1 fin 604 introduction and overview 1. investor vs. speculator 2. participants in the investment...
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FIN 604FIN 604Introduction and OverviewIntroduction and Overview
1. Investor vs. Speculator
2. Participants in the Investment Process
3. Steps in Investing
4. Types of Investors and Investments
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Investor Vs. SpeculatorInvestor Vs. Speculator
InvestorInterested in the L-
R holdingAssume moderate
riskInterested in
dividend, interest income as well as capital gains.
SpeculatorInterested in the S-
R holdingAssume high riskPrimarily interested
in capital gains.High rate of return.
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Investor Vs. SpeculatorInvestor Vs. Speculator
InvestorModerate rate of
return.Decision to buy is
made after careful analysis of the past performance
Use own money
SpeculatorDecision to buy is
based on intuitions, rumor, charts or market analysis.
Usually borrowed money.
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Participants in the Investment ProcessParticipants in the Investment Process
1. Federal, state and Local GovernmentsCapital expenditure, operating needs, etc.“Net demander of funds”?
2. BusinessBoth S- T and L-T financial needs.
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Participants in the Investment ProcessParticipants in the Investment Process
•Capital expenditure, mergers & acquisitions, etc
“Net demander of funds”?
3. HouseholdsBoth S- T and L-T financial needs.Loans. Mortgages, car loans , etc“Net suppliers of funds”?
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Steps in InvestingSteps in Investing Explain Investment
Sacrifice of current consumption for future consumption.
Life Cycle Hypothesis Steps in Investing
1. Meeting Financial Plan Preliminaries2. Establishing Investment Goals3. Evaluating Investment Vehicle4. Selecting Suitable Investment5. Constructing a Diversified Portfolio
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Individual InvestorIndividual InvestorLife CycleLife Cycle
Accumulation phase – early to middle years of working career
Consolidation phase – past midpoint of careers. Earnings greater than expenses
Spending/Gifting phase – begins after retirement
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Individual Investor Life Individual Investor Life CycleCycle
25 35 45 55 65 75
Net Worth
Age
Accumulation Phase
Long-term: Retirement Children’s college
Short-term: House Car
Consolidation Phase
Long-term: Retirement
Short-term:
Vacations
Children’s College
Spending Phase Gifting Phase
Long-term: Estate Planning
Short-term: Lifestyle Needs Gifts
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Financial Plan PreliminariesFinancial Plan Preliminaries
Insurance– Life insurance
Term life insurance - Provides death benefit only. Premium could change every renewal period
Universal and variable life insurance – provide cash value plus death benefit
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Financial Plan PreliminariesFinancial Plan Preliminaries
Insurance– Health insurance– Disability insurance– Automobile insurance– Home/rental insurance– Liability insurance
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Financial Plan PreliminariesFinancial Plan Preliminaries
Cash reserve– To meet emergency needs– Includes cash equivalents (liquid
investments)– Equal to six months living expenses
recommended by experts
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Investment ObjectivesInvestment Objectives
Risk ToleranceAbsolute or relative percentage
returnGeneral goals
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Investment ObjectivesInvestment ObjectivesGeneral Goals
Capital preservation– minimize risk of real loss
Capital appreciation– Growth of the portfolio in real terms to meet
future need
Current income– Focus is in generating income rather than capital
gains
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Investment ObjectivesInvestment Objectives
General GoalsTotal return
– Increase portfolio value by capital gains and by reinvesting current income
– Maintain moderate risk exposure
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Investment ConstraintsInvestment Constraints Liquidity needs
– Vary between investors depending upon age, employment, tax status, etc.
Time horizon– Influences liquidity needs and risk tolerance
Tax Consideration– Capital gains Vs. Dividend income– Realized Vs. Unrealized Capital gains– Tax planning Vs. Diversification
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Equivalent Taxable YieldEquivalent Taxable Yield
RateTax Marginal1
Yield MunicipalETY
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Investment ConstraintsInvestment Constraints
Legal and Regulatory Factors – Limitations or penalties on withdrawals– Fiduciary responsibilities -
“prudent man” rule– Investment laws prohibit insider trading
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The Importance The Importance of Asset Allocationof Asset Allocation
An investment strategy is based on four decisions– What asset classes to consider for investment– What normal or policy weights to assign to each
eligible class– Determining the allowable allocation ranges based
on policy weights– What specific securities to purchase for the
portfolio
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The Importance The Importance of Asset Allocationof Asset Allocation
According to research studies, most (85% to 95%) of the overall investment return is due to the first two decisions, not the selection of individual investments
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Returns and Risk of Different Returns and Risk of Different Asset ClassesAsset Classes
Historically, small company stocks have generated the highest returns. But the volatility of returns have been the highest too
Inflation and taxes have a major impact on returns
Returns on Treasury Bills have barely kept pace with inflation
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The Portfolio Management ProcessThe Portfolio Management Process
1. Policy statement - Focus: Investor’s short-term and long-term needs, familiarity with capital market history, and expectations
2. Examine current and project financial, economic, political, and social conditions - Focus: Short-term and intermediate-term expected conditions to use in constructing a specific portfolio
3. Implement the plan by constructing the portfolio - Focus: Meet the investor’s needs at the minimum risk levels
4. Feedback loop: Monitor and update investor needs, environmental conditions, portfolio performance
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The Portfolio Management ProcessThe Portfolio Management Process
1. Policy statement– specifies investment goals and acceptable risk levels– should be reviewed periodically– guides all investment decisions
2. Study current financial and economic conditions and forecast future trends– determine strategies to meet goals– requires monitoring and updating
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The Portfolio Management ProcessThe Portfolio Management Process
3. Construct the portfolio– allocate available funds to minimize
investor’s risks and meet investment goals
– Mutual funds vs. individual stock.
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The Portfolio Management ProcessThe Portfolio Management Process
4. Monitor and update– evaluate portfolio performance– Monitor investor’s needs and market
conditions– revise policy statement as needed– modify investment strategy
accordingly
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Investors and Investments Investors and Investments
Types of Investors
1. Individual Investors
2. Institutional InvestorsTypes of Investments
– Securities or Properties Stocks , bonds vs. real tangible
investment or personal properties.
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Investors and Investments Investors and Investments
– Direct or Indirect Direct: Stocks , bonds, real estate,
coins, paintings, etc ….Indirect: investment made in a
portfolio. Mutual fund.– Debt, equity and Derivative Securities– Domestic Vs. Foreign