Bognadon, Kylee Russel R.

Bitayan, Valery Bugayong, Demy

Investment Theories

1. Bernsteins Psychology of uccessful Investing !s "a#e Bernstein e$%lains in his classic on the %sychology of trading and investing, even &ith the 'est system the &ea#est lin# in the chain is al&ays the trader. The Investor(s )uotient offers a com%lete and highly effective investment %sychology regimen that %uts traders on the road to consistent %rofits. Traders &ill discover %ractical, %roven techni*ues for shar%ening %erce%tion+ develo%ing %ositive attitude and confidence+ learning from failures+ losing less on 'ad trades and ma#ing more on %rofita'le ones+ and finding the system 'est suited to their %ersonalities.

,. To% do&n Investing !n investment a%%roach that involves loo#ing at the -'ig %icture- in the economy and financial &orld and then 'rea#ing those com%onents do&n into finer details, after loo#ing at the 'ig %icture conditions around the &orld, the different industrial sectors are analy.ed in order to select those that are forecasted to out%erform the mar#et. /rom this %oint, the stoc#s of s%ecific com%anies are further analy.ed and those that are 'elieved to 'e successful are chosen as investments. 0. Bottom u% Investing !n investment a%%roach that de1em%hasi.es the significance of economic and mar#et cycles. This a%%roach focuses on the analysis of individual stoc#s. In 'ottom1u% investing, therefore, the investor focuses his or her attention on a s%ecific com%any rather than on the industry in &hich that com%any o%erates or on the economy as a &hole. 2. Buy the rumor and sell the fact old trading rule, 'ut highly misunderstood 3 the rules dictates that you dont have to sell the fact and not 'uy the fact. 4ne o'vious %oint im%lied in the rule is that the rumor should 'e 'ullish5 if it is 'ullish only then you stand a 'etter chance to &in 3 to earn more then reasona'le levels. 4ne thing should also 'e #e%t in vie& 3 any rumor may also have 'earish connotations. /ollo&ing the rule Buy the Rumor, ell the /act loo#s sim%le, 'ut it re*uires some %ractice and agility to monitor and analy.e the information coming out of mar#et.

6. 7astle1in1the air theory rather o%%osite in its %ostulations com%ared to the /irm /oundation Theory. The /irm /oundation Theory 'elieves and tries to understand the intrinsic value of any stoc# or other asset. The castle1in1the1air theory delves dee% into another as%ect of investing 'ehaviour 1 it tries to unravel and understand the %sychic values and 'ehaviour of the grou% of investors. This theory &as made %o%ular in 1809 'y "ohn :aynard Keynes, a famous economist ;as also an investor< and the theory %ostulates that the investors try to 'uild a sort of castles in the air and thin# of the %ro'a'le %rice rise in the future than estimating the intrinsic values of stoc#s. 4nce the investor has estimated this, he=she tries to 'eat the cro&d 'y 'uilding %ositions in the %referred stoc#s 'efore the cro&ds ;read other investors< start 'uying those stoc#s and the %rice surges ahead.

9. 7onstant1stoc#1'ond ratio theory Investment #no&ledge is critical in ma#ing sound investment decisions. Therefore, it &ill greatly influence your successes, hence the need to 'e ade*uate.

>. 7y'ernetic !nalysis a. In 7y'ernetic !nalysis for toc#s and /utures, noted technical analyst "ohn ?hlers continues to enlighten readers on the art of %redicting the mar#et 'ased on tested systems. @ith a%%lication of his engineering e$%ertise, ?hlers e$%lains the latest, most advanced techni*ues that hel% traders %redict stoc# and futures mar#ets &ith surgical %recision. Ani*ue ne& indicators and automatic trading systems are descri'ed in te$t as &ell as ?asy Banguage and ?/ code. The a%%roaches are universal and ro'ust enough to 'e a%%lied to a full range of mar#et conditions.

C. Diversification Theory

Diversification is one of the long standing and &idely %revalent Investment Theories to reduce the Investment Ris#s relating to holding and investing in stoc#s and other financial assets. Diversification may 'e %racticed in different &ays, one or more of these &ays may 'e com'ined to create a diversified %ortfolio. Denerally, diversification of a %ortfolio may 'e achieved 'y5 toc# Diversification Deogra%hical Diversification trategy Diversification

!sset Diversification

8. ?//I7I?ET :!RK?T TF?4RG. ?fficient :ar#et Theory is one of the Investment Theories, and the theory %ostulates that at any given %oint of time the %rices of securities 'eing traded in a stoc# mar#et or any other financial mar#et fully reflects all availa'le information and data. Peo%le 'uy securities thin#ing that the %rice shall move u%, and they sell securities thin#ing that the %rice shall go do&n. Eo&, according to ?fficient :ar#et Theory, as the %rices fully reflect all the availa'le information, any %rice movement u%&ard or do&n&ard is a matter of luc#. Fo&ever, li#e many Investment Theories, the ?fficient :ar#et Theory has also its %lus and negative %oints. 1H. /IR: /4AED!TI4E TF?4RG The firm1foundation theory argues that each investment instrument, 'e it a common stoc# or a %iece of real estate, has a firm anchor of something called intrinsic value, &hich can 'e determined 'y careful analysis of %resent conditions and future %ros%ects. @hen mar#et %rices fall 'elo& ;rise a'ove< this firm foundation of intrinsic value, a 'uying ;selling< o%%ortunity arises, 'ecause this fluctuation &ill eventually 'e corrected I or so the theory goes. Investing then 'ecomes a dull 'ut straightfor&ard matter of com%aring something(s actual %rice &ith its firm foundation of value. It is difficult to ascri'e to any one individual the credit for originating the firm1foundation theory. . ?liot Duild is often given this distinction, 'ut the classic develo%ment of the techni*ue and %articularly of the nuances associated &ith it &as &or#ed out 'y "ohn B. @illiams. 11. Bife 7ycle Theory of Investing 7lients come to us #no&ing that aside from &hat they create for themselves, there are fe&, if any, relia'le financial safety nets availa'le to them in old age. The defined 'enefit %ension %lan is virtually dead. tate %ension %lans are ac#no&ledged to 'e insolvent. In the real &orld, insolvency means Jno can %ayK. @hat the state &ill eventually do a'out this is an o%en *uestion. tates have reached the %oint &here they are saying, -Ges, &e have a %ro'lem-. They are still &or#ing to&ards -This is &hat &e &ill do a'out it-. /urthermore, %eo%le are living longer and health care costs are increasing. /amily su%%ort is not as availa'le as in %rior generations, and there are some very unrealistic e$%ectations a'out a%%ro%riate savings rates and e$%ected investment returns. !s &e have seen in the mar#et turmoil recently. The &iss mar#et inde$ returned 111L from 188C to ,HHC. To these challenges, the @ealth :anagement industry 'y and large res%onds &ith the old %aradigm vie& outlined in the ta'le 'elo&. @e feel strongly that the ne& %aradigm is far more a%%ro%riate to the challenges and issues facing us today and &e try to incor%orate that into our %lanning and advice.

1,. :!RK4@ITM P4RT/4BI4 ?B?7TI4E TF?4RG The Portfolio Theory also #no&n as :odern Portfolio Theory &as first develo%ed 'y Farry :ar#o&it.. Fe had introduced the theory in his %a%er NPortfolio election &hich &as %u'lished in the "ournal of /inance in 186,. In 188H, he along &ith :erton :iller and @illiam har%e &on the Eo'el Pri.e in ?conomic ciences for the Theory. The theory suggests a hy%othesis on the 'asis of &hich, e$%ected return on a %ortfolio for a given amount of %ortfolio ris# is attem%ted to 'e ma$imi.ed or alternately the ris# on a given level of e$%ected return is attem%ted to 'e minimi.ed. This is done so 'y choosing the *uantities of various securities cautiously ta#ing mainly into consideration the &ay in &hich the %rice of each security changes in com%arison to that of every other security in the %ortfolio, rather than choosing securities individually. In other &ords, the theory uses mathematical models to construct an ideal %ortfolio for an investor that gives ma$imum return de%ending on his ris# a%%etite 'y ta#ing into consideration the relationshi% 'et&een ris# and return. !ccording to the theory, each security has its o&n ris#s and that a %ortfolio of diverse securities shall 'e of lo&er ris# than a single security %ortfolio. im%ly %ut, the theory em%hasi.es on the im%ortance of diversifying to reduce ris#. 10. ?BBIED TF?4RI? elling Theories 1. J!ID! K Theory5 @here ! stands for !ttention I stand for Interest D stand for Desire ! stand for !ction stand for atisfaction ,. Right set of circumstances5 This theory is similar to that of situation res%onse theory. I.e. sales%erson must secure attention, gain interest, %resent and get desired res%onse. It de%ends u%on the s#ills the sales%erson utili.es to a set of circumstances for %redicta'le res%onse. ales %ersonnel try to a%%ly this theory+ although they e$%erience difficulties in many rightful selling situations as it cannot 'e mani%ulated. The set of circumstances includes e$ternal and internal factors &hich the sales%erson tries to create favoura'le for getting desired res%onse from a given situation. This theory is #no&n as seller1oriented theory. 0.JBuying /ormulaK theory of selling5 This theory is #no&n as Buyer1oriented theory .It loo#s out at 'uyers side i.e. needs and e$%ectation . The theory su%%orts the thin#ing %rocess that goes on in %ros%ects mind that causes decision to 'uy=not to 'uy. Buying /ormula Eeed ;%ro'lem< solution %urchase .

ince, %urchase results in continuous relationshi% 'et&een 'uying and selling. o a fourth element must 'e %reset. Eeed ;%ro'lem< solution %urchase satisfaction. @hen need is felt solution may involve t&o com%onents. Eeed ;%ro'lem< solution %urchase satisfn=dissatisfn. To ensure %urchase the com%onent Jtrade nameK must 'e considered ade*uate O 'uyer must e$%erience %leasant feeling. !de*uacy Eeed=%ro'lem %roduct O services and Trade name Purchase satisfaction Pleasant feeling

2. JB?F!VI4R!B ?)A!TI4EKTF?4RG5 Asing timuli1Res%onse :odel, this theory has develo%ed. /our essentials elements re*uired in learning %rocess to e$%lain 'uying 'ehavior and %urchasing decision %rocess. P Drives5 a strong internal stimuli that im%el the 'uyers res%onse 3i<Innate drive ;%sychological< 1ii<learned drive ;status=social< P 7ues5 &ea# stimuli &hen the 'uyers res%ond. i<Triggering cue1activates decision %rocess for given %roduct. ii< Eon triggering cue 3influences the decision %rocess 'ut not activate. iii< %ecific %roduct=information1also functions as triggering cue. P Res%onse5 @hat 'uyer doesQ P Reinforcement5 event that strengthens 'uyers tendency of res%onse. BR P S D S K S V. BRRes%onse. PR Predis%osition=in&ard res%onse tendency ha'it. DR Present drive level. KR incentive %otential i.e. value of the %roduct=%otential satisfaction of the 'uyer. VR Intensity of all customer.

12. TF? 1H P?R7?ET RAB? The Ten Percent Rule

4riginally the rule came into e$istence 'ased on em%irical o'servations &hen it &as seen that out of an action, o'Tects or elements infused, only 1HL &ould reach a %re1desired state and of these, only a further 1HL &ould reach the ultimate desired state. Thin# of it as a

reformed form of a %rinci%le similar to the CH=,H %rinci%le. It is a conservative 'ut safe a%%roach to investment and %articularly a%%lies to ne& forms of investment instruments or %ractices.

Bet us try to understand it &ith the hel% of hy%othetical e$am%le. Bet us say that you invent a ne& form of investment instrument &hich tries to %rice s%eculation or emotions. !s %er the 1H Percent Rule, out of your target investors, only 1HL &ould ever come to #no& a'out this and understand it and of these only 1HL &ill actually invest in the instrument. This in other &ords means that only 1L of you all %ro'a'le customers &ill actually invest. This rule does not state that this &ill ha%%en every time, 'ut the chances are that more often than not, this rule &ill a%%ly to any ne& action infused into the &orld i.e. the success stories &e tal# a'out are the 1L &hich succeed after 88 %revious failed attem%ts. !rgua'ly a theory &ith a lot of limitations, 'ut interesting nonetheless.... The 1H Percent Rule The 1H Percent Rule is one of the Investment Theories. The 1H Percent Rule hel%s the investor in identifying and understanding 'road mar#et s&ings. It is a sim%le rule and assists the investor in avoiding defective value Tudgments. The investor calculates the value of his= her %ortfolio at a s%ecified interval, say every &ee#. 4nce in a month the &ee#ly values are aggregated and average value is determined. In case, the monthly average continues to rise, the investor does not have to ta#e any action 1 the %rofits may 'e allo&ed to run. Fo&ever, a 1H %ercent fall in the monthly value of investments is considered a signal to sell and li*uidate the %ortfolio fully, and sometimes %artially. 4n the other hand, if after such a li*uidation, the notional value of the %ortfolio ;so li*uidated< rises 'y 1H %ercent, it give a signal to 'uy and re1create the same %ortfolio or a different %ortfolio of the same value. In 1H Percent Rule, the construction of the initial and su'se*uent %ortfolio %lays the most significant role. Thus, a %ortfolio of Blue 7hi%s shall %erform differently than a %ortfolio of average stoc#s or "un# toc#s. 16. TF? @IEDB!D TF?4RG

19. Bird in the hand theory

Definition of (Bird In Fand( ! theory that %ostulates that investors %refer dividends from a stoc# to %otential ca%ital gains 'ecause of the inherent uncertainty of the latter. Based on the adage that a 'ird in the hand is &orth t&o in the 'ush, the 'ird1in1hand theory states that investors %refer the certainty of dividend %ayments to the %ossi'ility of su'stantially higher future ca%ital gains. 1>. ignaling theory

ignaling theory is 'ased on the assum%tion that information is not e*ually availa'le to all %arties at the same time, and that information asymmetry is the rule. Information asymmetries ;see also asymmetry 3 issuer=investor< can result in very lo& valuations or a su'1o%timum Investment %olicy. ignaling theory states that cor%orate financial decisions are signals sent 'y the com%any(s managers to Investors in order to sha#e u% these asymmetries. These signals are the cornerstone of financial communications %olicy.

18.

Trade-off theory

Trade1off theory refers to the ca%ital structure &here'y a com%any chooses ho& much de%t finance and ho& much e*uity finance to s%end 'y 'alancing the cost of %rofit or 'enefit. ! trade off is a situation &hich involves loosing or e$changing one(s as%ect of something for gaining another as%ect at no cost. Trade1off theory allo&s the 'an#ru%tcy cost to e$ist. It states that there is an advantage to financing &ith de't ;namely, the ta$ 'enefits of de't< and that there is a cost of financing &ith de't ;the 'an#ru%tcy costs and the financial distress costs of de't<. The marginal 'enefit of further increases in de't declines as de't increases, &hile the marginal cost increases, so that a firm that is o%timi.ing its overall value &ill focus on this trade1off &hen choosing ho& much de't and e*uity to use for financing. ?m%irically, this theory may e$%lain differences in D=? ratios 'et&een industries, 'ut it doesn(t e$%lain differences &ithin the same industry.

18. Dividend Irrelevance Theory

:uch li#e their &or# on the ca%ital1structure irrelevance %ro%osition, :odigliani and :iller also theori.ed that, &ith no ta$es or 'an#ru%tcy costs, dividend %olicy is also irrelevant. This is #no&n as the -dividend1irrelevance theory-, indicating that there is no effect from dividends on a com%any(s ca%ital structure or stoc# %rice. ,H. /inance Theory Eumerous economists have e$%lained the role of finance in the mar#et &ith the hel% of different finance theories. The conce%t of finance theory involves studying the various &ays 'y &hich 'usinesses and individuals raise money, as &ell as ho& money is allocated to %roTects &hile considering the ris# factors associated &ith them. It also includes the study of

money and other assets, managing and %rofiling %roTect ris#s, control and management of assets, and the science of managing money. In sim%le terms, financing also means %rovision and allocation of funds for a %articular 'usiness module or %roTect. There are a num'er of finance theories that offer se%arate a%%roaches to the finance hy%otheses. ome of the maTor %o%ular finance theories of the &orld &ere5 !r'itrage Pricing Theory, Rational 7hoice Theory, Pros%ect Theory, 7umulative Pros%ect Theory, :onte 7arlo 4%tion :odel, Binomial 4%tions Pricing :odel, Dordon :odel, International /isher ?ffect, Blac# :odel, and Begal 4rigins Theory. The !r'itrage Pricing Theory, for e$am%le, addresses the general theory of asset %ricing. ,1. Dordon1Bintners Theory It &as also #no&n as the Bird1in1the1hand Theory. It is one of the maTor theories concerning dividend %olicy in an entre%rise. This theory &as develo%ed 'y :yron Dordon and "ohn Bintner as a res%onse to :odigliani and :iller(s dividend irrelevance theory. Dordon and Bintner claimed that :: made a mista#e assuming lac# of im%act of dividend %olicy on firm(s cost of ca%ital. They argued that lo&er %ayouts result in higher costs of ca%ital. They suggested that investors %refer dividend as it is more certain than ca%ital gains that might or might not a%%ear if they let the firm retain its earnings. The authors indicated that the higher ca%ital gains=dividend ratio is, the larger total return is re*uired 'y investors due to increased ris#. In other &ords, Dordon and Bintner claimed that one %ercent dro% in dividend %ayout has to 'e offset 'y more than one %ercent of additional gro&th. Bird1in1the1hand theory &as criticised 'y :odigliani and :iller &ho claimed that dividend %olicy does not affect the firm(s cost of ca%ital and that investors are totally indifferent if they receive more dividend or ca%ital gains. They called Dordon and Bintner(s theory a 'ird1 in1the1hand fallacy indicating that most investors &ill reinvest the dividend in the similar or even the same com%any and that com%any(s ris#iness is only affected 'y its cash1flo&s from o%erating assets.

,,. The :odigliani3:iller theorem

It is a theorem on ca%ital structure, argua'ly forming the 'asis for modern thin#ing on ca%ital structure. The 'asic theorem states that, under a certain mar#et %rice %rocess ;the classical random &al#<, in the a'sence of ta$es, 'an#ru%tcy costs, agency costs, and asymmetric information, and in an efficient mar#et, the value of a firm is unaffected 'y ho& that firm is financed. It does not matter if the firm(s ca%ital is raised 'y issuing stoc# or selling de't. It does not matter &hat the firm(s dividend %olicy is. Therefore, the :odigliani3 :iller theorem is also often called the ca%ital structure irrelevance %rinci%le.

The :odigliani3:iller theorem states that, in the a'sence of ta$es, 'an#ru%tcy costs, and asymmetric information, and in an efficient mar#et, a com%anys value is unaffected 'y ho& it is financed, regardless of &hether the com%anys ca%ital consists of e*uities or de't, or a com'ination of these, or &hat the dividend %olicy is. ! num'er of %rinci%les underlie the theorem, &hich holds under the assum%tion of 'oth ta$ation and no ta$ation. The t&o most im%ortant %rinci%les are that, first, if there are no ta$es, increasing leverage 'rings no 'enefits in terms of value creation, and second, that &here there are ta$es, such 'enefits, 'y &ay of an interest ta$ shield, accrue &hen leverage is introduced and=or increased. The theorem com%ares t&o com%aniesIone unlevered ;i.e. financed %urely 'y e*uity< and the other levered ;i.e. financed %artly 'y e*uity and %artly 'y de't<Iand states that if they are identical in every other &ay the value of the t&o com%anies is the same. ,0. Pure ?$%ectation Theory This theory e$%lains the yield curve in terms of e$%ected short1term rates. It is 'ased on the idea that the t&o1year yield is e*ual to a one1year 'ond today %lus the e$%ected return on a one1year 'ond %urchased one year from today. The one &ea#ness of this theory is that it assumes that investors have no %reference &hen it comes to different maturities and the ris#s associated &ith them. Ta$1Preference Theory Ta$es are im%ortant considerations for investors. Remem'er ca%ital gains are ta$ed at a lo&er rate than dividends. !s such, investors may %refer ca%ital gains to dividends. This is #no&n as the -ta$ Preference theory-. !dditionally, ca%ital gains are not %aid until an investment is actually sold. Investors can control &hen ca%ital gains are reali.ed, 'ut, they can(t control dividend %ayments, over &hich the related com%any has control. ,2. Residual Theory1 Dividends The most easily understood theory of dividend %ayment determination is called the residual theory. !s the name im%lies, this theory holds that firms %ay dividends out of earnings that remain after it meets its financing needs. These are funds for &hich the firm has no immediate use. The %rocedure for a residual dividend %olicy follo&s several ste%s5 1. ,. Determine the firm(s o%timal ca%ital 'udget. Determine the amount of e*uity needed to finance that 'udget. To the e$tent %ossi'le, use the firm(s retained earnings to su%%ly the needed e*uity. Distri'ute any leftover earnings as dividends. The 'asic assum%tion of residual dividend theory is that shareholders &ant the firm to retain earnings if reinvesting them can generate higher rates

0.
2.

Residual dividend %olicy is used 'y com%anies, &hich finance ne& %roTects through e*uity that is internally generated. In this %olicy, the dividend %ayments are made from the e*uity that remains after all the %roTect ca%ital needs are met. This e*uity is also #no&n as residual e*uity. It is advisa'le that those com%anies, &hich follo& the %olicy of residual dividend, should maintain a 'alanced de't=e*uity ratio. If a certain amount of money is left after all forms of 'usiness e$%enses then the cor%orate houses distri'ute that money among its shareholders as dividends. :oreover, it involves the ris# of varia'le dividends. This %olicy hel%s to set a target %ayout. Before o%ting for the %olicy of residual dividend, the earnings that need to 'e retained to 'ac# u% the ca%ital 'udget have to 'e calculated. Then, the earnings that are left can 'e %aid out in the form of dividends to the shareholders. Thus, the issue of ne& e*uities gets considera'ly reduced and this in turn leads to reduction in signaling and flotation costs. The amount %aya'le as dividend fluctuates heavily if this %olicy is %racticed. @hen the total value of %roductive investments is in e$cess of the total value of retained earnings and sustaina'le de't, the com%anies feel the urge to e$%loit the o%%ortunities thus created to %ost%one a fe& investment schemes. ,6. 7a%ital tructure Theory The ma#eu% of the lia'ilities and stoc#holders( e*uity side of the 'alance sheet, es%ecially the ratio of de't to e*uity and the mi$tureof short and long maturities. In finance, ca%ital structure refers to the &ay a cor%oration finances its assets through some com'ination of e*uity, de't, or hy'rid securities. ! firm(s ca%ital structure is then the com%osition or (structure( of its lia'ilities. The :odigliani1:iller theorem, %ro%osed 'y /ranco :odigliani and :erton :iller, forms the 'asis for modern thin#ing on ca%ital structure, though it is generally vie&ed as a %urely theoretical result since it disregards many im%ortant factors in the ca%ital structure %rocess. The theorem states that, in a %erfect mar#et, ho& a firm is financed is irrelevant to its value. This result %rovides the 'ase &ith &hich to e$amine real &orld reasons &hy ca%ital structure is relevant, that is, a com%any(s value is affected 'y the ca%ital structure it em%loys. ome other reasons include 'an#ru%tcy costs, agency costs, ta$es, and information asymmetry. This analysis can then 'e e$tended to loo# at &hether there is in fact an o%timal ca%ital structure5 the one &hich ma$imi.es the value of the firm. References5 htt%5==&&&.investo%edia.com=terms=m=modigliani1millertheorem.as% htt%5==&&&.investo%edia.com=e$am1guide=cfa1level11=fi$ed1income1investments=interest1 rate1term1structure.as%

htt%5==&&&.nasda*.com=investing=glossary=%=%ure1e$%ectations1theory htt%5==&&&.s%ringerreference.com=docs=html=cha%terd'id=,091.html htt%5==finance.ma%sof&orld.com=dividend=stoc#=residual1%olicy.html htt%5=='log'school.com=,H1H=1H=,>=residual1theory1of1dividends= htt%5==financial1dictionary.thefreedictionary.com=7a%italUstructureUtheory htt%5==en.&i#i%edia.org=&i#i=7a%italVstructure