1 / 47

Chapter 1

Chapter 1. The Investment Setting. Learning Objectives. Financial vs. real assets Key considerations in setting investment objectives Changes in investment strategy caused by tax law revisions Relationship of risk and return

eagan
Download Presentation

Chapter 1

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Chapter 1 The Investment Setting

  2. Learning Objectives • Financial vs. real assets • Key considerations in setting investment objectives • Changes in investment strategy caused by tax law revisions • Relationship of risk and return • Three factors that comprise the required rate of return for an investor • Career opportunities in investments

  3. The Investment Setting • Forms of Investment • The Setting of Investment Objectives • Measures of Risk and Return • Actual Consideration of Required Returns • What you will learn • Career Opportunities in Investments

  4. Investment Defined • The commitment of current funds in anticipation of receiving a larger future flow of funds.

  5. Financial vs. Real Assets • Financial Asset • Financial claim on an asset • Real Asset • Tangible asset that may be seen, felt, held, or collected

  6. Forms of Investment

  7. The setting of investment objectives • Risk and Safety of Principal • Current Income versus Capital Appreciation • Liquidity Considerations • Short-Term versus Long-Term Orientation • Tax Factors • Ease of Management • Retirement and Estate Planning Considerations

  8. Risk and Safety of Principal • A BIG QUESTION: • What factors can affect the value of your portfolio?

  9. Risk and Safety of Principal • ANSWER: • Anything that happens during the day, e.g. • A snow storm in the Midwest • Congressional testimony by Ben Bernanke • Surprise earnings announcements • Anything to do with • Finance • Economics • Legal issues • Investors’ psychology • New scientific discoveries • Politics • War

  10. Risk and Safety of Principal • Risk is the variability in the expected return • High return with high risk • Aggressive investors • Pork belly options or futures • Low return with low risk • Conservative investors • Bank Saving accounts, CD’s, T-Bills, T-Notes, and T-Bonds

  11. Current Income vs. Capital Appreciation (trade-off) • Current income • Objective: Income NOT growth • Bond Interests and stock dividends • High-yielding utilities, mature industries, … • Capital appreciation • Objective: Price gains NOT income • Increase in value - NO cash dividends • High growth industries

  12. Liquidity Considerations • Liquidity is measured by the ability to convert an investment quickly into cash at fair market value • Other Liquidity Factors

  13. Other Liquidity Factors • Transaction costs • Commissions • Difference between “bid” and “ask” price • Alternative investment opportunities with higher/unusual expected returns • Arbitrage EXAMPLES – (with hindsight!) IPO’s of • Microsoft • Amazon.com • eBay

  14. Short-Term versus Long-Term Orientation • Short term (one year or less) • Intermediate term (between 1 to 10 years) • Long term (over 10 years) • Diversification of maturity dates

  15. SHORT TERM PESPECTIVE • Traders • Short term market tactics • Investment horizon = days, hours, or seconds • Technical analysis • Market indicator series • Charting • Moving averages • Ceilings, floors, turning points,…

  16. LONG TERM PESPECTIVE • Investors • Buy and hold • Fundamental analysis • Growth rate in sales, market share,… • Earnings per share (EPS), profit margin,… • Financial Statement Analysis • Balance sheet • Income statement • Cash flow statement

  17. Tax Factors • High tax brackets • Municipal bonds • Tax free • Real estate • Depreciation & interest write-offs • Tax credits • Tax shelters • Tax Relief Act of 2003

  18. Tax Relief Act of 2003 • 15% tax on dividends and long-term capital gains through 2008 • 5% tax on dividends and long-term capital gains for taxpayers in the 10% and 15% brackets through 2007, and 0% in 2008

  19. Tax Relief Act of 2003Please click on the hyperlink icons www.ustreas.gov www.turbotax.com

  20. Ease of Management • “Professional investment managers” vs. “do-it-yourself approach” • Manager’s fee versus possible higher return • Opportunity costs • Time needed to analyze, choose, & manage • Psychic income • Leisure time

  21. Retirement and Estate Planning Considerations • When is the best time to start a retirement plan? • As early as possible • TAX BENEFIT • COMPOUNDING EFFECT • Other factors: • Personal or family obligations • Legal issues

  22. EXAMPLE - Calculating the dollar Amount of Retirement Funds Using Excel Please click on the Excel icon

  23. Inflation • General increase in prices for goods and services • Purchasing power falls • Example: If inflation = 2%, then a $1 pack of gum will cost $1.02 in a year.

  24. Inflation – Why should I worry?Impact of 6% inflation over 20 years Please click on Excel icon– sample calculation

  25. Measures of Risk and Return CALCULATING THE RATE OF RETURN IN PERCENTAGE

  26. Measures of Risk and Return P1 = Price at the end of the period P0 = Price at the beginning of the period D1 = Dividend income

  27. Measures of Risk and Return P1 = $22P0 = $20D1 = $1

  28. Measures of Risk and Return P1 = $22P0 = $20D1 = $1

  29. RISK – comparing investments • Uncertainty associated with outcomes from an investment • The higher the risk, the higher the expected return (compensation) • Greater uncertainty displayed with wider dispersion • Higher variance and higher standard deviation

  30. Examples of Risk

  31. RISK – of a security relative to the market expressed as beta

  32. Actual Consideration of Required Return • The real rate of return. • The anticipated inflation factor. • The risk premium.

  33. Real Rate of Return • The return investors require for allowing others to use their money • The annual percentage return realized on an investment • Before inflation • Before consideration of risk

  34. Anticipated Inflation Factor • Inflation factor added to the real rate of return

  35. Anticipated Inflation Factor • Example: 2% real-rate-of-return 3% anticipated rate of inflation

  36. Risk Premium • Extra return over the risk free rate to compensate for market riskA higher rate of return is required to entice investors into a riskier investment

  37. Three Key Components of Total Required Rate of Return

  38. Three Key Components of Total Required Rate of Return

  39. Risk-Return Characteristics

  40. Compound Annual Rates of Return by Decade (in percent)

  41. Appendix 1A: Career Opportunities in Investments • Stockbroker • Security Analyst • Portfolio Manager • Mergers and Acquisitions • Investment Banker • Financial Planner

  42. 30 Largest U.S. Brokerage Houses

  43. Topics Covered in CFA Exams

More Related