreciation and other noncash
expenses)/number of shares
Book value per share: Net worth attributable
to common shareholders/number of shares

Company Analysis-Financial
Net Profits Net Profits
Sales
Total Assets
ROE

Equity
Sales
Total Assets
Equity
Ratio 1
ROE

Ratio 1 = NPM

Ratio 2

Ratio 3

Net profits after taxes

Net profits

Common stockholders' equity Common equity

Ratio 2 = TATO

Ratio 3 = Equity Kicker

The DuPont System suggests that ROE (which drives stock price) is a function
of cost control, asset management, and debt management.

Conclusion
The end goal of performing fundamental analysis is to produce a
value that an investor can compare with the underlying assets
current price in hopes of figuring out what sort of position to take
with that security(under priced = buy, overpriced = sell).
Valuation of Stock
The intrinsic value of a share is the present value of all future cash flows
INTRINSIC VALUE = DIVIDENDS + CAPITAL APPRECIATION

Investment decision:
1. If the market price of a share is currently lower than its intrinsic
value, such a share would be bought because it is perceived to be
under-priced.
2. A share whose current market price is higher than its intrinsic value
would be considered as overpriced and hence sold.

REFERENCES
Modern Portfolio Theory: Why It's Stil
l Hip | Investopedia http://www.invest
opedia.com/articles/06/mpt.asp#ixzz3y9
Sm161d
http://www.investopedia.com/
Investment Analysis and Portfolio Mana
gement By: Reilly & Brown