Post on 27-Dec-2015
transcript
11
Chapter One
The Investment Setting
McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.
Prepared byVictor Abraham
American InterContinental University, Los Angeles&
DeVry University, West Hills, California
22
Forms of InvestmentForms of InvestmentFinancial AssetsFinancial Assets Real AssetsReal Assets
11 Equity claims-directEquity claims-direct
Common stocksCommon stocks
WarrantsWarrants
OptionsOptions
Real estateReal estate
Office buildingOffice building
ApartmentsApartments
Shopping centersShopping centers
Personal residence Personal residence
22 Equity claims-indirectEquity claims-indirect
Mutual fundsMutual funds
Pension fundsPension funds
Whole life insuranceWhole life insurance
Retirement accounts Retirement accounts
Precious metalsPrecious metals
GoldGold
PlatinumPlatinum
SilverSilver
Continued Continued
33
Financial AssetsFinancial Assets Real AssetsReal Assets
33 Creditor claimsCreditor claims
Savings accountSavings account
Money market fundsMoney market funds
Commercial paperCommercial paper
Treasury bills, notes, bondsTreasury bills, notes, bonds
Municipal notes, bondsMunicipal notes, bonds
Corporate bonds Corporate bonds
Precious gemsPrecious gems
DiamondsDiamonds
RubiesRubies
SapphiresSapphires
EmeraldsEmeralds
44 Preferred stockPreferred stock CollectiblesCollectibles
ArtArt
AntiquesAntiques
Stamps Stamps Coins Coins Continued Continued
44
Financial AssetsFinancial Assets Real AssetsReal Assets
55 Commodity Commodity
FuturesFutures
OptionsOptions
Options on futuresOptions on futures
OtherOther
CattleCattle
OilOil
Common metalsCommon metals
66 Foreign CurrencyForeign Currency
CashCash
Futures Futures
Forward contracts Forward contracts
LeasesLeases
EquipmentEquipment
MachineryMachinery
Real estate Real estate
55
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
66
Risk and Safety of PrincipalRisk and Safety of Principal
A BIG QUESTION: What A BIG QUESTION: What factors can you think of that factors can you think of that can affect the value of your can affect the value of your portfolio?portfolio?
77
ANSWER:ANSWER: Everything that happens during the day can Everything that happens during the day can
affect the value of your portfolio, e.g.affect the value of your portfolio, e.g.• A snow storm in the MidwestA snow storm in the Midwest• Congressional testimony by Alan GreenspanCongressional testimony by Alan Greenspan• A surprise earnings announcements A 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
88
RiskRisk
Variability in the expected returnVariability 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 riskConservative investorsConservative investorsBank Saving accounts, CD’s, T-Bills, Bank Saving accounts, CD’s, T-Bills, T-Notes, and T-BondsT-Notes, and T-Bonds
99
Current Income versus Capital Current Income versus Capital Appreciation (trade-off)Appreciation (trade-off)
Current incomeCurrent income• Objective: Income NOT growthObjective: Income NOT growth EXAMPLES -EXAMPLES -
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 EXAMPLES -EXAMPLES -
Increase in value - NO cash dividendsIncrease in value - NO cash dividends High growth industriesHigh growth industries
1010
Liquidity ConsiderationsLiquidity Considerations
Ability to convert Ability to convert an investment an investment
quickly into quickly into cash cash
at fair market value at fair market value
1111
Other Liquidity FactorsOther Liquidity Factors Transaction costsTransaction costs CommissionsCommissions Difference between the “bid” and “ask” priceDifference between the “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
1212
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 in the maturity dates of Diversification in the maturity dates of
investmentsinvestments
1313
SHORT TERM PESPECTIVESHORT TERM PESPECTIVE TradersTraders
• Technical analysis Technical analysis Market indicator seriesMarket indicator seriesChartingChartingMoving averagesMoving averagesCeilings, floors, turning points,…Ceilings, floors, turning points,…
N.B.: Short term for a trader could be counted in hours, N.B.: Short term for a trader could be counted in hours, or even in seconds i.e. buy and sell (or “sell short” or even in seconds i.e. buy and sell (or “sell short” and buy) in one dayand buy) in one day
1414
LONG TERM PESPECTIVELONG TERM PESPECTIVE
Long term investorsLong term investors• Buy and hold investorsBuy and hold investors• 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,… Analyzing the Financial Statement Analyzing the Financial Statement
(Balance sheet, income statement, & cash (Balance sheet, income statement, & cash flow)flow)
1515
Tax FactorsTax Factors
High tax bracketsHigh tax brackets• Municipal bonds (tax free)Municipal bonds (tax free)• Real estate (depreciation & interest Real estate (depreciation & interest
write-offswrite-offs• Tax creditsTax credits• Tax sheltersTax shelters• Tax Relief Act of 2003Tax Relief Act of 2003
1616
The Bush Tax Relief Act of 2003The Bush Tax Relief Act of 2003Please click on the hyperlink iconsPlease click on the hyperlink icons
Jobs & Growth Tax Jobs & Growth Tax Relief Reconciliation Relief Reconciliation Act of 2003Act of 2003
Six examples of the Tax Six examples of the Tax effect in Acrobateffect in Acrobat www.ustreas.govwww.ustreas.gov
2003 Tax Relief Act2003 Tax Relief ActHow will it affect you?How will it affect you? www.planningtips.comwww.planningtips.com
Quicken/TurboTax Quicken/TurboTax estimator/calculatorestimator/calculator
www.turbotax.cwww.turbotax.comom
www.ustreas.gowww.ustreas.govv
1717
Reduction in Tax Rates on Dividends and Reduction in Tax Rates on Dividends and Capital GainsCapital Gains: The maximum tax rate on : The maximum tax rate on dividends paid by corporations to individuals dividends paid by corporations to individuals and on individuals’ capital gains is reduced to and on individuals’ capital gains is reduced to 15% in 2003 through 2008. For taxpayers in the 15% in 2003 through 2008. For taxpayers in the 10% and 15% ordinary income tax rate 10% and 15% ordinary income tax rate brackets, the rate on dividends and capital gains brackets, the rate on dividends and capital gains is reduced to 5% in 2003 through 2007, and to is reduced to 5% in 2003 through 2007, and to zero in 2008. zero in 2008.
The new rates apply to capital gains realized on The new rates apply to capital gains realized on or after May 6, 2003, and to dividends received or after May 6, 2003, and to dividends received in 2003 and after. This provision reduces the in 2003 and after. This provision reduces the double taxation of corporate earnings. Tax double taxation of corporate earnings. Tax Relief: CY 2003: $8 billion.Relief: CY 2003: $8 billion.
Please click on the link for the FULL PRESS RELEASEPlease click on the link for the FULL PRESS RELEASE
www.ustreas.gov/press/www.ustreas.gov/press/releasesreleases
1818
Ease of ManagementEase of Management
Trade-offs between “professional Trade-offs between “professional investment managers” and “do-it-yourself investment managers” and “do-it-yourself approach”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
1919
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
2020
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
2121
InflationInflation
The rate at which the general level of The rate at which the general level of prices for goods and services is rising, and prices for goods and services is rising, and subsequently, purchasing power is falling.subsequently, purchasing power is falling.
As inflation rises, every dollar will buy a As inflation rises, every dollar will buy a smaller percentage of a good.smaller percentage of a good.
Example - if the inflation rate is 2%, then a Example - if the inflation rate is 2%, then a $1 pack of gum will cost $1.02 in a year.$1 pack of gum will cost $1.02 in a year.
2222
Inflation – Why should I worry?Inflation – Why should I worry?Impact of 6% inflation over 20 yearsImpact of 6% inflation over 20 years
2001 Price2001 Price 2021 Price2021 Price
Average automobileAverage automobile $18,000$18,000 $61,110$61,110
Mercedes BenzMercedes Benz $42,000$42,000 $134,694$134,694
Typical 3-bedroom houseTypical 3-bedroom house $130,000$130,000 $416,910$416,910
BBA starting salaryBBA starting salary $42,000$42,000 $142,590$142,590
MBA starting salaryMBA starting salary $85,000$85,000 $272,590$272,590
Tuition private college/yearTuition private college/year $15,000$15,000 $57,715$57,715
Ivy League annual tuitionIvy League annual tuition $32,000$32,000 $102,624$102,624
Poverty level (family of 4)Poverty level (family of 4)Please click on Excel icon– sample calculationPlease click on Excel icon– sample calculation
$36,000$36,000 $122,220$122,220
2424
CALCULATING THE RATE OF CALCULATING THE RATE OF RETURN IN PERCENTAGERETURN IN PERCENTAGE
valueBeginning
Income value)Beginning - Value (Ending return of Rate
2525
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
2626
RISK – comparing investmentsRISK – comparing investments
Uncertainty associated with outcomes Uncertainty associated with outcomes from an investmentfrom an investment
The higher the risk, the higher the The higher the risk, the higher the expected return (compensation)expected return (compensation)
Greater uncertainty displayed with wider Greater uncertainty displayed with wider dispersion (i.e. higher variance and higher dispersion (i.e. higher variance and higher standard deviation)standard deviation)
2727
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
2828
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 premium.The risk premium.
2929
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 The annual percentage return realized on an investmenton an investment
3030
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
3131
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
3232
Three Key Components of Three Key Components of Total Required Rate of ReturnTotal Required Rate of Return
Real rate of returnReal rate of return Anticipated inflationAnticipated inflation Risk PremiumRisk Premium
Combine to Combine to provide risk-free provide risk-free raterate
3333
Three Key Components of Three Key Components of Total Required Rate of ReturnTotal Required Rate of Return
Real rate of returnReal rate of return Anticipated inflationAnticipated inflation Risk PremiumRisk Premium
Combine to Combine to provide risk-free provide risk-free raterate
3434
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
3535
WEBSITEWEBSITE COMMENTCOMMENT
http://www.aaii.org/http://www.aaii.org/ A non profit website educating do it yourself A non profit website educating do it yourself investors.investors.
www.nasdaq.comwww.nasdaq.com Provides information about Nasdaq stocks Provides information about Nasdaq stocks and bonds.and bonds.
www.nyse.comwww.nyse.com Provides information about New York Stock Provides information about New York Stock Exchange, listings and regulations.Exchange, listings and regulations.
www.nareit.comwww.nareit.com Provides information and data about real Provides information and data about real estate investment trusts.estate investment trusts.
www.quicken.comwww.quicken.com Provides understandable coverage of Provides understandable coverage of financial planning and investingfinancial planning and investing
www.amex.comwww.amex.com Provides information about corporate and Provides information about corporate and government bonds.government bonds.
3636
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.tradearca.comwww.tradearca.com Clients: institutions, Nasdaq Market Makers, broker/dealers and Clients: institutions, Nasdaq Market Makers, broker/dealers and professional trading accounts. Retail investors cannot send orders professional trading accounts. Retail investors cannot send orders directly to Archipelago. However, retail investors can contact their directly to Archipelago. However, retail investors can contact their brokerage firms to see if they route orders to Archipelago. brokerage firms to see if they route orders to Archipelago.
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 and Provides links to finance sites and glossary of finance technology.glossary of finance technology.
www.business.comwww.business.com Provides a searchable databaseProvides a searchable database
www.ebrut.comwww.ebrut.com
www.attain.comwww.attain.com
3737
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.instintnet.comwww.instintnet.com Four largest electronic Four largest electronic communication networks ECNscommunication networks ECNs
www.nestrade.comwww.nestrade.com