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The
The
Financial Data
Ma!y
o the exercises use real i!a!cial data This is obtai!ed rom %ahoo &i!a!ce $hare prices are obtai!ed by typi!g compa!y !ame i!to the 'Get (uotes) box '*istorical "rices) provides data at a chose! re+ue!cy ,daily- weekly- mo!thly. The data ca! be dow!loaded to a spreadsheet
$ome i!vestme!ts ca! be very success ul. /10-000 i!vested i! $eptember 1001 i! Lastmi!ute.com would have bee! worth /123-132 i! August 1002 410-000 i!vested i! August 1556 i! 7ephalo! would have bee! worth 4108-059 i! $eptember 1002 ,a!d 4160-000 i! 1008.
:ut past per orma!ce is a very poor guide to uture per orma!ce A!d this is despite rece!t headli!es
;ctober 1005 $cie!ti ic America! Maga<i!e Turbocharging the Brain Pills to Ma!e "ou #marter$ % Previe& ' Will a (ill at brea!fast im(rove concentration and memory) and &ill it do so &ithout long term detriment to your health$
And Losses
Losses i! value ca! be eve! more spectacular 410-000 i!vested i! $eptember 1000 i! "alm =!c. would have bee! reduced to 451 by April 1002 A holdi!g i! >uly 1000 o /1? millio! i! #xeter #+uity Growth &u!d would have bee! worth /81-392 i! August 1002 ,the share price ell rom 102.?0 to 0.?0.
*ariability
The
esse!tially eature o stock prices is u!predictable variability #ve! whe! averaged i!to a! i!dex this variability is appare!t "ort olio ma!ageme!t is about copi!g with the variability =!vestme!t a!alysis is about u!derlyi!g lo!ger@term tre!ds The same pri!ciples apply to both
*ariability
*ariability
*ariability
*ariability
Today
+vervie&
This
semester is about i!vestme!t i! i!a!cial port olios =!vestme!t is de i!ed as a sacri ice made !ow to obtai! a retur! later
Two
Real investment is the purchase o la!d- machi!eryetc Financial investment is the purchase o a ApaperA co!tract
+vervie&
Beal
&i!a!cial
i!vestme!t ca! provide i!a!ce or real i!vestme!t decisio!s &i!a!cial i!vestme!t ca! guide real i!vestme!t decisio!s
Financial Investment
There
are !umerous compo!e!ts to i!a!cial i!vestme!t MarketsC where assets are bought a!d solda!d the orms o trade SecuritiesC the ki!ds o securities availabletheir retur!s a!d risks Investment processC the decisio! about which securities- a!d how much o each Financial theoryC the actors that determi!e the rewards rom i!vestme!t ,a!d the risks.
Mar!ets
A
market is a!y orga!i<ed system or co!!ecti!g buyers a!d sellers There are ma!y security markets Markets may have a physical locatio!
;r
Markets
vary i! the securities that are traded a!d i! the way securities are traded
,haracteristics of Mar!ets
There
The
Lo!do! $tock #xcha!ge is a seco!dary market Most activity o! stock excha!ges is i! the seco!dary market
,haracteristics of Mar!ets
Trades
irms Trades o! the seco!dary market do !ot raise additio!al capital or irms The seco!dary market is still importa!t
=t gives li+uidity to primary issues. Dew securities would have a lower value i they could !ot be subse+ue!tly traded =t sig!i ies value. Tradi!g i! assets reveals i! ormatio! a!d provides a valuatio! o the assets. This helps to guide i!vestme!t decisio!s
,haracteristics of Mar!ets
A
,haracteristics of Mar!ets
Markets
$ome
assets- such as most bo!ds- have a ixed li espa! 7ommo! stock have a! i!de i!ite li espa!
Bro!ers
A
broker is a represe!tative appoi!ted by a! i!dividual i!vestor :rokers have two co! licti!g roles
An advisorC a broker ca! o er i!vestme!t advice a!d i! ormatio! A sales personC brokers are rewarded through commissio! a!d have a! i!ce!tive to e!courage trade
full-service broker is a brokerage house that ca! o er a ull ra!ge o services i!cludi!g i!vestme!t advice a!d port olio ma!ageme!t
Bro!ers
A
discount broker o ers a restricted ra!ge o services at a lower price To complete a trade additio!al brokers are !eeded A floor broker is located o! the loor o the excha!ge a!d does the actual buyi!g a!d selli!g A specialist e!sures trade happe!s by holdi!g a! i!ve!tory o stock a!d posti!g prices
#ecurities
The sta!dard de i!itio! o a security isC "A le al contract representin the ri ht to receive future benefits under a stated set of conditions" The piece o paper de i!i!g the property rights held by the ow!er is the security
#ecurities
Mo!ey
market securities
$hort@term debt i!strume!ts sold by gover!me!tsi!a!cial i!stitutio!s a!d corporatio!s They have maturities whe! issued o o!e year or less The mi!imum si<e o tra!sactio!s is typically largeusually exceedi!g 4100-000
1.
Treasury :ills
E$ Treasury :ills are the least risky a!d the most marketable o all mo!ey markets i!strume!ts They represe!t a short@term =;E o the E$ ederal gover!me!t $imilar bills are issued by ma!y other gover!me!ts
#ecurities
Dew 51@ a!d 161@ day T@bills are issued weekly- by auctio! whereas ?1@week T@bills are issued mo!thly. A! active seco!dary market with very low tra!sactio!s costs exists or tradi!g T@bills T@bills are sold at a discou!t rom ace value a!d pay !o explicit i!terest payme!ts.
T@bills
are co!sidered to have !o risk o de ault- have very short@term maturities- a!d have a k!ow! retur! T@bills are the closest approximatio!s that exist to a risk@ ree i!vestme!t
#ecurities
7apital
market securities
=!strume!ts havi!g maturities greater tha! o!e year a!d those havi!g !o desig!ated maturity at all
1.
&ixed i!come securities have a speci ied payme!t schedule :o!ds promise to pay speci ic amou!ts at speci ic times &ailure to meet a!y speci ic payme!t puts the bo!d i!to de ault with all remai!i!g payme!ts. The creditor ca! put the de aulter i!to ba!kruptcy
#ecurities
&ixed
maturity o the bo!ds The creditworthi!ess o the issuer The taxable status o the bo!d
=!come
a!d capital gai!s are taxed di ere!tly i! ma!y cou!tries :o!ds are desig!ed to exploit these di ere!ces
#ecurities
1.1
The gover!me!t issues ixed i!come securities over a broad ra!ge o the maturity spectrum :oth !otes a!d bo!ds pay i!terest twice a year a!d repay pri!cipal o! the maturity date
1.1
7orporate bo!ds
These promise to pay i!terest at periodic i!tervals a!d to retur! pri!cipal at a ixed date These bo!ds are issued by busi!ess e!tities a!d thus have a risk o de ault
#ecurities
1.
7ommo! stock represe!ts a! ow!ership claim o! the ear!i!gs a!d assets o a corporatio! A ter holders o debt claims are paid- the ma!ageme!t o the compa!y ca! either pay out the remai!i!g ear!i!gs to stockholdi!gs i! the orm o divide!ds or rei!vest part or all o the ear!i!gs The holder o a commo! stock has limited liability F the most they ca! lose is the value o the shares
#ecurities
2.
Derivative i!strume!ts
Derivative i!strume!ts are securities whose value derives rom the value o a! u!derlyi!g security or basket o securities The i!strume!ts are also k!ow! as co!ti!ge!t claims- si!ce their values are co!ti!ge!t o! the per orma!ce o u!derlyi!g assets The most commo! co!ti!ge!t claims are options a!d futures 2.1 A! option o! a security gives the holder the right to either buy ,a call optio!. or sell ,a put optio!. a particular asset at a uture date or duri!g a particular period o time or a speci ied price
#ecurities
2.1 A future is the obligatio! to buy or sell a particular security or bu!dle o securities at a particular time or a stated price A uture is simply a delayed purchase or sale o a security 2.2 The corporatio! ca! issue contin ent claims. 7orporate@issued co!ti!ge!t claims i!clude rights a!d warra!ts- which allow the holder to purchase commo! stocks rom the corporatio! at a set price or a particular period o time
#ecurities
?.
=!direct i!vesti!g
The purchase o a shares o a! i!vestme!t port olio A mutual fund holds a port olio o securities- usually i! li!e with a stated policy obGective. !nit trusts i!vest depositorsH u!ds i! bo!ds or e+uities. $i<e is determi!ed by i! low o u!ds. Investment trusts =ssue a certai! ixed sum o stock to raise capital. This ixed capital is the! ma!aged by the trust. The i!itial i!vestors purchase shares- which are the! traded o! the stock market "ed e funds actively ma!age deposits i! excess o /100-000. Trade i! all i!a!cial markets- i!cludi!g derivatives.
-eturn
Return = end - of - period wealth -- beginning - of - period wealth beginning - of - period wealth
V1 V0 r= 100 V0
-eturn
#xample
A!
i!itial i!vestme!t o 410-000 is made. ;!e year later- the value o the i!vestme!t has rise! to 411-?00. The retur! o! the i!vestme!t is
#xample
A!
i!vestme!t i!itially costs 4?-000. Three mo!ths later- the i!vestme!t is sold or 49-000. The retur! o! the i!vestme!t per three mo!ths is
6000 5000 r= 100 = 20% 5000
risk i!here!t i! holdi!g a security is the variability- or the u!certai!ty- o its retur! &actors that a ect risk are 1. Maturity
E!derlyi!g
actors have more cha!ce to cha!ge over a lo!ger hori<o! Maturity value o the security may be eroded by i! latio! or curre!cy luctuatio!s =!creased cha!ce o the issuer de aulti!g the lo!ger is the time hori<o!
7reditworthi!ess
The
gover!me!ts o the E$- EI a!d other developed cou!tries are all Gudged as sa e si!ce they have !o history o de ault i! the payme!t o their liabilities $ome other cou!tries have de aulted i! the rece!t past 7orporatio!s vary eve! more i! their creditworthi!ess. $ome are so lacki!g i! creditworthi!ess that a! active HHGu!k bo!dHH market exists or high retur!- high risk corporate bo!ds that are Gudged very likely to de ault
"riority
:o!d
holders have the irst claim o! the assets o a li+uidated irm :o!d holders are also able to put the corporatio! i!to ba!kruptcy i it de aults o! payme!t
3.
Li+uidity
Li+uidity
relates to how easy it is to sell a! asset The existe!ce o a highly developed a!d active seco!dary market raises li+uidity A securityHs risk is raised i it is lacki!g li+uidity
E!derlyi!g Activities
The
eco!omic activities o the issuer o the security ca! a ect how risky it is $tock i! small irms a!d i! irms operati!g i! high@tech!ology sectors are o! average more risky tha! those o large irms i! traditio!al sectors
greater the risk o a security- the higher is expected retur! Betur! is the compe!satio! that has to be paid to i!duce i!vestors to accept risk $uccess i! i!vesti!g is about bala!ci!g risk a!d retur! to achieve a! optimal combi!atio! The risk always remai!s because o u!predictable variability i! the retur!s o! assets
Ese
a. Tech!ical a!alysis F the exami!atio! o past prices or tre!ds b. &u!dame!tal a!alysis F true value based o! uture expected retur!s
Portfolio Construction
=de!ti
Portfolio #valuation
the per orma!ce o port olio previous three steps
Assess
Portfolio Revision
Bepeat
a! accou!t with a brokerage a!d speci y 1. Dame o irm 1. :uy or sell 2. $i<e o order 3. *ow lo!g u!til order is ca!celled ?. Type o order
Limit
This
is the time withi! which the broker should attempt to ill the order $ay order % ill duri!g the day it is e!tered or else ca!cel &pen order ,or 'ood (ill Cancelled. % remai!s i! e ect u!til illed or ca!celled Fill-or-kill F ca!celled i !ot executed immediately $iscriminatory order F le t to broker
o ;rder
Market
price
)imit
a
o ;rder
or A maximum price is placed above the stop@price or a buy "rice is certai! withi! a ra!ge #xecutio! is u!certai!
Margin Account
A
mar in account with a broker allows or limited borrowi!g to purchase assets A margi! accou!t !eeds a hypothecatio! agreeme!t
a. broker ca! pledge securities as collateral b. broker ca! le!d the securities to others
&or
Margin Account
Margi!
"urchase
:orrow mo!ey rom broker to i!vest The cost o borrowi!g is i!terest plus a service charge
Initial
mar in re*uirement
Actual
mar in
Margin Account
A
actual margi! M mai!te!a!ce margi! the! a mar in call is issued The i!vestor is obliged to add cash or securities to the margi! accou!t
o! margi! purchase
cost N /?0 x 100 N /?000 =!terest rate N 11K =!itial margi! N 90K so loa! N /1000
Betur!
is i!creased
i price alls
#hort #ales
A
short sale is the sale o a security you do !ot ow! This is achieved by borrowi!g share certi icates rom someo!e else The borrowi!g process is arra!ged by a broker To allow shares to be borrowed the broker either
a. Eses shares held i! street !ame b. :orrows rom a!other broker
#hort #ales
%roker
+rovides margin -ends sto k +a&s pri e Re eives sto k ,old C owns sto k
*hort *eller A
'nitial (wner B
%roker
%u&er C
)irm
Reports
*hort *eller A
'nitial (wner B
%u&er C
)irm
#hort #ales
Margi!
There
is a risk i!volved so short seller ,A. must make a! i!itial margi! adva!ce to the broker The broker the! calculates the margi! each day $hort sales should be used whe! prices are expected to all