Investment Analysis and Portfolio Management Solution Manual
Chapter 4 Investment Analysis and Portfolio Management
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Transcript of Chapter 4 Investment Analysis and Portfolio Management
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ISLAMIC INVESTMENT
Mahyuddin Khalidemkay@
salam.uitm
.edu.my
Investment Analysis and Portfolio Management
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Chapter Outline
Individual Investor Life Cycle The Portfolio Management Process The Need for Policy Statement Constructing the Policy Statement The Importance of Asset Allocation
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What is asset allocation?
Asset Allocation
•Process of deciding how to distribute an investor’s wealth among different countries and asset classes for investment purposes
Asset Class
•Group of securities that have similar characteristics, attributes, and risk/return relationships
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Managing Risk
Since risk drives
expected return,
investing involves
managing risk rather than managing
return.
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Risk Management Strategies
Risk Avoidance
• Can avoid any real chances of loss• Generally a poor strategy except for
a part of an overall portfolio
Risk Anticipation
• Position part of your portfolio to protect against anticipated risk factors
• For example, maintain a cash reserve
Risk Transfer
• Insurance and other investment vehicles can allow for the transfer of risk, often at a price, to another investor who is willing to bear the risk
Risk Reduction
• Effective diversification and asset allocation strategies can reduce risk, sometimes without sacrificing expected return.
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Individual Investor Life Cycle
The individual investors life
cycle can often be
described using four separate phases or
stages
Accumulation Phase
Consolidation Phase
Spending Phase
Gifting Phase
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Phases of an Investor’s Life Cycle7
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Accumulation Phase
Early to middle years of careers
Attempting to satisfy
intermediate and long-term goals
Net worth is usually small, debt
may be heavyLong-term
investment horizon means usually willing to take
moderately high risks in order to
make above-average returns
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Consolidation Phase
Past career midpoi
nt
Have paid off much of their accumulated
debt
Earnings now exceed living expenses, so
the balance can be invested Time horizon is
still long-term, so moderately
high risk investments
are still attractive
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Spending Phase
Usually begins at retiremen
t
Saving before, prudent spending
now
Living expenses covered by Social
Security and retirement plans
Changing emphasis toward preservation of capital, but still
want investment values to keep
pace with inflation
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Gifting Phase
Can be concurren
t with spending
phase
If resources allow, individuals
can now use excess assets to provide gifts to
other individuals or organizations
Estate planning becomes
important, especially tax considerations
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The Portfolio Management Process
4 step process:Construct a
policy statement
Study current financial
conditions and forecast future
trends
Construct a portfolio
Monitor needs and
conditions
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Portfolio Management Process13
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The Portfolio Management Process
Specifies investmen
t goals and
acceptable risk levels
Should be reviewed periodicall
y
The “road map” that guides all investment decisions
Policy stateme
nt
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The Portfolio Management Process
Study current financial and
economic conditions and forecast future
trends
Determine strategies that
should meet goals within the expected
environment
Requires monitoring and updates since financial markets are ever-changing
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The Portfolio Management Process
Allocate available
funds to meet goals while
managing risk
Given the policy
statement and the
expected conditions, go
about investing
Construct the portfolio
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The Portfolio Management Process
Monitor and update
Revise policy
statement as needed
Monitor changing financial
and economic conditions
Evaluate portfolio
performance
Modify portfolio
investments
accordingly
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The Policy Statement
Understand and articulate realistic investment objectives and constraints Know yourself Know the risks and potential rewards from investments
Learn about standards for evaluating portfolio performance Know how to judge average performance Adjust for risk
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The Policy Statement
Don’t try to navigate without a map! Begins with:
Profile analysis Investor’s current and future financial situations
Important Inputs: Investment Objectives Investment Constraints
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Investment Objectives
Need to specify return and risk
objectives
Need to consider the risk
tolerance of the
investor
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Investment Objectives
Capital preservatio
n• Maintain purchasing power• Minimize the risk of loss
Capital appreciatio
n
• Achieve portfolio growth through capital gains
• Accept greater risk
Current income
• Look to generate income rather than capital gains
• May be preferred in “spending phase”
• Relatively low risk Total
return• Combining income returns and
reinvestment with capital gains• Moderate risk
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Investment Constraints
These factors may limit or at least impact the investment choices
• How soon will the money be needed?Liquidity needs
• Influences liquidity needs and risk tolerance
• Longer investment horizons generally requires less liquidity and more risk tolerance
Time horizon
• Limitations or penalties on withdrawals• Fiduciary responsibilities• Retirement regulations
Legal and Regulatory
Factors
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Investment Constraints
• Unrealized capital gains: Reflect price appreciation of currently held assets that have not yet been sold
• Realized capital gains: When the asset has been sold at a profit
• Trade-off between taxes and diversification: Tax consequences of selling company stock for diversification purposes
Tax and Zakat
Concerns
• Personal preferences such as socially conscious investments could influence investment choice
• Perhaps the investor wishes to avoid types of investments for ethical reasons
Unique needs and preferenc
es
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Investment Education
The bottom line
If you do not plan for the future, you will likely not be prepared for it.
Data indicates that many Malaysians have greatly under-invested for the future.
The type of information necessary to construct a good policy statement is neither “common sense” or “common knowledge.”
Many investors fail to diversify. Many fail to plan completely.
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Asset Allocation Decisions
What asset classes
should be considered?
What should be the normal
weight for each asset
class?
What are the
allowable ranges for
the weights?
What specific
securities should be
purchased?
Four decisions in an investment strategy
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The Importance of Asset Allocation
The asset allocation decision (which classes and at what
weights) is very important. Using fund data:
About 90% of return
variability over time can be explained by
asset allocation.
About 40% of the differences
between returns can be explained by differences in
asset allocation.
Asset allocation is
thus the major factor that
drives portfolio risk and return.
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Risk/Return History and Asset Allocation
Looking at return data on various asset classes indicate some important factors for investors• Even apparent low-risk investments like T-bills can have
considerable reinvestment risk
Over long time horizons, stocks have always outperformed low-risk investments.• So the additional risk over shorter time horizons seems to all
but disappear over time.The only way to maintain purchasing power, net of taxes and inflation, is by investing in proper investment instruments like common stock, unit trust etc.
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Asset Allocation and Cultural Differences
Differences in social, political, and tax environments influence asset allocation.For instance, 38% of pension fund assets of Kumpulan Wang Amanah Pencen (KWAP) are invested in equities.• 79% in equities in United Kingdom, where high average inflation
impacts this choice• 8% in equities in Germany, where generous government
pensions and greater risk aversion seem to play a strong role
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Summary
In this chapter
you have learned about:
Individual Investor Life
Cycle
The Portfolio Management
ProcessThe
Importance of Asset
Allocation
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30 Thank You