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Modern Financial
Investment
Management
Modern Financial
Investment
Management
By

Ephraim Matanda
Modern Financial Investment Management

By Ephraim Matanda

This book first published 2020

Cambridge Scholars Publishing

Lady Stephenson Library, Newcastle upon Tyne, NE6 2PA, UK

British Library Cataloguing in Publication Data

A catalogue record for this book is available from the British Library

Copyright © 2020 by Ephraim Matanda

All rights for this book reserved. No part of this book may be reproduced,
stored in a retrieval system, or transmitted, in any form or by any means,
electronic, mechanical, photocopying, recording or otherwise, without
the prior permission of the copyright owner.

ISBN (10): 1-5275-4294-7

ISBN (13): 978-1-5275-4294-5
This book on Modern Financial Investment Management is dedicated to my
family, my wife Vharawei and my children Fortune Ephraim, Emmanuel
Tatenda, Elisha Nyasha, Elizabeth Paidamoyo and Tabeth Malon. Thank
you guys for your invaluable love and encouragement of my legacy and
indispensable publication endeavours.
 TABLE OF CONTENTS

Acknowledgements .................................................................................. xii

Foreword ................................................................................................. xiii

Chapter One ................................................................................................ 1

The Investment Environment and the Financial System of an Economy
1.0 Objectives
1.1 Introduction
1.2 The Financial System
1.3 Real and Financial Assets
1.4 Financial Markets and their Participants
1.5 Money and Capital Market Frameworks
1.5.1 Money Market Securities
1.5.2 Capital Market Securities
1.5.3 Equity Securities
1.6 The Functions of the Financial System
1.7 Equilibrium in Financial Markets
1.8 Summary
1.9 Exercises

Chapter Two ............................................................................................. 16

Trading of Money Market Securities
2.0 Objectives
2.1 Introduction
2.2 Functional Perspective
2.3 Valuation of Money Market Securities
2.4 The Time Value of Money
2.5 The Nominal and Equivalent Rates of Interest
2.6 Summary
2.7 Exercises

Chapter Three ........................................................................................... 29

The Theory and Conventional Valuation of Bonds
3.0 Objectives
3.1 Introduction
viii Table of Contents

3.2 Theory of Bonds

3.3 Valuation of Bonds
3.4 Yields, Durations and Convexities of Bonds
3.5 Summary
3.6 Exercises

Chapter Four ............................................................................................. 54

Advanced Bond Investment Portfolios and Yield Management
Strategies
4.0 Objectives
4.1 Introduction
4.2 Bond Investments and Dedicated Portfolios
4.3 Bond Portfolio Management Strategies
4.4 Valuation of Shares
4.5 Calculation of Yield or Discount Rates
4.6 Summary
4.7 Exercises

Chapter Five ............................................................................................. 72

Foreign Market Financial Investments
5.0 Objectives
5.1 Introduction
5.2 The Foreign Exchange Markets
5.3 Exchange Rates and the Trading of Currencies
5.4 Revaluation and Devaluation of Exchange Rates
5.5 Money Markets and the Protection of Foreign Market Investments
5.6 Forward Rate Agreements (FRAs) and Financial Dealings
5.7 Summary
5.8 Exercises

Chapter Six ............................................................................................... 93

Financial Market Investments and Portfolio Theory
6.0 Objectives
6.1 Introduction
6.2 Quantification and Assessment of Investment Returns and Risks
6.3 Portfolio Theory and Risk-return Analysis
6.4 Risk and Return to Investment Portfolios
6.5 The N-Asset Portfolio
6.6 Diversification and Portfolio Value Addition
6.7 The Impact of Individual Stocks on Portfolio Risk
6.8 Summary
6.9 Exercises
 Modern Financial Investment Management ix

Chapter Seven......................................................................................... 110

The Capital Asset Pricing Model (CAPM)
7.0 Objectives
7.1 Introduction
7.2 The History of the CAPM
7.3 The Market Investment Portfolio
7.4 Derivation of the Market Portfolio
7.5 The Security Market Line (SML)
7.6 The Beta Coefficient and the CAPM
7.7 The Application of the CAPM
7.8 The CAPM and Cost of Capital (or Equity)
7.9 The Alpha Coefficient and Valuation of Securities
7.10 Summary
7.11 Exercise

Chapter Eight .......................................................................................... 123

The Index and Arbitrage Pricing Models
8.0 Objectives
8.1 Introduction
8.2 The Arbitrage Pricing Theory or Model (APT/APM)
8.3 Derivation and Application of the Three Factor Model
8.4 The CAPM and the Simple Index Model
8.5 Derivation of the Simple Index Model
8.6 Application of the Simple Index Model
8.7 The Index Model and Total Returns to Financial Investments
8.8 Summary
8.9 Exercises

Chapter Nine........................................................................................... 144

Capital Allocation and Investment Decisions
9.0 Objectives
9.1 Introduction
9.2 Risk Tolerance and Asset Allocations
9.3 Allocation of Funds Between Risk-free and Risky Asset Portfolios
9.4 The Optimum Risky Investment Portfolio
9.5 The Complete Financial Investment Portfolio
9.6 The Investor’s Budget and Reward to Variability Ratio
9.7 Summary
9.8 Exercises
x Table of Contents

Chapter Ten ............................................................................................ 155

Valuation of Derivative Securities
10.0 Objectives
10.1 Introduction
10.2 The Theory of Forward and Futures Contracts
10.3 The Valuation of Forward and Futures Contracts
10.4 The Uses of Futures Contracts
10.5 The Theory of Options
10.6 Valuation of Option Contracts
10.7 Dynamic Asset Allocation (DAA)
10.8 Summary
10.9 Exercises

Chapter Eleven ....................................................................................... 202

Hedging of Investments Using Derivative Securities
11.0 Objectives
11.1 Introduction
11.2 Hedging Using Option Contracts
11.3 Hedging With Foreign Currency Futures Contracts (FCFCs)
11.4 Hedging of Investment Portfolios Using Portfolio Insurance
11.5 Hedging Using Forward Contracts
11.6 Hedging Using Futures Contracts
11.7 Hedging With Interest Rate and Currency Swaps
11.8 Summary
11.9 Exercises

Chapter Twelve ...................................................................................... 227

Market Efficiency and the Efficient Market Hypothesis (EMH)
by Eugene Fama
12.0 Objectives
12.1 Introduction
12.2 The Concept of Market Efficiency
12.3 The EMH by Eugene Fama
12.4 Implications of Market Efficiency to Stock Exchange Operations
12.5 Tests of the EMH
12.6 Summary
12.7 Exercises
 Modern Financial Investment Management xi

Chapter Thirteen ..................................................................................... 243

Financial Mergers and Acquisitions
13.0 Objectives
13.1 Introduction
13.2 Strategies and Types of Mergers and Acquisitions
13.3 Pros and Cons for the Growth of Firms
13.4 Contemporary Developments in Mergers and Acquisitions
13.5 Legal Procedures and Mergers and Acquisitions
13.6 Market Valuations of Mergers and Acquisitions
13.7 Mergers’ Exchange Rates Based on the Market Values of Shares
13.8 Codes Used in Takeovers and Mergers of Firms
13.9 Tactics for Mergers and Acquisitions
13.10 Considerations for Mergers and Acquisitions
13.11 Successes and Failures of Mergers and Acquisitions
13.12 Summary
13.13 Exercises

References .............................................................................................. 286

 ACKNOWLEDGEMENTS

My thanks go to the following people without whom this book would not
have been completed as scheduled. I extend special thanks to Reverend
Nyasha Madzokere of the Baptist Church in Zimbabwe, a genuine friend of
mine, for the spiritual, academic influence and support in coming up with
this manuscript. I also give thanks to Ms. Miriam Saungweme, Ms.
Josephine Mushonga and Mr Charles Muziri for the typing services and
adjusting the soft copy of the book for corrections suggested by the
typesetters. Messrs. Hlupeko Dube and Misheck Diza, my former students
and work mates, are also worth mentioning for their professional and
academic advice in the organization and sequencing of the chapters and the
finalization of the manuscript for submission for publication. Lastly, I
extend my utmost thanks to Edison Vengesai, a PhD in Finance graduate
with the University of Kwa-Zulu Natal, South Africa for providing me with
the indispensable editing services of the whole book.
 FOREWORD

The author of the book, Modern Financial Investment Management, is a

senior lecturer in Banking and Finance at the Great Zimbabwe University,
Masvingo, Zimbabwe. It was the author’s observation that most developing
economies the world over have failed to align their development processes
towards the sustainable development path because of lack of financial
resources and/or financial investment strategies. Therefore the writing of
this book was motivated by the author’s need to equip economic players and
the governments of emerging economies with the knowledge and expertise
needed for making finance a tool for their growth and development.
Countries without sufficient financial resources were just as weak as human
bodies without enough blood, hence their continuous failure to grow and
eradicate hunger, starvation, poverty and diseases amongst their people. The
majority of governments of developing countries have failed to invest their
countries’ financial resources since the attainment of political
independence, hence their failure to innovate, grow and develop. The book
is structured in such a way that it starts off with conventional notions of
finance where operations of money and capital markets are put forward
before the examination of financial models such as capital asset pricing,
arbitrage pricing, and three factor and simple index models. Countries are
introduced to conventional financial securities, mainly certificates of
deposit, bills, bonds and shares or stocks which can be traded on financial
markets and their indispensable use in the growth and development of
nations. The book proceeds to evaluate the need for perfect and efficient
market systems in an economy before considering the benefits that
developing countries would draw from the introduction of derivative
markets. Some of the specific benefits that countries would draw from the
introduction of derivative markets were the improved financialization of the
economy, efficiency, transparency, discipline, innovation and technical
progress. Most developing countries have very shallow conventional
financial markets yet on the other hand had abundant resource endowments
which favoured the introduction of derivative markets immediately. The
book concludes by exploring the framework on the acquisitions and mergers
of financial firms and how these can be exploited in order to rescue small
firms from liquidation and financial distress and/or lure much needed
foreign capital for economic growth and development.
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