CHAPTER 9 Investment Management: Concepts and Strategies Chapter 9: Investment Concepts 1.

CHAPTER 9

Investment Management:Concepts and Strategies

Chapter 9: Investment Concepts 1

FIXED INCOME SECURITIES

FIXED-INCOME SECURITY RETURN

FIXED-INCOME SECURITY RISK Interest Rate Risk Inflation Risk Maturity Risk Default Risk Callability Risk Liquidity Risk


RISK REDUCTION STRATEGIES

Ladder Bond Investments Invest in Tax-exempt Bonds Diversify with Intl. Bonds Adopt Dollar Cost Averaging

Strategy


Buying and Selling Bonds

Buying Bonds Bond Yield Bond Ratings Current Yield vs. Yield to Maturity

Selling Bonds Underperformance Change in Company Position Extent of Loss Tax Consequences


Investors’ Services Rating Classification


EQUITY RETURN AND RISK EQUITY RETURN

Over time, return based on increase in sale price plus dividend payments Should outpace inflation

EQUITY RISK Beta – market risk Alpha – estimated return if mkt = 0 Standard Deviation

Greater dispersion greater risk Sharpe Ratio

Risk adjusted return Morningstar Risk-adjusted Rating


TRADING IN EQUITIES

Buying Stocks Fundamentally Strong Selling Below Present or Intrinsic Value

Selling Stocks Theory of Undervalued Security Realization of Goals Change of Conditions


LIMITING EQUITY RISK

Dollar Cost Averaging Constant Ratio Plan Variable Installment Plan Strategy of Covered Calls


Market Volatility and Dollar Cost Averaging


SALE OF MUTUAL FUNDS

Basic Issue Change of Investment Objective Consistently Poor Performance Fund Size Miscellaneous Changes


MUTUAL FUNDS AND TAXES

Fund Distributions Calculation of Capital Gains or

Losses on Fund Sales Specific Identification Method First-in, First-out Method Average Cost Method


THEORY OF PORTFOLIO CONSTRUCTION

Most effective strategiesare based on: Diversification Asset Allocation


THEORY OF EFFICIENT PORTFOLIO Expected return of a portfolio is weighted average of individual assets in the portfolio If assets are not perfectly correlated, risk of the portfolio will be less than the weighted average of the risks of individual assets in the portfolio By diversifying a portfolio with assets that are not perfectly correlated, investor can reduce overall risk of the portfolio without sacrificing the average return This is the essence of modern portfolio theory


CAPITAL ASSET PRICING MODEL Investor expecting to beat the market

without assuming additional risk must generate a rate of return that exceeds return of this portfolio

If investor assumes higher level of risk than the risk of this efficient portfolio, then a higher level of return must be realized to compensate for the additional risk assumed

If the return of a portfolio with similar risk is less than the expected return of the efficient portfolio, then the investor failed to construct an efficient portfolio


POWER OF DIVERSIFICATION

Domestic DiversificationGlobal Diversification


EFFICIENT FRONTIER All portfolios below the efficient frontier curve are inefficient portfolios. As compared to portfolios on the frontier, they either offer lower returns or assume higher risks All portfolios on the efficient frontier curve are efficient. Each portfolio offers the highest expected return for the risk class


ASSET ALLOCATION MODEL (AAM)

Investors diversify holdings by spreading assets among companies, industries and countries

Investors should also diversify across a minimum of three asset classes: stocks, bonds, and money market securities


ASSET ALLOCATION MODEL (Contd.)

Risk and reward are positively related

Investors should hold a portfolio that is diversified among three asset classes and has investor’s desired level of risk


PORFOLIOS OF U.S. STOCKSAND BONDS


ASSET ALLOCATION STEPS

1. Determine type of portfolio that matches investor’s risk tolerance

2. Analyze prevailing market and financial conditions

3. Select different types of investment products in each asset class

4. Select mutual funds and individual securities that match selections made in Step 3


Rebalancing a Portfolio

Rebalancing is not a market timing strategy

It is a systematic approach to maintaining a consistent risk profile


How can you determine which mutual fund is the best to buy?1. First we need to select a fund family. The service of switching funds and the break points for obtaining lower investment costs makes the use of one fund family the best option.1. Many larger fund families have many mutual funds2. Each fund family will have good and bad funds.3. The greater the number to choose from the less likely

you would be “forced “ to invest in a poor performer.4. In a 401K this strategy is not important. You will have

a mix of fund families. Switching and break points are not important.

This is not scientific, but does start by identifying those characteristics that are important for return generation


2. Classify the mutual family’s funds by basic categories

1. Aggressive growth2. Growth3. Growth and income4. Income5. Sector6. Time targeted

3. Gather the information you deem important for fund performance for each fund in each group.

1. I would first filter the group by life as a fund.2. Eliminate all funds with an inception date sooner than 3

years.4. Create a checklist to rank the funds.


CHAPTER 9 Investment Management: Concepts and Strategies Chapter 9: Investment Concepts 1.

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Transcript of CHAPTER 9 Investment Management: Concepts and Strategies Chapter 9: Investment Concepts 1.