Assignment

Course title: Financial Engineering

Course no: FNB-405


Submitted To:

Mr. Nafeez Al Tarik
Course Instructor



Submitted By:

Name Students Id
Md. Shahruk Kabir 1258


BBA Program
Batch - 02







Savar, Dhaka-1342
April 10, 2014

Department of Finance & Banking
Jahangirnagar University



Assignment 01
Index: A factual measure of progress in an economy or a securities market. On account of money related
markets, a record is a nonexistent arrangement of securities speaking to a specific business sector or a part of
it. Each one list has its estimation approach and is normally communicated as far as a change from a base
quality. Consequently, the rate change is more imperative than the genuine numeric worth. Stock and
security market files are utilized to build file shared subsidizes and trade exchanged trusts (Etfs) whose
portfolios reflect the parts of the record.

Classification of Index: The classification of the index varies from country to country and each has unique
methodology. Therefore indexes can be classified and characterized by the below points:
Construction
Breadth
Region
Specialty Indexes

Index weighting methods: There are several different methods for weighting the shares of each security in
an index. The method chosen will result in certain biases and benefits. The three basic methods are price
weighted, value weighted and equal weighted. Recently there has also been a surge in fundamentally
weighted indices.
Price weighted indices are developed by adding the share price of each security and dividing the
total by the number of securities in the index. The primary advantage of this method is that it is easy
to calculate. It is also relatively easy to obtain historical pricing information, which allows back
testing of the index. This method is equivalent to buying the same number of shares of each company
in the index. For investors who follow such a strategy this method will provide a reasonable
benchmark. Furthermore, since it is based on a constant number of shares it is not necessary to re-
weight the index due to daily price fluctuations.
Value weighted indices are based on the market capitalization of each company included in the
index. In cases where certain shares (possibly resulting from family ownership) are not regularly
traded the weighting may be based on the float, or traded shares. Value weighted indices returns
track the return of all the publicly traded shares in the index. Advantages of this method are that it
automatically adjusts for corporate actions and share price changes. It also reflects the economic
changes in the overall stock market more accurately.
Equal weighted indices invest the same dollar amount in each stock. The method is easy to initially
construct and is probably more similar to the way many investors actually weight their holdings.
However, daily price fluctuations can alter the weight of each security, necessitating frequent
rebalancing (and associated transaction costs.) This method also assigns a higher relative weight to
small companies than to larger ones.
Fundamentally weighted indices weight the securities according to fundamental factors such as
sales, earnings or book value. The portfolio would only need to be rebalanced when such
fundamental factors are reported (generally no more frequently than quarterly.) Such indices
overweight shares of companies with high fundamental characteristics regardless of whether those
characteristics translate into value. Another disadvantage is that few investors employ such a
strategy, making its value as a benchmark questionable.

Index Construction Methodology: The construction methodology of an index varies because each of the
indexes is different and has its own methodology and criteria. In Bangladesh, The Dhaka Stock Exchange has
two indexes and I have taken DSE as an example to address the construction methodology of the index. These
are constructed by the following criteria.
Market Capitalization
Liquidity
Financial viability
Sector Classification
Base Date
Base Value
Moreover, these two indexes have been constructed and the methodology is Free-float methodology. These
indexes were designed by Standard and Poor.

How many Index in BD/DSE:
Stock Market Index
DSE (Dhaka Stock Exchange) 01. DSEX

02. DS30

CSE (Chittagong Stock Exchange) 01. CSE30

02. CSCX


DSEX and its construction methodology: DSEX can be considered as the benchmark general index of the
bourse, as it shows the exact price movement of the listed companies. DSEX, the newly-introduced broad
index and composed of 199 companies, will reflect around 97 per cent of the total market capitalization. In
case of DSEX, each of the eligible stocks must have a float-adjusted market capitalization of above Tk 100
million. To exist in the DSEX a stock must have a minimum six-month average daily value traded (ADVT) of Tk
1.0 million as of rebalancing reference date.

DGEN vs. DSEX

The problems with DGEN and the benefits of DSEX: The past file had out of request figuring technique and
subsequently made disarray and bedlam in the business. Additionally, the consideration of Grammeenphone
on the stock exchange constrained DSE to enlist another record. It happened on the grounds that the
benchmark record of DSE shot up more than 764 focuses. In this manner, DSE presented the new file of DSEX.

The DSE General Index (DGEN), presented in 2001 on the nation's fundamental bourse, will be taken off the
screen on and supplanted by DSEX as the principle file. DGEN, ascertained in a wrong system, has been the
most talked-about issue among the retail financial specialists in the course of the most recent five years. The
list soars throughout 2009-2010 proceeding nose-swooping to a record low. It had been declining for more
than two years, inciting the financial gurus to strive for fierce disturbance. In the midst of shows, business
sector controller SEC and other related stakeholders tried pointless exertions to change the file's trajectory.
The DGEN was presented with a base purpose of 817.62 and is continuously discarded when it was 4342.31
focuses. The flaws in the DGEN first went to the fore in November, 2009 when Grameenphone (GP) was
recorded on the DSE. Later, on Jan 28 in the not so distant future, the controller propelled another list, the
DSEX, created by the US-based budgetary administration association Standard and Poor's. The new list is
focused around the free-skim strategy utilized by the world's real files. It is currently being supplanted by
DSEX - a free buoy business sector top weighted record created by the Standard and Poor's. The Benchmark
Index of the DSE - DSEX went around 29.05 focuses or 0.73 for every penny. The blue chip Ds30 file likewise
lost 5.95 focuses or 0.40 for every penny.


Assignment: 02

The yield curve: The yield curve is a line graph that plots the relationship between yields to maturity and
time to maturity for bonds of the same asset class and credit quality. The plotted line begins with the spot
interest rate, which is the rate for the shortest maturity, and extends out in time, typically to 30 years.


Figure: 2.1 yield curve

Steep yield curve: A sharply upward sloping, or steep yield curve, has frequently gone before a monetary
upturn. The presumption behind a soak yield bend is investment rates will start to climb altogether later on.
Moguls request more yield as development broadens on the off chance that they expect fast monetary
development due to the co-partnered dangers of higher swelling and higher investment rates, which can both
damage security returns.

Figure: 2.2 Steep yield curve

Inverted yield curve: An inverted yield curve can be a harbinger of subsidence. At the point when yields on
fleeting securities are higher than those on long haul securities, it proposes that financial gurus anticipate
that investment rates will decrease later on, for the most part in conjunction with a moderating economy and
lower swelling. Generally, the yield bend has gotten altered 12 to year and a half before a subsidence.


Figure: 2.3 Inverted yield curve

Flat yield curve: A flat yield curve exists when there is little or no difference between short- and long-term
yields. This curve frequently signals an economic slowdown


Figure: 2.4 Flat yield curve

0
10
0 5 10 15
Y
i
e
l
d
s

Time to maturity
0
10
0 5 10 15
Y
i
e
l
d
s

Time to maturity
2
3
4
0 2 4 6

Y
i
e
l
d
s


Time to maturity
0
5
10
0 5 10 15 20 25
Y
i
e
l
d
s

Time to maturity
The pure expectations theory: The pure expectation theory (often simply referred to as the expectations
theory) assumes that bond traders establish bond prices and interest rates strictly on the basis of
expectations about future interest rates, and they are indifferent to maturity because they do not view long-
term bonds as being riskier than short-term bonds. If this were true, then the maturity risk premium (MRP)
would be zero, and long-term interest rates would simply be a weighted average of current and expected
future short-term interest rates. It expect that yields at higher developments, (for example, that of 5, 10, or 30
year securities), relate precisely to future acknowledged rates, and are intensified from the yields on shorter
developments. As it were, purchasing a ten year bond is equivalent to purchasing two five year bonds in
progression; you're as sheltered in a ten-year as in a five-year bond. At a careless thought, this ought to be
sure be the situation. Case in point, with the legislature securities in the Us the main hazard and prizes are
conceived of the investment rate return on the loaned sum. There is no noteworthy danger of default
partnered in the transaction. PET additionally assumes that desires of future rates concur precisely with
future rates acknowledged in time. The business is an impeccable indicator of future supply and interest. The
unadulterated desires hypothesis is in a few courses like the effective business sector theory, in that it expect
an immaculate business sector environment where desires are pretty much the main determinant of future
costs.

Liquidity premium: The premium required by investors investing in long-term debt. The liquidity premium
explains the shape of the yield curve, since tying up cash in an investment for a longer period of time exposes
the investor to more risk. The investor will demand a better return to compensate for this risk. For instance
assume an investor is looking at purchasing one of two corporate bonds, each with the same coupon
payments, and time to maturity. Assuming one of these bonds is traded on a public exchange, while the other
is not, the investor will not be willing to pay as much for the non-public bond. The difference in prices, and
yields, the investor is willing to pay for each bond is called the liquidity premium.

Market Segmentation: Market Segmentation is a marketing term referring to the aggregating of prospective
buyers into groups (segments) that have common needs and will respond similarly to a marketing action.
Market division empowers organizations to target distinctive classifications of buyers who see the full
estimation of specific items and administrations uniquely in contrast to each other. By and large three criteria
might be utilized to recognize diverse business sector sections:

1) Homogeneity (regular needs inside section)

2) Distinction (exceptional from different gatherings)

3) Reaction (comparative reaction to market)

For instance, a physical footwear organization may have business sector sections for b-ball players and long-
remove runners. As different gatherings, b-ball players and long-separate runners will react to altogether
different notices.


Preferred habitat: This is a hypothesis on the contributing conduct of security purchasers, expressing that
individual speculators have a favored reach of security development lengths, and will just go outside of this
extent if a higher yield is guaranteed. This hypothesis likewise states that financial specialists favor shorter-
term bonds to longer-term bonds. The favored environment hypothesis is a development on the desires
hypothesis which proposes that long haul yields are an appraisal without bounds expected fleeting yields.
The thinking behind the desires hypothesis is that security speculators just think about yield and are eager to
purchase obligations of any development, which in principle would mean a level term structure unless
desires are for climbing rates. The favored environment hypothesis develops the desire hypothesis by saying
that bond financial guru's consideration in regards to both development and return. It proposes that fleeting
yields will very nearly dependably be lower than long haul yields because of an added premium required to
allure security moguls to buy longer term securities, as well as securities outside of their development
inclination.
References:

http://www.investinganswers.com/financial-dictionary/bonds/expectations-theory-3100
http://www.forextraders.com/forex-analysis/forex-fundamental-analysis/pure-expectations-
theory.html
http://www.investopedia.com/terms/e/expectationstheory.asp
http://www.investopedia.com/terms/m/marketsegmentation.asp
http://www.businessdictionary.com/definition/market-segment.html
http://www.facebook.com/l.php?u=http%3A%2F%2Fwww.sec.gov%2Fanswers%2Findices.htm&h
=AAQHoZDt
http://www.facebook.com/l.php?u=http%3A%2F%2Fwww.dsebd.org%2F&h=AAQHpoZDt
http://www.facebook.com/l.php?u=http%3A%2F%2Farchive.thedailystar.net%2FnewDesign%2Fn
ews-details.php%3Fnid%3D266952&h=AAQHpoZDt
http://www.investopedia.com/terms/y/yieldcurve.asp
http://en.wikipedia.org/wiki/Yield_curve
http://www.investinganswers.com/financial-dictionary/bonds/yield-curve-810
http://www.businessdictionary.com/definition/preferred-habitat-theory.html
http://www.investopedia.com/terms/p/preferred-habitat-theory.asp
http://www.investopedia.com/terms/l/liquiditypremium.asp
http://www.investorwords.com/11674/liquidity_premium_theory.html