mcgraw-hill/irwin copyright © 2008 by the mcgraw-hill
TRANSCRIPT
McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 1Chapter 1
The Investment The Investment SettingSetting
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Investment DefinedInvestment Defined
The commitment of current funds in The commitment of current funds in anticipation of receiving a larger future anticipation of receiving a larger future flow of funds.flow of funds.
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Financial vs. Real AssetsFinancial vs. Real Assets
Financial AssetFinancial Asset• Financial claim on an assetFinancial claim on an asset
Real AssetReal Asset• Tangible asset that may be seen, felt, held, or Tangible asset that may be seen, felt, held, or
collectedcollected
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Forms of InvestmentForms of Investment
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The setting of investment objectivesThe setting of investment objectives
Risk and Safety of PrincipalRisk and Safety of Principal Current Income versus Capital AppreciationCurrent Income versus Capital Appreciation Liquidity ConsiderationsLiquidity Considerations Short-Term versus Long-Term OrientationShort-Term versus Long-Term Orientation Tax FactorsTax Factors Ease of ManagementEase of Management Retirement and Estate Planning Retirement and Estate Planning
Considerations Considerations
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Risk and Safety of PrincipalRisk and Safety of Principal
A BIG QUESTION: A BIG QUESTION: • What factors can affect the value of What factors can affect the value of
your portfolio?your portfolio?
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Risk and Safety of PrincipalRisk and Safety of Principal ANSWER:ANSWER:
• Anything that happens during the day, e.g.Anything that happens during the day, e.g. A snow storm in the MidwestA snow storm in the Midwest Congressional testimony by Ben BernankeCongressional testimony by Ben Bernanke Surprise earnings announcements Surprise earnings announcements Anything to do withAnything to do with
FinanceFinance EconomicsEconomics Legal issuesLegal issues Investors’ psychologyInvestors’ psychology New scientific discoveriesNew scientific discoveries PoliticsPolitics WarWar
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Risk and Safety of PrincipalRisk and Safety of Principal
Risk is the variability in the expected returnRisk is the variability in the expected return
• High return with high riskHigh return with high risk Aggressive investorsAggressive investors
• Pork belly options or futuresPork belly options or futures
• Low return with low riskLow return with low risk Conservative investorsConservative investors
• Bank Saving accounts, CD’s, T-Bills, T-Notes, and Bank Saving accounts, CD’s, T-Bills, T-Notes, and T-BondsT-Bonds
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Current Income vs. Capital Current Income vs. Capital Appreciation (trade-off)Appreciation (trade-off)
Current incomeCurrent income• Objective: Income NOT growthObjective: Income NOT growth
Bond Interests and stock dividendsBond Interests and stock dividends High-yielding utilities, mature industries, …High-yielding utilities, mature industries, …
Capital appreciationCapital appreciation • Objective: Price gains NOT incomeObjective: Price gains NOT income
Increase in value - NO cash dividendsIncrease in value - NO cash dividends High growth industriesHigh growth industries
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Liquidity ConsiderationsLiquidity Considerations
Liquidity is measured by the ability to Liquidity is measured by the ability to convert an investment quickly into cash convert an investment quickly into cash at fair market valueat fair market value
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Other Liquidity FactorsOther Liquidity Factors Transaction costsTransaction costs CommissionsCommissions Difference between “bid” and “ask” priceDifference between “bid” and “ask” price Alternative investment opportunities with Alternative investment opportunities with
higher/unusual expected returnshigher/unusual expected returns• ArbitrageArbitrageEXAMPLES – (with hindsight!) IPO’s ofEXAMPLES – (with hindsight!) IPO’s of
MicrosoftMicrosoft Amazon.comAmazon.com eBayeBay
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Short-Term versus Long-Term Short-Term versus Long-Term OrientationOrientation
Short term (one year or less)Short term (one year or less) Intermediate term (between 1 to 10 years)Intermediate term (between 1 to 10 years) Long term (over 10 years)Long term (over 10 years) Diversification of maturity dates Diversification of maturity dates
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SHORT TERM PESPECTIVESHORT TERM PESPECTIVE TradersTraders
• Short term market tacticsShort term market tactics Investment horizon = days, hours, or Investment horizon = days, hours, or
secondsseconds• Technical analysis Technical analysis
Market indicator seriesMarket indicator seriesChartingChartingMoving averagesMoving averagesCeilings, floors, turning points,…Ceilings, floors, turning points,…
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LONG TERM PESPECTIVELONG TERM PESPECTIVE
InvestorsInvestors• Buy and holdBuy and hold• Fundamental analysisFundamental analysis
Growth rate in sales, market share,…Growth rate in sales, market share,… Earnings per share (EPS), profit margin,…Earnings per share (EPS), profit margin,… Financial Statement AnalysisFinancial Statement Analysis
• Balance sheetBalance sheet• Income statementIncome statement• Cash flow statementCash flow statement
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Tax FactorsTax Factors
High tax bracketsHigh tax brackets• Municipal bondsMunicipal bonds
Tax freeTax free
• Real estateReal estate Depreciation & interest write-offsDepreciation & interest write-offs
• Tax creditsTax credits• Tax sheltersTax shelters
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Ease of ManagementEase of Management
““Professional investment managers” vs. Professional investment managers” vs. “do-it-yourself approach”“do-it-yourself approach”• Manager’s fee versus possible higher returnManager’s fee versus possible higher return• Opportunity costsOpportunity costs• Time needed to analyze, choose, & manage Time needed to analyze, choose, & manage • Psychic incomePsychic income• Leisure timeLeisure time
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Retirement and Estate Planning Retirement and Estate Planning ConsiderationsConsiderations
When is the best time to start a retirement When is the best time to start a retirement plan?plan?
As early as possibleAs early as possible• TAX BENEFITTAX BENEFIT• COMPOUNDING EFFECTCOMPOUNDING EFFECT
Other factors:Other factors:• Personal or family obligationsPersonal or family obligations• Legal issuesLegal issues
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EXAMPLE - Calculating the dollar EXAMPLE - Calculating the dollar Amount of Retirement Funds Amount of Retirement Funds
Using ExcelUsing Excel
Please click on the Excel iconPlease click on the Excel icon
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InflationInflation
General increase in prices for goods and General increase in prices for goods and servicesservices
Purchasing power fallsPurchasing power falls
Example: If inflation = 2%, then a $1 pack Example: If inflation = 2%, then a $1 pack of gum will cost $1.02 in a year.of gum will cost $1.02 in a year.
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Inflation – Why should I worry?Inflation – Why should I worry?Impact of 6% inflation over 20 yearsImpact of 6% inflation over 20 years
Please click on Excel icon– sample calculationPlease click on Excel icon– sample calculation
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CALCULATING THE RATE OF RETURN IN CALCULATING THE RATE OF RETURN IN PERCENTAGEPERCENTAGE
valueBeginning
Income value)Beginning - Value (Ending return of Rate
Measures of Risk and ReturnMeasures of Risk and Return
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PP11 = Price at the end of the period = Price at the end of the period
P P00 = Price at the beginning of the period = Price at the beginning of the period
D D11 = Dividend income = Dividend income
0
101 )( return of Rate
P
DPP
Measures of Risk and ReturnMeasures of Risk and Return
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PP11 = $22 = $22
PP00 = $20 = $20
DD11 = $1 = $1
%1515.
20$
3$
$20
1$20$$22 return of Rate or
Measures of Risk and ReturnMeasures of Risk and Return
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RISK – comparing investmentsRISK – comparing investments
Uncertainty associated with outcomes from Uncertainty associated with outcomes from an investmentan investment
The higher the risk, the higher the expected The higher the risk, the higher the expected return (compensation)return (compensation)
Greater uncertainty displayed with wider Greater uncertainty displayed with wider dispersion dispersion • Higher variance and higher standard deviationHigher variance and higher standard deviation
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Examples of RiskExamples of Risk
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RISK – of a security relative to the RISK – of a security relative to the market expressed as betamarket expressed as beta
beta beta ββ ImplicationImplication
ββ = 1 = 1 Move in tandem with the marketMove in tandem with the market
ββ >1 >1 More risk than the marketMore risk than the market
ββ <1 <1 Less risk than the marketLess risk than the market
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Actual Consideration of Actual Consideration of Required ReturnRequired Return
1.1. The real rate of return.The real rate of return.
2.2. The anticipated inflation factor.The anticipated inflation factor.
3.3. The risk premiumThe risk premium..
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Real Rate of ReturnReal Rate of Return
The return investors require for allowing The return investors require for allowing others to use their moneyothers to use their money
The annual percentage return realized on The annual percentage return realized on an investmentan investment• Before inflationBefore inflation• Before consideration of riskBefore consideration of risk
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Anticipated Inflation FactorAnticipated Inflation Factor
Inflation factor added to the real rate Inflation factor added to the real rate of returnof return
1- inflation) of rate Expected rate)(1 Real (1 rate freeRisk
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Anticipated Inflation FactorAnticipated Inflation Factor
Example:Example: 2% real-rate-of-return2% real-rate-of-return
3% anticipated rate of inflation3% anticipated rate of inflation
5.06%or.05061-1.05061- .03) .02)(1 (1 rate freeRisk
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Risk PremiumRisk Premium
Extra return over the risk free rate to Extra return over the risk free rate to compensate for market riskcompensate for market risk A higher rate of return is required to entice A higher rate of return is required to entice investors into a riskier investment investors into a riskier investment
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Three Key Components of Three Key Components of Total Required Rate of ReturnTotal Required Rate of Return
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Three Key Components of Three Key Components of Total Required Rate of ReturnTotal Required Rate of Return
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Risk-Return CharacteristicsRisk-Return Characteristics
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Compound Annual Rates of Return Compound Annual Rates of Return by Decade (in percent)by Decade (in percent)
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Appendix 1A: Career Opportunities Appendix 1A: Career Opportunities in Investmentsin Investments
StockbrokerStockbroker Security AnalystSecurity Analyst Portfolio ManagerPortfolio Manager Mergers and AcquisitionsMergers and Acquisitions Investment BankerInvestment Banker Financial PlannerFinancial Planner
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30 Largest U.S. Brokerage Houses30 Largest U.S. Brokerage Houses
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Topics Covered in CFA ExamsTopics Covered in CFA Exams
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WEBSITEWEBSITE COMMENTCOMMENT
http://www.mhhe.com/hirtblock9e Web site for this textbook provides Web site for this textbook provides valuable student resources.valuable student resources.
http://www.aaii.comhttp://www.aaii.com A non profit website educating do it A non profit website educating do it yourself investors.yourself investors.
www.nasdaq.comwww.nasdaq.com Provides information about Nasdaq Provides information about Nasdaq stocks and bonds.stocks and bonds.
www.nyse.comwww.nyse.com Provides information about New Provides information about New York Stock Exchange, listings and York Stock Exchange, listings and regulations.regulations.
www.nareit.comwww.nareit.com Provides information and data about Provides information and data about real estate investment trusts.real estate investment trusts.
www.quicken.comwww.quicken.com Provides understandable coverage Provides understandable coverage of financial planning and investingof financial planning and investing
1-40
WEBSITEWEBSITE COMMENTCOMMENTwww.investopedia.comwww.investopedia.com Provides a general education site Provides a general education site
about stock and investing.about stock and investing.
www.amex.comwww.amex.com Provides information about Provides information about corporate and government bonds.corporate and government bonds.
www.dfin.comwww.dfin.com Provides job search links, loan Provides job search links, loan calculator, financial links, and calculator, financial links, and educational links.educational links.
www.investorwords.comwww.investorwords.com Provides links to finance sites Provides links to finance sites and glossary of finance and glossary of finance technology.technology.
www.business.comwww.business.com Provides a searchable databaseProvides a searchable database
http://www.nasdaqtrader.comhttp://www.nasdaqtrader.com
www.attain.comwww.attain.com
1-41
WEBSITEWEBSITE COMMENTCOMMENT
www.morningstar.comwww.morningstar.com Contains evaluations of and Contains evaluations of and information about stocks and mutual information about stocks and mutual funds.funds.
www.bondmarkets.comwww.bondmarkets.com Provides information about corporate Provides information about corporate and government bonds and government bonds
www.moneyadvisor.comwww.moneyadvisor.com Provides insurance-based financial Provides insurance-based financial calculators and links to financial calculators and links to financial institutionsinstitutions
www.reuters.comwww.reuters.com Contains business and financial Contains business and financial market news for United States and market news for United States and other countries other countries
www.instinet.comwww.instinet.com Four largest electronic Four largest electronic communication networks ECNscommunication networks ECNs
http://www.nextrade.com/http://www.nextrade.com/
1-42
WEBSITEWEBSITE COMMENTCOMMENT
http://www.iclub.comhttp://www.iclub.com Provides information and Provides information and education for investment club education for investment club members.members.
http://web.utk.edu/~jwachowi/part2.htmlhttp://web.utk.edu/~jwachowi/part2.html Created by finance professor with Created by finance professor with links to information resources.links to information resources.
http://www.bloombergtradebook.comhttp://www.bloombergtradebook.com