Investment Management Unit 1
1. Importance of ethics –
2. Investments strategies
3. Career paths in investment.
a. Investment Analyst
b. Portfolio Manager
c. Financial Planner
Common stock valution
4. What are stock market indicators series
a. Priced weighted
b. Value weighted
5. What is the impact of a risk-free portfolio correlation
6. How does risk free impact the standard deviation
7. Expected return
8. unSystemic risk – diversation – how to elimate unsystemic risk
10. describe an efficient capital market theory
11. why analyst need to focus on mid-tier stocks instead of top tier stocks
12. Why would an investor appreciate the option deverative
13. Difference between future and forward markets
15. What is common stock valuations Investment
UNIT 1 – THE INVESTMENT ENVIRONMENT
Reilly, F. K. & Brown, K.C. (2003). Investment Analysis, Portfolio
Management. 7th Ed. South Western Publishing
Investment is the current commitment of dollars, for a
period, in order to derive future payments that will
compensate the investor for:
(1) the time the funds are committed
(2) the expected rate of inflation, and
(3) the uncertainty of the future payments
The emphasis of investments is Returns (the reward for
owning an investment)
Income from investment (such as dividend)
Increase in value of investment
Financial investment is not to be confused
with investment in economics.
To the economist, investment is the net
addition made to the nation’s capital stock
that consists of goods and services that are
used in the production process.
The Investment Process
Types of Investors
An “investor” can be an individual, a government, a pension fund, or a
This definition includes all types of investments, including investments by
corporations in plant and equipment, and investments by individuals in stocks,
bonds, commodities, or real estate (Reilly, 2006, p.15).
Individual investors are large in number but their investable resources are
They generally lack the skill to carry out extensive evaluation and analysis
before investing. Moreover, they do not have the time and resources to
engage in such an analysis.
Institutional investors are fewer, such as mutual funds, investment
companies, banking and non-banking companies, insurance
corporations, etc. with large amounts of surplus funds.
They engage professional fund managers to carry out extensive analysis and
evaluation of different investment opportunities.
Income streams and spending needs do not coincide.
If income is greater than spending – people tend to invest the
If spending is greater than income – people tend to borrow to
cover the deficit.
Therefore, people would be willing to forgo current
consumption only if they can achieve greater
consumption in the future.
The rate of exchange between future consumption and
present consumption is the pure rate of interest.
Market forces determine this rate.
Objectives of an Investor
The objectives of an investor can be stated as:
Maximization of return
Minimization of risk
Hedging against inflation
Investors, in general, desire to earn as large returns as possible with the minimum
Risk is the probability that actual returns realized from an investment may be different
from the expected return. If we consider the financial assets available for investment,
we can classify them into different risk categories.
Government securities would constitute the low risk category as they are practically risk free.
Debentures and preference shares of companies may be classified as medium risk assets.
Equity shares of companies would form the high risk category of financial assets.
An investor would be prepared to assume higher risk only if he expects to get
proportionately higher returns. Thus, there is a trade-off between risk and return.
Characteristics of Investments
All investments are characterized by the
expectation of a return and are engaged
with that being the primary objective.
The return may be received in the form of
yield plus capital appreciation (gain).
The difference between the sale price and
the purchase price is capital appreciation.
The dividend or interest received from the
investment is the yield.
Different types of investments promise
different rates of return.
The return from an investment depends
upon the nature of the investment, the
maturity period, among other factors.
Risk is inherent in any investment.
This risk may relate to loss of capital, delay in
repayment of capital, non-payment of interest,
or variability of returns.
While some investments like government
securities and bank deposits are almost riskless,
others are more risky. The risk of an investment
depends on the following factors.
The longer the maturity period, the larger is the
The lower the credit worthiness of the borrower,
the higher is the risk.
The risk varies with the nature of investment.
Investments in ownership securities like equity
shares carry higher risk compared to investments
in debt instruments like debentures and bonds.
Risk and return of an investment are related. Normally, the higher the risk, the higher is the return.
Characteristics of Investments
The safety of on investment implies the
certainty of return of capital without
loss of money or time.
Every investor expects to get back his
capital on maturity without loss and
An investment which is easily saleable or
marketable without loss of money and
without loss of time is said to possess
Some investment instruments like
preference shares and debentures are
marketable, but there are no buyers in
many cases and hence their liquidity is
Equity shares of companies listed on
stock exchanges are easily marketable
through the stock exchanges.
An investor generally prefers liquidity for his investments, safety of his funds, a good return
with minimum risk or minimization of risk and maximization of return.
Types of Investments
Securities or Property
Securities: stocks, bonds, options
Real Property: land, buildings
Tangible Personal Property: gold, artwork,
Direct or Indirect
Direct: investor directly owns a claim on a
security or property
Indirect: investor owns an interest in a
professionally managed collection of securities
Types of Investments
These are fixed-income securities commonly
referring to any securities that are founded
When you purchase a bond, you are lending
out your money to a company or government.
In return, they agree to give you interest on
your money and eventually the principal.
The main attraction of bonds is their relative
Government bonds are stable; your
investment is virtually guaranteed, or risk-free.
The safety and stability, however, come at a
cost – with little risk, there is little potential
return. As a result, the rate of return on bonds is
generally lower than other securities.
Stocks, or equities purchase comes with
part owner of a business, voting rights at
shareholders’ meeting and allows you to
receive any profits (dividends), that the
company allocates to its owners.
Stocks are volatile. That is, they fluctuate
in value on a daily basis.
Stocks don’t guarantee any returns –
many don’t even pay dividends, in which
case, the only way that you can make
money is if the stock increases in value –
which might not happen.
Compared to bonds however, stocks
provide relatively high potential returns.
Types of Investments
A mutual fund is a collection of stocks
When you buy a mutual fund, you are
pooling your money with a number of
other investors, which enables you (as
part of a group) to pay a professional
manager to select specific securities for
Mutual funds are all set up with a specific
strategy in mind, and their distinct focus
can be nearly anything: large stocks,
small stocks, bonds from governments,
bonds from companies, stocks and
bonds, stocks in certain industries, stocks
in certain countries, etc.
Deposits/Fixed Term Deposits
This type of investment is used by a large
proportion of the population e.g. bank
The appeal is easy access and the very
unlikely event of losing your capital.
Unfortunately, very little income or
capital growth takes place simply
because of the low interest rates.
Another important point to bear in mind
is the devaluation of your particular
currency which will eat away at any
gains made especially if cash is held on
deposit in the long-term. For this reason
alone, it is not good practice to leave
large deposits in this type of investment.
Alternative Investments Types
This is an investment that is not one of the three traditional asset types (stocks, bonds
Most alternative investment assets are held by institutional investors or accredited, high-net-
worth individuals because of their complex nature, limited regulations and relative lack of
Alternative investments include:
real estate – Property investment offers value to investors in two ways:
(1) Properties increase in capital value over time as house and land prices rise; and (2)You earn rental
income from your tenants.
derivatives contracts -A security whose price is dependent upon or derived from one or more
underlying assets. The derivative itself is merely a contract between two or more parties. Its
value is determined by fluctuations in the underlying asset. The most common underlying
assets include stocks, bonds, commodities, currencies, interest rates and market indexes. Most
derivatives are characterized by high leverage.
A financial derivative that represents
a contract sold by one party (option
writer) to another party (option
The contract offers the buyer the
right, but not the obligation, to buy
(call) or sell (put) a security or other
financial asset at an agreed- upon
price (the strike price) during a
certain period of time or on a
specific date (exercise date).
Call options give the option to buy
at certain price, so the buyer would
want the stock to go up.
Put options give the option to sell at
a certain price, so the buyer would
want the stock to go down.
Say, for example, that you discover a house that you’d love to purchase.
Unfortunately, you won’t have the cash to buy it for another three months. You talk
to the owner and negotiate a deal that gives you an option to buy the house in
three months for a price of $200,000. The owner agrees, but for this option, you pay a
price of $3,000.
Now, consider two theoretical situations that might arise:
It’s discovered that the house is actually the true birthplace of Elvis! As a result,
the market value of the house skyrockets to $1 million. Because the owner sold
you the option, he is obligated to sell you the house for $200,000. In the end, you
stand to make a profit of $797,000 ($1 million – $200,000 – $3,000).
While touring the house, you discover not only that the walls are chock-full of
asbestos, but also that the ghost of Henry VII haunts the master bedroom;
furthermore, a family of super-intelligent rats have built a fortress in the
basement. Though you originally thought you had found the house of your
dreams, you now consider it worthless. On the upside, because you bought an
option, you are under no obligation to go through with the sale. Of course, you
still lose the $3,000 price of the option.
This example demonstrates two very important points. First, when you buy an option,
you have a right but not an obligation to do something. You can always let the
expiration date go by, at which point the option becomes worthless. If this happens,
you lose 100% of your investment, which is the money you used to pay for the option.
Second, an option is merely a contract that deals with an underlying asset. For this
reason, options are called derivatives, which means an option derives its value from
something else. In our example, the house is the underlying asset. Most of the time,
the underlying asset is a stock or an index.
A financial contract obligating the buyer
to purchase an asset (or the seller to sell
an asset), such as a physical commodity
or a financial instrument, at a
predetermined future date and price.
Futures contracts detail the quality and
quantity of the underlying asset; they are
standardized to facilitate trading on a
Some futures contracts may call for
physical delivery of the asset, while others
are settled in cash.
Futures can be used either to hedge or
to speculate on the price movement of
the underlying asset.
For example, a producer of corn could
use futures to lock in a certain price and
reduce risk (hedge). On the other hand,
anybody could speculate on the price
movement of corn by going long or short
By participating in the futures market does
not necessarily mean that you will be
responsible for receiving or delivering large
inventories of physical commodities –
remember, buyers and sellers in the futures
market primarily enter into futures contracts
to hedge risk or speculate rather than to
exchange physical goods (which is the
primary activity of the cash/spot market).
That is why futures are used as financial
instruments by not only producers and
consumers but also speculators.
The consensus in the investment world is that
the futures market is a major financial hub,
providing an outlet for intense competition
among buyers and sellers and, more
importantly, providing a center to manage
price risks. The futures market is extremely
liquid, risky and complex by nature.
Alternative Investments Types
The market in which currencies are traded.
The forex market is the largest, most liquid
market in the world with an average traded
value that exceeds $1.9 trillion per day and
includes all of the currencies in the world.
There is no central marketplace for currency
exchange; trade is conducted over the
counter. The forex market is open 24 hours a
day, five days a week and currencies are
traded worldwide among the major financial
centers of London, New York, Tokyo, Zürich,
Frankfurt, Hong Kong, Singapore, Paris and
Gold that is physical gold should be thought of
as an insurance policy against poor economic
conditions rather than an investment vehicle.
Having said that we are in a bull market at
present (2009) and it is highly likely you will make
money if you invest in physical gold today.
Gold prices are on a record-breaking spree
globally due to concerns over rising Covid-19
cases, simmering US-China tensions,
expectations of a second stimulus
announcement in the United States and decline
in the dollar. It has already surged almost 40 per
cent this year as the precious metal is perceived
as currency of last resort and a safe haven in
times of economic and geo-political upheavals.
A good source of physical gold is Bullion vault.
Time Value of Money (TVM)
Time value of money is the concept that the value of a dollar to be received
in future is less than the value of a dollar on hand today.
One reason is that money received today can be invested thus generating more
Another reason is that when a person opts to receive a sum of money in future
rather than today, he is effectively lending the money and there are risks involved in
lending such as default risk and inflation.
Default risk arises when the borrower does not pay the money back to the lender. Inflation
is the rise in general level of prices.
Time value of money principle also applies when comparing the worth of
money to be received in future and the worth of money to be received in
In other words, TVM principle says that the value of a given sum of money to be
received on a particular date is more than the same sum of money to be received
on a later date.
Time Value of Money (TVM)
FV = PV x [ 1 + (i / n) ] (n x t)
PV = FV / [ 1 + (i / n) ] (n x t) Where:
FV = Future value of money
PV = Present value of money
i = interest rate
n = number of compounding periods per year
t = number of years
Time Value of Money (TVM)
Assume a sum of $10,000 is invested for five years at 10% interest.
What is the FV?
FV = 10,000 x [ 1 + (10% / 1) ] (1 x 5) =$16,105.1
The present value of $5,000 two years from today, compounded
at 7% interest, is:
PV = 5000/ [ 1 + (7% / 1) ] (1 x 2) = $4,367
An investment strategy is a set of rules, behaviours or procedures, designed to
guide an investor’s selection of an investment portfolio based on goals, risk
tolerance, and future needs for capital.
The best strategies are those that work best for the individual investor’s objectives
and risk tolerance.
Investment strategies allow for diversification of risk in the portfolio by investing
in different types of investments and industry based on timing and expected
A portfolio can be made of a single strategy or a combination of strategies to
accommodate the preferences and needs of the investors.
Investing strategically allows investors to gain maximum out of their investments.
Investment strategies help reduce transaction cost and pay less tax.
Passive and Active Strategies
The passive strategy
involves buying and
holding stocks for a period
of time without trading
frequently and to avoid
higher transaction costs.
Passive investors believe
they cannot outperform the
market due to its volatility,
so they tend to adopt a less
Investors who employ
active strategies buy and
These investors believe
they can outperform the
market and can gain
more returns than an
average investor would.
Growth strategies imply focusing on the future rather than current profit.
They look for the “next big thing” and involves evaluating a stock’s current health as well
as its potential to grow.
It focuses on capital appreciation.
Growth investors look for companies that exhibit signs of above-average growth, through
revenues and profits, even if the share price appears expensive in terms of metrics such as
price-to-earnings or price-to-book ratios.
Investors chose the holding period based on the value they want to create in their
If investors believe that a company will grow in the coming years and the intrinsic value of
a stock will go up, they will invest in such companies to build their corpus value. On the
other hand, if investors believe that a company will deliver good value in a year or two,
they will go for short term holding.
The holding period also depends upon the preference of investors.
For example, how soon they want money to say to buy a house, school education of kids,
retirement plans, etc.
This is a style of investing based on picking shares that have low valuations
relative to their current profits, cash flows and dividend yield. It is one of the two
main approaches to stock picking, the other being growth investing.
Value investing strategy involves investing in the company by looking at its
intrinsic value because such companies are undervalued by the stock market.
The idea is that when the market goes for correction, it will correct the value for such
undervalued companies and the price of the stock will increase, leaving investors with
high returns when they sell.
Value investing strategies can be used by investors looking for either capital
gains or income — although an income investor is likely to use a different value
strategy to one who wants capital gains.
There is strong evidence that value shares outperform growth shares over the
Income investing involves buying securities that generally pay out returns
on a steady schedule.
This type of strategy focuses on generating cash income from stocks rather
than investing in stocks that only increase the value of your portfolio.
There are two types of cash income which an investor can earn –
(1) Dividend and (2) Fixed interest income
Bonds are the best known type of fixed income security, but the category also
includes dividend paying stocks, exchange-traded funds (ETFs), mutual funds,
and real estate investment trusts (REITs).
Fixed income investments provide a reliable income stream with minimal risk
and depending on the risk the investor is looking to take, should comprise at
least a small portion of every investment strategy.
This type of investment strategy allows investors
to invest a small portion of stocks in a market
These can be Standard & Poor 500, mutual
funds, or exchange-traded funds.
Dividend Growth Investing
In this type of investment strategy, the investor looks
out for companies that consistently paid a dividend
Companies that have a track record of paying
dividends consistently are stable and less volatile
compared to other companies and aim to increase
their dividend payout every year.
The investors reinvest such dividends and benefit from
compounding over the long term.
This types of strategy allow investors to buy stocks of companies at the time
of the down market.
This strategy focuses on buying at low and selling at high.
The downtime in the stock market is usually at the time of recession,
wartime, calamity, etc.
However, investors shouldn’t just buy stocks of any company during downtime.
They should look out for companies that have the capacity to build up value
and have a branding that prevents access to their competition.
Contrarian investing can be very successful during bubbles and busts as
contrarian investors are likely to sell during a bubble and buy when the
investors are unduly pessimistic about shares.
The problem is that the market is right most of the time and therefore contrarians
will find it hard to do well most of the time.
Small Cap Investing
This strategy involves purchasing stock of small companies
with smaller market capitalization (usually between $300
million and $2 billion).
An investment strategy fit for those looking to take on a little more
risk in their portfolio.
Small Cap stocks are appealing to investors due to their
ability to go unnoticed. They to tend to have less attention
on them because:
a) investors stay away from their riskiness and
b) institutional investors (like mutual funds) have restrictions when it
comes to investing in small cap companies.
The Financial Environment
The financial environment is composed of three key components:
Investors (including creditors)
Financial managers are responsible for deciding how to invest a company’s
fund to expand its business and how to obtain funds (financing).
The actions taken by financial managers to make financial decisions for their
respective firms are referred to as financial management (or managerial finance).
Financial decisions will include those that maximize the firm’s value and therefore
maximize the value of the firm’s stock price. They are usually compensated in a
manner that encourages them to achieve this objective.
Financial markets represent forums that facilitate the flow of funds among
investors, firms, and government units and agencies.
Each financial market is served by financial institutions that act as
The equity market facilitates the sale of equity by firms to investors or between
investors. Some financial institutions serve as intermediaries by executing
transactions between willing buyers and sellers of stock at agreed-upon prices.
The debt markets enable firms to obtain debt financing from institutional and
individual investors or to transfer ownership of debt securities between investors.
Some financial institutions serve as intermediaries by facilitating the exchange of
funds in return for debt securities at an agreed-upon price.
Thus, it is quite common for one financial institution to act as the institutional
investor while another financial institution serves as the intermediary by
executing the transaction that transfers funds to a firm that needs financing.
Primary and Secondary Market
Market for issuing a new security and distributing to saver-lenders.
Initial Public Offering Market (IPO).
Investment Banks—Information and marketing specialists for newly
Market where existing securities can be exchanged
New York Stock Exchange
American Stock Exchange
Over-the-counter (OTC) markets (NASDAQ).
Investors are individuals or financial institutions that
provide funds to firms, government agencies, or
individuals who need funds.
The focus regarding investors is on their provision of funds
Individual investors commonly provide funds to firms by
purchasing their securities (stocks and debt securities).
The financial institutions that provide funds are referred to
as institutional investors.
Some of these institutions focus on providing loans, whereas
others commonly purchase securities that are issued by firms.
Investing Over the Life Cycle
Investors tend to follow different investment
philosophies as they move through different
stages of the life cycle.
Investing Over the Life Cycle
Growth-oriented Youth Stage
Twenties and thirties (20s & 30s)
Higher potential growth; Higher potential risk
Stress capital gains over current income
Middle-Aged Consolidation Stage
Ages 45 to 60
Family demands & responsibilities become important (education
expenses, retirement savings)
Move toward less risky investments to preserve capital
Transition to higher-quality securities with lower risk
Investing Over the Life Cycle
Ages 60 and older
Preservation of capital becomes primary goal
Highly conservative investment portfolio
Income needed to supplement retirement income
Some investments for each stage
Growth-oriented: Common stocks, options or futures
Middle-age: Low-risk growth and income stocks, preferred stocks,
convertible stocks, high-grade bonds
Income-oriented: Low-risk income stocks and mutual funds, government
bonds, quality corporate bonds, bank certificates of deposit
Ethics in Investing
For markets to effectively facilitate the deployment of capital resources to
their most productive uses, there must be an acceptable level of
transparency that allows investors to make well-informed decisions.
Ethical behaviour is congruent to maximizing Shareholders’ wealth.
Companies benefit from having a good reputation and are penalized by
having bad ones.
Unethical behaviour by individuals have serious personal consequences—ranging
from job loss and reputational damage to fines and even jail time.
Unethical conduct from market participants, investment professionals, and
those who service investors can damage investor trust and thereby impair the
sustainability of the global capital markets as a whole.
A strong ethical culture that helps honest, ethical people engage in ethical
behaviour will foster the trust of investors, lead to robust global capital
markets, and ultimately benefit society.
The Financial Services Commission
The Commission is an integrated regulator with responsibility for the
regulation of all financial services businesses operating in or from the
Turks and Caicos Islands (TCI), and the supervision of designated non-
financial business and persons (DNFBPs) and not-for-profit entities
operating in or from the TCI.
The Commission, through the Commercial Registry, is also responsible
for the administration of company formation, registration, patents,
trademarks and business names.
The Securities and Exchange
Securities Exchange Act of 1934
With this Act, Congress created the Securities and Exchange Commission.
The Act …