Financial market refers to the market where people, rather investors buy or sell different kinds of financial securities, shares, bonds, debentures and others (Bond, Edmans & Goldstein, 2012). The transaction cost is low in the financial market and the prices of the securities reflect the demand and supply of the economy. At the time of the making of investment-decision, the investors need to take into consideration various aspects of financial market like the risk factors, the nature of return, the current condition of the economy and many others. Detailed research or analysis of the above-mentioned factors is needed at the time of the making of investment-decision. Different kinds of securities are there in the financial market like direct securities and indirect securities. The determination of securities whether they are direct securities or indirect securities is essential at the time of investments. The type and amount of retune vastly depends on the type of securities.
1: As per the provided case study, Troy Dexter is a wealthy venture capitalist who has his business based on Sydney. He established a hedge fund named ‘Northwest Capital Management’ in the year of 2009. In this regard, it is essential to know about hedge fund. To various kinds of investors, hedge funds have its importance. Hedge funds refer to an alternative investment vehicle that is available for the sophisticated shareholders. Individuals and financial institutions having significant amount of asset base can invest into the hedge funds. On a more presence note, hedge funds pool of securities and with the assistance of hedge funds, people or investors can invest in different kinds of securities. The main motto or objective of hedge fund is to provide higher amount of positive return by minimising different kinds of risk factors related with investment.
It can be seen that hedge funds use the long-short strategies. In the case of long position strategies, the stocks are bought from the share market. On the other hand, in the case of the short position strategies, the securities are sold and they are bought again when the price of the securities has fallen. Apart from this, in many of the cases, it has been seen that large kind of hedge funds invests in financial derivatives. In the process of derivative, the securities are bought and sold with specific prices as per contracts. The hedging fund is not as liquid as the mutual funds. Thus, it implies that the selling of shares under the hedge funds is not an easy process. On the other hand, it has been seen that many hedge funds all over the world have been using the strategy of advantages. In this strategy, the investment process is done with the borrowed money. This strategy has been helpful to the investors to derive higher amount of positive retunes. However, the main disadvantage of this strategy is that a high amount of risk is involved in this hedging strategy. Hence, it can be said that in spite of the possibility of higher amount of positive return, hedging fund includes higher amount of risk (Fergusson & Platen, 2014).
In this regard, another important aspect is the concept of direct and indirect securities. At the time of making the investment decision, all the investors are required to consider the factors of direct or indirect securities. It can be seen that there is a huge difference between the concept of direct securities and indirect securities. In case of the direct securities, the investors own the particular assets in which the investment has been made. In the process of direct securities, the investors are responsible for their investments and they have total control over their investments. In case of the direct securities, the process of investment is totally depends on the investors himself. The investors do not have to depend on any third person or intermediaries at the time of investing in the direct securities. At the time of investing in the direct securities, the investors need to take all the risks and for this reason, he takes all the rewards from these kinds of direct securities. The process of investing in the direct securities is a time consuming process as it is not easy like investing in share and bonds (Chan, 2017).
The concept of indirect securities is different from the concept of direct securities. In the process of investing in indirect securities, the investors use the investment vehicle to pool the money of the investors. In case of the indirect investments, the inventors do not own the property and the process of indirect investment need to be carries out with the help of a third party or an intermediate. In case of the indirect securities, the investors borrow different kinds of funds from the financial market with the help of the intermediaries (Davis & Lewis, 2013). As per the provided case study, Troy Dexter is investing his own money in the new hedging fund called Northwest Capital Management. Apart from his own money, Troy Dexter has made the fund open for the other investors so that they can also invest in this particular hedging fund. As per the vision of Troy Dexter, the continuous growing housing market of Australia is to going to fall and the economic growth of the country will be shattered. In this kind of situation, he is buying treasury bonds and energy stocks in the share market. In this situation, Troy Dexter is not taking the help of any third party or intermediaries at the time of buying the treasury bonds and energy shares. On the other hand, he has the ownership of the properties or money that he has invested in the hedging funds. All the risks regarding this particular investment are beared by him and for this reason, he can get all the rewards from this hedging fund. All these above-mentioned factors are matching with the major characteristics of direct securities. Hence, from the perspective of Northwest Capital Management, the treasury bonds and the energy stocks are the direct securities.
2. The above discussion shows the various components of direct securities and indirect securities. According to the above discussion, in the process of the investment of the indirect securities, the investors do not invest directly in the property or shares. The performance of these kinds of properties or shares is totally based on some measures of the performance of the properties. In case of the process of the investment of indirect securities, the investors have to largely depend on the skill and expertise of other people that is the portfolio manager and others. The process of investment fully depends on the portfolio managers who carry on the total process of investment. The selection of the shares of the companies or the bonds depends on the portfolio manager. Another important aspect is the ownership of the properties. In case of the investment process of indirect securities, the investors do not have the ownership of the properties and they do not have to bear all the risk factors of the portfolio. Due to the presence of fewer amounts of risks, the opportunities of gaining a higher amount of properties become lesser (Scholtens, 2014).
As per the question of the provided case study, an investor has invested her money in Troy Dexter’s Northwest Capital management. In this case, the investor has invested his money with the help of Troy Dexter in the share and bond portfolio. In this process, the investor needs to depend on the Troy Dexter for the management of his investment. She does not need to take any additional risks and this is the reason she is going to get less amount of return. Another crucial aspect is the fee that the investor needs to pay to Troy Dexter for the management of her investments. Hence, from the above discussion, it can be seen that the investment of the mentioned investor matches all the criteria to be an indirect investment. All the necessary characteristics that need to be in indirect securities are present in the investment of the investor. Hence, it can be said that the investor does not hold a direct security by investing in Northwest Capital Management, as it is an indirect security.
Conclusion:
From the above discussion, it can be seen that hedging fund is a complex investment process, as many important aspects need to be considered at the time of investment. In this regard, two of the major concepts are direct securities and indirect securities. In the process of the investment of direct securities, the investors have the ownership of the properties and they need to take greater amount of risks. This is the reason the amount of return is higher. On the other hand, in the process of the investment of indirect securities, the investors do not have the ownership and they do not have to take larger risks. This reason leads to less amount of return for the investors.
This section of the report deals with the specific case study of Norwich Tool, which is a large lathe machine shop. It is planning to replace one of its machines with either lathe A or lathe B. Lathe A is automated and computer-controlled lathe, which might lead to increased production of the organisation (Andor, Mohanty & Toth, 2015). On the other hand, lathe B is less costly in comparison to lathe A, as it uses standard technology.
In order to evaluate these two alternatives, the organisation has appointed a financial analyst for developing estimates of initial outlays and relevant cash flows related to each lathe. Therefore, the various capital budgeting techniques like payback period, net present value and internal rate of return have been used for assessing the overall project feasibility. Accordingly, recommendations have been provided to the organisation by assuming that it has either unlimited funds or capital rationing.
|
Cost of Capital |
13% |
|||
|
Years |
Lathe A (in $) |
Lathe B (in $) |
Cumulative Cash Flows (Lathe A) |
Cumulative Cash Flows (Lathe B) |
|
0 |
(660,000) |
(360,000) |
(660,000) |
(360,000) |
|
1 |
128,000 |
88,000 |
(532,000) |
(272,000) |
|
2 |
182,000 |
120,000 |
(350,000) |
(152,000) |
|
3 |
166,000 |
96,000 |
(184,000) |
(56,000) |
|
4 |
168,000 |
86,000 |
(16,000) |
30,000 |
|
5 |
450,000 |
207,000 |
434,000 |
237,000 |
|
Payback Period |
|
|
4.05 years |
3.65 years |
According to the provided case study, it has been identified that Norwich Tool is able to accept those projects, which have maximum payback period of 4 years. As commented by Brunzell, Liljeblom & Vaihekoski (2013), payback period is the amount of time, where the initial outlay of a project could be recovered from the probable cash inflows of the project. The payback period is a significant indicator in deciding whether to undertake a specific project. This is because a project having longer payback period is not a feasible option for investment. In this case, it has been observed that the payback period for lathe A has been 4.05 years and that for project B has been 3.65 years. As the payback period for lathe A is lower than the maximum acceptable payback period of the organisation and vice-versa for lathe B, the latter is a viable option to invest.
|
Cost of Capital |
13% |
||||
|
Years |
Lathe A (in $) |
Lathe B (in $) |
Discounting Factor @13% |
Discounted Cash Flows (Lathe A) |
Discounted Cash Flows (Lathe B) |
|
0 |
(660,000) |
(360,000) |
1 |
(660,000) |
(360,000) |
|
1 |
128,000 |
88,000 |
0.88 |
113,274 |
77,876 |
|
2 |
182,000 |
120,000 |
0.78 |
142,533 |
93,978 |
|
3 |
166,000 |
96,000 |
0.69 |
115,046 |
66,533 |
|
4 |
168,000 |
86,000 |
0.61 |
103,038 |
52,745 |
|
5 |
450,000 |
207,000 |
0.54 |
244,242 |
112,351 |
|
Net Present Value |
|
|
|
58,133 |
43,483 |
|
Internal Rate of Return |
|
|
|
15.95% |
17.34% |
From the above table, it is evident that the NPV of lathe A is $58,133, while that of lathe B is obtained as $43,483. The higher the NPV, the better it is for the organisation, since it would help in maximising the return on investment (Daunfeldt & Hartwig, 2014). In that case, lathe A has higher NPV, which denotes that the organisation should undertake lathe A for maximising return on investment. On the other hand, the IRR for lathe A is 15.95%, while that for lathe B is 17.34%. The greater the IRR, the better it is for the organisation to maximise its overall return (Ghahremani, Aghaie & Abedzadeh, 2012). However, as the projects are mutually exclusive, it is feasible to use NPV method, since it provides more realistic assumptions and greater measure of profitability. Therefore, according to this technique, lathe A needs to be accepted.
In case, the organisation has adequate funds, the first priority needs to be given to lathe B, as it has positive NPV and IRR. In addition, the payback period of lathe B is within the desired payback period of the organisation at the time of commencement of the project (Tang & Chang, 2012). However, it could also consider lathe A, since it would fetch positive NPV with higher IRR, which is greater than the cost of capital.
In case of capital rationing, it is expected that the organisation should choose lathe B, since the payback period is above the desired level. In addition, due to limitation of funds, the organisation could proceed with lathe B, as it fulfils all the basic requirements of the organisation.
Conclusion:
From the above evaluation, it could be stated that lathe B is highly recommended to the organisation, as it has both positive NPV and IRR along with a desired payback period. However, if the organisation has additional funds, it could undertake both the lathes to increase its overall production capacity.
References:
Andor, G., Mohanty, S. K., & Toth, T. (2015). Capital budgeting practices: a survey of Central and Eastern European firms. Emerging Markets Review, 23, 148-172.
Bond, P., Edmans, A., & Goldstein, I. (2012). The real effects of financial markets. Annu. Rev. Financ. Econ., 4(1), 339-360.
Brunzell, T., Liljeblom, E., & Vaihekoski, M. (2013). Determinants of capital budgeting methods and hurdle rates in Nordic firms. Accounting & Finance, 53(1), 85-110.
Chan, K. (2017). Securities markets.
Daunfeldt, S. O., & Hartwig, F. (2014). What determines the use of capital budgeting methods? Evidence from Swedish listed companies. Journal of Finance and Economics, 2(4), 101-112.
Davis, K., & Lewis, M. (2013). 6 The bond market in Australia. International Bond Markets (Routledge Revivals), 130.
Fergusson, K., & Platen, E. (2014). Hedging long-dated interest rate derivatives for Australian pension funds and life insurers.
Ghahremani, M., Aghaie, A., & Abedzadeh, M. (2012). Capital budgeting technique selection through four decades: with a great focus on real option. International Journal of Business and Management, 7(17), 98-119.
Scholtens, B. (2014). Indicators of responsible investing. Ecological Indicators, 36, 382-385.
Tang, Y. C., & Chang, C. T. (2012). Multicriteria decision-making based on goal programming and fuzzy analytic hierarchy process: An application to capital budgeting problem. Knowledge-Based Systems, 26, 288-293.
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