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RISK MANAGEMENT AND PORTFOLIO ANALYSIS IN THE CAPITAL MARKETS

ABSTRACT

This research work is entitled "Risk Management and Portfolio Analysis in the Capital Market". This work is embarked on with the purpose of examining critically risks with the context of financial investment decision. Appreciating the various criteria for management and managing investment risks and its possibility of reduction and to show the effects of changes in market on risks and return. Data derived from this research study has been subjected to the statistical analysis of chi-square (X2) contingency tables have collected data from primary sources via research questionnaires. Findings in this study has been able to indicate investment risks can be identified, diversified portfolio does not reduce/eliminate all risks, macro economic factors are responsible for the difficulties in diversifying market risks. From the findings, it is recommended that a conducive platform should be created for capital market investment; speculative decisions are to be taken into consideration in returns. There is a need to invest in securities combinations that are perfectly negatively correlated and portfolio combinations be correctly balanced for two or more assets, with the same expected returns.

CHAPTER ONE

INTRODUCTION

1.1BACKGROUND OF THE STUDY

Following precedence on what Nigeria capital market has been like before the introduction of the Structural Adjustment programme (SAP). Ayadi (1983) highlighted that many companies could afford to ignore the capital market since they had vast pool of loanable funds to draw from. However, according to the federal government gazette (1989), the introduction of SAP and certain policy measures such as the deregulation of interest rate, mopping up of excess liquidity were introduced with the measures, it becomes impossible for business organizations to borrow funds from the money market and as a result more companies are now turning to the capital market.

According to Samuels and Yaccounts (1981), the Nigerian Stock Exchange Market follows a random walk hypothesis. The problem with Ajayi's work which was quite exhaustive is that his conclusions may not be valid anymore in the structural changes sweeping across Nigerian financial system. Ekechi (1980), in a study of monthly returns between 1977 and 1987 of twenty companies quoted on the Nigerian Stock Exchange also found substantial support for the random walk hypothesis.

In an effort to refute the randomness of stock prices, Alexander (1964), tried to device some trading values solely on prices of a security moves up at least T percent from a subsequent high, at which time go short. The short position is maintained until the prices rises to at least Y percent above a subsequent low. In order to appreciate the research work, it is better to briefly define the following terms; risk, portfolio and capital market with the content of financial management.

Blume (1978), defined risk “as the degree of profitability of occurrence assigned to an investing or financial decision from the observed knowledge of the part of existing events”. Where there are certain parameters of decision problem, whole value are impossible to fully specify in advance, we say, it is risky, better still, risky events are predictable and foreseeable only within the existence of some degree of confidence.

Unugbro (2004), “risk is the possibility of an adverse deviation from a desired outcome that is expected”. Portfolio is a collection of investment for an investor. Portfolio can be collection of shares, for an investor property company his portfolio can be a collection of buildings. For a financial manager of various projects, these will be fully expanciated in the subsequent chapter. It is a market which comprises of many participants which primarily deals with facilities of raising new capital for companies to survive and to enjoy operation in perpetuity.

1.2   STATEMENT OF THE PROBLEM

How can an optimal risk portfolio on investment be attained? And in carrying out evaluation analysis on capital structures, can it ensure a high return on the investment? Can effective diversification of portfolio reduce all risks or not?

1.3   OBJECTIVES OF THE STUDY

The objective of the study is to show in details how risks can be effectively managed and how varying portfolios can be analyzed to ensure high return on investment.

In relation to the statement of the problem, it is the objective of this research work that will effectively diversify away non market risks and as much as possible to monitor the non market risks which is to be represented with the Beta factor.

And finally to examine how earning criteria such as Earning Per Share (EPS), Market Value per share (M/v per share) and price earnings ration (PER) can be integrated in the management of risks.

1.4   SCOPE OF THE STUDY

Conventionally, the scope of the study is restricted to the capital market and particularly to the stock market and the brokering firms.

1.5   SIGNIFICANCE OF THE STUDY

The essence of the study is to be a benefit to people, each particular person needs to rely on this study for a specific reason. To be a potential equity investor and individual loan investor. It will help them in making effective investment and financial decisions. To the stock brokering firms, it will provide assistance for effective management of portfolio risks. The same benefit will be enjoyed by the financial analysts and staffs on the floor of the stock exchange market. It will help them to have objectives and speculative mind in order to follow the trend within the markets; others include the insurance companies, merchant banks, issuing houses etc.

1.6   RESEARCH HYPOTHESES

Ho: the risk of an investment is related to the return on such investment.

Hi: the risk of an investment is related to the return on such investment.

Ho: diversified portfolio cannot reduce all risks.

Hi: diversified portfolio can reduce all risks.

Ho: management of risk cannot be attained in the capital market.

Hi: management of risk can be attained in the capital market.

1.7    RESEARCH METHODOLOGY

The major sources of data used in the research study are thee primary and secondary data. The primary data was obtained from responses to personal interviews and questionnaires while the secondary data used extensively for the literature review include: journals, textbooks, newspaper, magazines, speeches and working papers. Most importantly, materials from previously published works of other scholars who had been involved in studies related to the risk management and portfolio analysis.

1.8   LIMITATIONS OF THE STUDY

This study is constrained by time available to carry out the study, backed up with compromising one’s studies. Management reluctance to provide accurate and relevant information and data, unavailability of needed staff at every particular point of contact with the company. Most companies do not have a portfolio management department that is headed by a portfolio manager, thereby making data collection cumbersome. Whether conditions was also a constrain, the heavy rains during the rainy season which was actually the period of this research work also contributed to the limitations.

1.9   DEFINITION OF TERMS

Beta Coefficient: This is a risk factor which measures the covariance of a security’s return with the average return of the market to which the particular security belongs.

Capital Market: This is a number of institutions that provide long terms funds to industry and the government.

Capital Asset Pricing: Is a model which relates the returns from the investment to the degree of risk associated with the investment.

Cost of Capital: Is the minimum rate of return by investors from their investment in the company’s security.

Dividend: Is an amount of the profits that a company pays to people who own shares in the country.

Dividend Decision: This includes the percentage of profit paid out of shareholders in cash, stability of dividends over many years and the issue of script (bonus shares).

Financial Decisions: Is concerned with obtaining the best financial mix or capital structure for the company.

Gearing: This is a term used to describe the relationship between shareholders’ capital plus reserves and either prior change capital borrowing or both.

Investment: Is the purchasing of stocks, bonds, mutual funds, real estate etc. made the expectation of future income or capital gains.

Investment Decision: This is concerned with organizing, leading and controlling the work of an organization members and using all available resources to reach stated organizational goals.

Portfolio: This is the collection of investment held by an organization or private individual.

Risk in Investment: It is the degree to which decisions embarked upon in investment is able to achieve expected returns; measures of performance are variance, standard deviation, new present value.

Securities Market: This is the aspect of the stock exchange involved with the selling and buying of shares.

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