Professional Documents
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Indirect Investing
Chapter 3
Indirect Investing
Learning Objectives
What is Indirect Investing?
Direct Investing Indirect Investing
Buying & Selling of shares of investment companies, which then hold portfolios of securities. Funds are given to professional money managers to make decisions on an investors behalf (for better or worst) Fees are charged for this service
In-direct Investing
Investment Company?
In-direct Investing
Investment Company?
A financial company which sells shares in itself to the public & uses these funds to invest in a portfolio of securities
particular index, sector, investment style, geographical area or the market as a whole. ETFs unlike mutual funds can be bought on margin & sold short. Tax Efficient Very small premiums & discounts from NAV Unlike mutual Funds, can be traded anytime during the day. Lower Expenses
exempt securities put together by a sponsor & handled by an independent trustee. Redeemable trust certificates representing claims against the assets of the trust are sold to investors at Net Asset Value plus commission.
managed portfolio of securities. Its capitalization is fixed unless a new public offering is made. Shares of closed-end Funds trade on Stock exchanges & hence their prices are determined by forces of supply & demand.
securities held by the investment company on a given day. If NAV > Market price Discount If NAV < Market price Premium NAV = (Market Value of Funds Securities Liabilities) Total Number of shares outstanding
formed by an investment advisory firm that selects the board of trustees (Directors) for the company. The trustees, in turn, hire a separate management company, normally, the investment advisory firm to manage the fund. The number of shares outstanding of an open end investment company is continually changing.
Mutual Funds
Value Funds Vs Growth Funds Index Funds
Hedge Funds
Hedge Funds
Hedge Funds are unregulated companies that seek to exploit
various market opportunities & thereby earn larger returns than are ordinarily available. As hedge funds are unregulated, they may invest in assets not typically available to mutual Funds. A high water mark provision
stock positions, use leverage & are invested in markets world wide.
Market-neutral Funds: These funds take long & short
positions, but the positions will offset each other so that the effect is a net zero exposure to the market.
Global Macro Funds: These funds are typically highly
Fund of Funds
Fund of Funds investing involves creating a fund open to
both individual & institutional investors, which in turn invests in hedge funds. Benefits for investors with limited capital? Benefits for investors with more capital? Drawbacks?
Alternative Investments
Closely held companies Distressed Securities Venture Capital Investing
traded & are not subject to the same SEC regulations as public companies regarding reporting & disclosure. The Cost approach The comparables approach The income approach
already filed for bankruptcy protection, their securities are considered Distressed.
equity investments in business venture. Investments may be made at any point of the business cycle of the company, from the initial planning stage of a new venture to an established firm ready to go public. Long term investment horizon Difficulty in valuation Requirement for extensive operation analysis
calculated as: (1-0.20)*(1-0.20)*(1-0.17)*(1-0.15)*(1-0.15) = 0.3838 NPV if the project survives: [-2.5 m + {12m/(1.155)}] = $3.466121 Million NPV if the project fails: = - $2.5 million (Initial Investment) Expected NPV of the project (Probability weighted average): = (0.3838*3,466,121) + (0.6162* (-2,500,000)) = - $210,203
Assignment # 3
Q1: A venture capital fund manager is considering investing 3.5 million in a new project that he believes will pay $30 million at the end of five years. The cost of equity for the investor is 13% & the estimated probability of failure is presented in the figure below.
Year 1 2 3 4 5 Failure Probability 0.10 0.20 0.07 0.25 0.05
Assignment # 3
Q2: A venture capital fund manager is considering investing 1.75 million in a new project that he believes will pay $25 million at the end of six years. The cost of equity for the investor is 12% & the estimated probability of survival is presented in the figure below.
Year 1 2 3 4 5 6 survival Probability 0.75 0.80 0.80 0.85 0.90 0.95