Equity

categories provided by DFM: (1) Shares: The DFM market lists various share

types, such as ordinary shares that provide investors with a stake of the

company, preferred shares that are virtual and issued by the companies and

traded in the market, and rights shares. Ownership in companies has limits in

order to avoid any obstacles for companies. (2) Dual listed shares: This type

of share is when companies list and trade their shares in more than one stock

exchange. An example of that could be RAK Ceramics, which is traded on the Abu

Dhabi Securities Exchange (ADX) and the Dhaka Stock Exchange in Bangladesh. (3)

Other financial instruments: DFM is working closely with the SCA to introduce

more financial instruments to benefit investors, and these include Short

Selling (not included currently), Market Makers, ETFs, Mutual Funds, and many

more.

DFM was the

first market to consolidate its operations with NASDAQ Dubai to facilitate

transactions for investors and provide them with more asset classes to choose

from, while each market is regulated separately. Dubai Financial Market

provides investors with a wide diversity of economic sectors, such as banking,

transportation, insurance, consumer staples sectors etc…

UAE Securities

and Commodities Authority (SCA) regulates the DFM market and issues laws and

standards to ensure maximum protection and security for investors and

introduced an initiative (Margin Trading and Delivery v Payment mechanism).

Demand exceeded

expectations and reached AED 201 Billion. It became publicly listed on 7th

March 2007 and was the first regional exchange to become publicly listed.

Furthermore, DFM is Sharia compliant reflecting His Highness Sheikh Mohammad

Bin Rashid Al Maktoum’s vision for the Emirate.

The DFM was

first launched on 26 March 2000 by Government of Dubai with a Decree of

14/2000. It became a public shareholding company on 27th December 2005, with a

very high IPO and 20% capital issued on the stock exchange.

The DFM market

has strengthened the Dubai market and made it the most successful financial

centre hub in the region in a very short time period. It is a secondary market

for trading securities for publicly listed companies and institutions, bonds,

notes and T-bills issued by the federal government, in addition to mutual funds

and diverse financial instruments.

About DFM Equity Market

is the beta of asset i at time t.

where

A simple regression allows to estimate the beta of an

asset starting from the time series of risk-free rate and market returns. The

regression takes the form

The graph of the beta against the volatility is called

Security Market Line (SML). It is the line where all efficient portfolios lie.

is the weight of the market in the portfolio.

is the expected return of the market.

where

It is possible to derive the CAPM from decomposing a

portfolio between an asset and the market. Consider forming a portfolio p by investing an amount

in a risky asset I, and an

amount

in the market portfolio m. The expected return of

the portfolio is then given by

Moreover, the risk associated to an asset is dependent

on its covariance with the market portfolio. The asset is affected by the

market causing undiversifiable systematic risk that should be compensated;

according to the relationship between excess return of the asset and excess

return of the market.

Recall that one of the main findings of CAPM is the

identification of the market portfolio as the tangent portfolio (Schneeweis, et

al, 2010).

The opposite works for low-beta stocks, which are less

sensitive to market changes and less risky, yielding lower discount rate and

higher present value for the stock.

It is known that beta measures the volatility, which

in fact is proportional to the riskiness of the asset. The higher the beta, the

higher the discount rate, and the lower the present value of the future cash

flows, with a resulting lower present value of the asset.

The CAPM model applied to an asset gives the right

discount rate for the future cash flows generated by it. Such a rate depends on

the riskiness of the asset compared to the market, as defined by the beta.

The factor

called the beta

(beta) of the asset

shows the proportionality of the asset risk premium to the market risk premium.

The resulting model is the CAPM and is typically written as:

The formula of the CAPM can be simplified as

In case of a null covariance with the market, the

asset has no risk attached, and can only earn the risk-free rate, in normal

market conditions. On the other hand, for a value of the covariance equal to

one, the asset is perfectly related to the market, earning the market return.

The expected premium on asset i should be equal to the risk premium per each unit of risk

multiplied by the relationship of the asset with the market, expressed in the

form of covariance.

The right compensation for each asset is calculated

according to the covariance between the asset and the market (Lintner, 1965).

As shown in the graph

above, a direct relation is drawn between the risk premium and the excess

return on the market. On the other side, there is an inverse relation with the

market risk, known as variance.

If an investor holds an amount of market portfolio,

the single asset risk compensation should be an effect of how the single asset

behaves compared to the market; as CAPM states (Sharpe,1964)

–

The market

is characterized by homogeneous information for all investors

–

Funds are

lent and borrowed at the same risk-free rate

–

Investors

optimize the investment in the risk-return space, as by MPT

–

The holding

period of the assets is the same for all investors

–

Markets are

frictionless, and transactions are free of costs

–

Markets are

complete with price taking investors

The main assumptions underlying the derivation of CAPM

are

Moving on, investors invest their money between

risk-free and tangency portfolio held in same proportions by all of them,

however, this is based on assumptions.

The CAPM model mentioned above, identifies the

tangency portfolio that lies on both the efficient frontier and CML, as the

market portfolio, and relating the price of any asset on the market to the

market itself.

is the dependence

factor between market and asset.

is the return of the

market.

where

Recalling, the (Capital

Market Line) CML illustrates the relationship between the excess return of an

asset and the excess return of the market; as a line in the risk-return

space.

Moreover, investors tend to hold combinations of the risk-free rate and

tangency portfolio. At last, the systematic risk of the asset is a proportion of the market risk and the risk

premium of an asset is proportional to its systematic risk.

On the other side, Modern portfolio theory determines the right expected

return on a portfolio of assets. The main point of this method is

diversification towards elimination of all non-systematic risk.

However, after the premium is calculated it is multiplied by a

coefficient called “Beta”. Beta measures how risky an asset is in proportion to

the market risk. This links between the expected return on the asset and the

risk premium in the market.

This model’s beginning point is the risk-free rate as

a benchmark for measuring a risk premium controlling the expected return on

some specific asset. The premium is demanded by the investors as compensation

for the risk.

The Capital Asset Pricing Model (CAPM) describes and

comprehends issues through mathematical demonstration of systematic risk;

proven to be a solution for the issue of risk measurement and remuneration as

depicted by Corelli (2016).

CAPM Model and Efficiency

3. In addition, possible impact of the introduction of

short selling to the model is analyzed

2. The task is solved by drawing the efficient

frontier, CML and SML of the market.

1. The purpose of the research is to analyze the DFM

equity market in Dubai

Outline points