Portfolio management and others

Posted: August 26th, 2021

Final Assignment

Name

Institutional Affiliation

Final Assignment

From:

[your name]

 Sent: 1^st May 2020 11:00am

To: Diane McLean

Subject: Portfolio management and others

 Dear: Diane McLean,

Following your earlier email, I would like to answer your questions based on my expert knowledge acquired from the Portfolio Management course at Zayed University.

Question 1: Expectations and Liquidity Theory

The two theories define the maturity periods of interest rates by describing the correlation between the bond yields or interest rates and maturity periods.The approaches reflect the expectations of investors on the changes in the future interest rate and the corresponding impact on monetary policy conditions. The expectation hypothesis predicts the future value of short-term interest rates per the present long-term interest rate. It is also known as unbiased expectations theory (Pusch, 2017). However, liquidity preference theory holds that the market players and investors should demand greater interest in financial securities with long maturity periods as they have a higher risk in investments and high liquid holdings. Besides, the theory states that liquidity demand in investment has a speculative power as liquid financial investments are easily converted to cash for their full market value (Pusch, 2017). Thus, interests in short-term investments should be lower as investors are not foregoing the opportunity cost of liquidity in their investments for a longer time compared to medium and long- term securities.

Question 2: Spot Rates

Interest and inflation rates have a direct relationship. Therefore, a rise in inflation rates leads to an increase in the interest rates as creditors will demand higher interest rates to reimburse the decrease in purchasing power of the future value of money (Anari & Kolari, 2017). The two years spot rate is more significant than one year, as investors anticipate rising short-term interest rates due to the increase in inflation rates. The situation is worsened by the ongoing COVID-19 pandemic that has shaken economic conditions, thus increasing inflation.

Question 3: Markowitz Portfolio Optimization Model

The theory is also referred to as modern portfolio theory. It holds that investors can either invest in risky and risk-free assets. When investing in financial instruments, one should always consider the objectives and maximize the expected return while minimizing the financial risk (Dai & Wen, 2018). Thus, your portfolio should include both risky investments as they have high yields and risk-free investments, such as bonds to reduce the risk of losing investment due to uncertainty.

Kind Regards,

[Your name]

References

Anari, A., & Kolari, J. W. (2017). Impacts of Monetary Policy Rates on Interest and Inflation      Rates. Available at SSRN 3088133.

Dai, Z., & Wen, F. (2018). Some improved sparse and stable portfolio optimization problems. Finance Research Letters, 27, 46-52.

Pusch, T. (2017). The role of uncertainty in the euro crisis–an application of liquidity preference theory. International Review of Applied Economics, 31(4), 527-548.