ch 03 indirect investing
TRANSCRIPT
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Chap 3
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Chapter 3
Indirect Investing
Learning Objectives
What is Indirect Investing?
Direct Investing
Indirect Investing
What is an Investment Company?
What are Types of Investment Companies?
What are Types of Mutual Funds?
What are the mechanics of Investing Indirectly?
What is Investment Company Performance?
What are Exchange Traded Funds?
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DIRECT INVESTING
Non-Marketablesecurities
Money Markets
Capital Markets
Derivatives Markets
INDIRECT INVESTING
Investment Companies Mutual Funds
Stock, Bond Funds
Exchange Traded Funds
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What are major types of Financial Assets?
In-direct Investing
Buying & Selling of shares of investment
companies, which then hold portfolios ofsecurities.
Funds are given to professional money managersto make decisions on an investors behalf (forbetter or worst)
Fees are charged for this service
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What are major types of Financial Assets?
In-direct Investing
Investment Company?
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Exchange Traded Funds
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Exchange Traded Funds An exchange traded fund is a basket of stocks that tracks a
particular index, sector, investment style, geographical areaor 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
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Unit Investment Trusts
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Unit Investment Trusts Unit Investment Trust is an unmanaged portfolio of tax
exempt securities put together by a sponsor & handled by anindependent trustee.
Redeemable trust certificates representing claims against the
assets of the trust are sold to investors at Net Asset Valueplus commission.
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Closed-End Investment Companies
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Closed-End Investment Companies Closed Investment Company offers investors an actively
managed portfolio of securities. Its capitalization is fixedunless 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.
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Closed-End Investment Companies-
Mechanics of Investing Indirectly Net Asset Value- NAV is per share value of portfolio of
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
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Open-End Investment Companies
(Mutual Funds)
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Open-End Investment Companies
(Mutual Funds) Mutual Funds are either corporations or Business trusts
formed by an investment advisory firm that selects the boardof 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.
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Mutual Funds - TypesThere are four basic types of Mutual Funds:1. Money Market Mutual Funds
2. Equity Funds
3. Bond Funds4. Hybrid Funds
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Mutual Funds - Types1. Money Market Mutual Funds No Load Funds
Taxable Vs Tax Exempt Funds
2.Equity Funds Capital Appreciation Fund
Total Return fund
World Equity Fund
3. Bond Funds
4. Hybrid Funds
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Mutual Funds Value Funds Vs Growth Funds
Index Funds
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Mutual Funds- Trading MechanicsMutual Fund Share prices Owners of shares can sell them back to the company anytime
they choose; the mutual fund is legally obligated to redeemthem.
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Mutual Funds- Trading MechanicsFees Vs Expenses Front-End Load
Back-end Load
Management Fee
Distribution Fee (12b-1)
Load & No load Funds
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Hedge Funds
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Hedge Funds Hedge Funds are unregulated companies that seek to exploit
various market opportunities & thereby earn larger returnsthan are ordinarily available.
As hedge funds are unregulated, they may invest in assets
not typically available to mutual Funds. A high water mark provision
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Hedge Funds - Classifications Long/Short Funds: These funds take long & short common
stock positions, use leverage & are invested in markets worldwide.
Market-neutral Funds: These funds take long & shortpositions, but the positions will offset each other so that theeffect is a net zero exposure to the market.
Global Macro Funds: These funds are typically highlyleveraged & rely heavily upon derivatives.
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Fund of Funds Fund of Funds investing involves creating a fund open to
both individual & institutional investors, which in turn investsin hedge funds.
Benefits for investors with limited capital?
Benefits for investors with more capital?
Drawbacks?
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Hedge fund performance
measurementThere are numerous hedge fund indices designed to measurehistorical performance. Some general conclusions regardinghedge funds can be derived:
Hedge Funds have demonstrated a lower risk profile than
traditional equity investments as measured by a standarddeviation.
In recent years, the Sharpe Ratio has been consistentlyhigher for hedge funds than for most equity investments.
There is a low correlation between the performance of hedgefunds & conventional investments.
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Hedge fund performance
measurement - Biases Self selection Bias
Backfilling Bias
Survivorship Bias
Smoothed pricing of infrequently traded assets
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Alternative Investments Closely held companies
Distressed Securities
Venture Capital Investing
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Alternative InvestmentsClosely
held companies The equity shares of closely held companies are not publicly
traded & are not subject to the same SEC regulations aspublic companies regarding reporting & disclosure.
The Cost approach
The comparables approach The income approach
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Alternative InvestmentsDistressed
Securities When companies are on the brink of bankruptcy or have
already filed for bankruptcy protection, their securities areconsidered Distressed.
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Alternative InvestmentsVenture
Capital Investing Venture Capital Investments are private, non exchange traded
equity investments in business venture.
Investments may be made at any point of the business cycleof 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
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Valuing a Venture Capital
Investment - ExampleA venture capital fundmanager is consideringinvesting 2.5 million in anew project that he believes
will pay $12 million at theend of five years. The costof equity for the investor is15% & the estimatedprobability of failure is
presented in the figurebelow.
Year Failure Probability
1 0.20
2 0.20
3 0.17
4 0.15
5 0.15
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Assignment # 3Q1: A venture capital fund
manager is consideringinvesting 3.5 million in anew project that he believes
will pay $30 million at theend of five years. The costof equity for the investor is13% & the estimatedprobability of failure is
presented in the figurebelow.
Year Failure Probability
1 0.10
2 0.20
3 0.07
4 0.25
5 0.05
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Assignment # 3Q2: A venture capital fund
manager is consideringinvesting 1.75 million in anew project that he believes
will pay $25 million at theend of six years. The cost ofequity for the investor is12% & the estimatedprobability of survival is
presented in the figurebelow.
Year survival Probability
1 0.75
2 0.80
3 0.80
4 0.85
5 0.90
6 0.95
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Chapter 3
Indirect Investing
Summary
What is Indirect Investing?
Direct Investing
Indirect Investing
What is an Investment Company?
What are Types of Investment Companies?
What are Types of Mutual Funds?
What are the mechanics of Investing Indirectly?
What is Investment Company Performance?
What are Exchange Traded Funds?
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Thank you for your time
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