Investment Management Process p2ch1
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Transcript Investment Management Process p2ch1
Introduction
Overview of Financial
Markets and Investment
Risk and Return
Investment Management Process
1.
2.
3.
4.
5.
Setting investment Objective
Establishing Investment Policy
Selecting a portfolio strategy
Selecting the assets
Measuring and Evaluating
Performance
Investment Management Process
1.Setting investment Objective
Understand profiles and risk tolerant level
in order to set objective to satisfy the
obligations stipulated in the policy.
i.e. pension fund, insurance company,
retirement person etc.
2.Establishing Investment Policy
Must be correspond with the objectives
Make asset allocation decision
Investment Alternatives
Major
Categories
Financial
Assets
Direct
Investing
Real Assets
Indirect
Investing
Mutual
Funds
Non marketable
Money market
-Saving deposit
-T-bill
-CD
-NCD
-Whole Life Insurance
-Commercial Paper i.e.
B/E and P/N
-Foreign Exchange
Real
Estate
Precious
Metals
Fix
Assets
Hedge
Funds
Capital market
-Fixed Income i.e.
Gov.bond, State
Enterprise bond,
Corporate bond, T-note,
Prefer stocks, Mortgage
pass-through
-Common Stock
Derivative Securities
- Options i.e.Calls/Puts
- Corporate created i.e
Convertibles, Warrants
- Forward
- Futures
Investment Alternatives
The Historical Record:
A First Look
McGraw Hill / Irwin
Investment Alternatives
Average Returns: The First Lesson
McGraw Hill / Irwin
Market sizes of developed stock markets
Market coverage of developed stock market
Market capitalization of emerging markets
Size of govy bond market
Investment Management Process
3. Selecting a portfolio strategy
Actives - use information and forecasting
techniques to seek a better performance
Passives – diversification
Structured – match the funds received from
contributions to the future liabilities
4.Selecting the assets
Picking securities to build your portfolio
Efficient portfolio – provides the greatest
expected return at a given level of risk
Investment Management Process
5. Measuring and Evaluating Performance
Benchmark
Return vs. Risk
Risk management
Risk and Return
Two key observations emerge
There is a reward for bearing risk, and at least on
average, that reward has been substantial.
Greater rewards are usually accompanied by
greater risks.
In summary, high risk should compensated by high
return
Return Components
Returns consist of two elements:
– Periodic cash flows such as interest or
dividends (income return)
– Price appreciation or depreciation (capital
gain or loss)
Total Return =Yield +Price Change
Measuring Returns
For comparing performance over time or
across different securities
Total Return is a percentage relating all cash
flows received during a given time period,
denoted CFt +(PE - PB), to the start of period
price, PB
CFt (PE PB )
TR
PB
Measuring Returns
Example: Calculating Returns
Suppose you invested $1,000 in a stock at
$25 per share. After one year, the price
increases to $35. For each share, you also
received $2 in dividends.
CFt (PE PB ) $2+($35-$25)
TR
=
48%
PB
$25
Total dollar return = 48% of $1,000 = $480
At the end of the year, the value of your
$1,000 investment is $1,480.
Measuring Returns
Total Return can be either positive or
negative
– When cumulating or compounding,
negative returns are problem
A Return Relative solves the problem
because it is always positive
CFt PE
RR
1 TR
PB
Measuring Returns
Example:
What is Relative Return in the previous
example?
RR 1 TR =1+48%=1.48
Measuring Returns
To measure the level of wealth created by
an investment rather than the change in
wealth, need to cumulate returns over time
Cumulative Wealth Index, CWIn, over
n periods, =
WI (1 TR )(1 TR )...(1 TR )
0
1
2
n
Measuring Returns
Example:
The Return Relatives of a particular stock
investment in two consecutive years are 1.48
and 0.95, assume CW0 is $1000, what is
Cumulative Wealth Index, CWI2, over these 2
years?
CWI WI (1 TR )(1 TR ) $1000*1.48*0.95 $1406
2
0
1
2
Measures Describing a Return
Series
Arithmetic mean, or simply mean,
X
X
n
Arithmetic Versus Geometric
Arithmetic mean does not measure the
compound growth rate over time
– Does not capture the realized change in
wealth over multiple periods
– Does capture typical return in a single
period
Geometric mean reflects compound,
cumulative returns over more than one period
Geometric Mean
Defined as the n-th root of the product of n
return relatives minus one or G =
(1 TR1)(1 TR2 )...(1 TRn )
1/ n
1
Difference between Geometric mean and
Arithmetic mean depends on the variability of
returns, s
1 G 1 X s
2
2
2
Adjusting Returns for Inflation
Returns measures are not adjusted for
inflation
– Purchasing power of investment may
change over time
– Consumer Price Index (CPI) is possible
measure of inflation
TRIA
1 TR
1
1 CPI
Measuring Risk
Risk is the chance that the actual outcome is
different than the expected outcome
Standard Deviation measures the deviation of
returns from the mean
X X
s
n1
2
1/ 2
Risk Sources
Financial Risk
– Tied to debt
financing
Market Risk
– Overall market
effects
Liquidity Risk
– Marketability without sale prices
Inflation Risk
– Purchasing power
variability
Exchange Rate Risk
Country Risk
– Political stability
Interest Rate Risk
– Affects income return
Business Risk
Risk Types
Two general types:
– Systematic (general) risk
• Pervasive, affecting all securities, cannot be
avoided
• Interest rate or market or inflation risks
– Nonsystematic (specific) risk
• Unique characteristics specific to issuer
Total Risk =General Risk +Specific Risk
Risk Premiums
Premium is additional return earned or
expected for taking additional risk
Equity risk premium is the difference between
stock and risk-free returns
Equity Risk Premium, ERP, =
1 TRCS
1
1 RF
Risk and Return
McGraw Hill / Irwin
The Lesson
The greater the potential reward, the
greater the risk.