Investment and Portfolio

Management
 WEEK 1
September 2, 2009
Prepared by Mrs.Mahlaqa
Lecture Contents
I. Investment defined
II. Importance of Investments.
III. Investment Alternatives.
Learning Objectives
 To appreciate the scope of investment decisions and the
operating environment in which they are made.
 Understand the basics of two derivative securities, options and
futures and how they fit into the investor's choice.
 Appreciate the importance of indirect investing (the use of
investment companies and exchange-traded funds) to individual
investors.
 Understand exchange-traded funds, a bridge between direct and
indirect investing.
1. Definitions:

 Investment is an activity that commits funds in any

financial/physical form in the present with an expectation of
receiving additional return in the future.
 The commitment of funds to one or more assets that will be
held over some future time period.
 In its broadest sense, “an investment is a sacrifice of current
money or other resources for future benefits”.
 We can still define investment as; investment is the current
commitment of dollars for a period of time in order to derive
future payments that will compensate the investor for:

 The time the funds are committed

 The expected rate of inflation
 The uncertainty of the future payments
 Investments can be classified as financial investments or
economic investments.
 The financial investment is the commitment of funds to derive
future income in the form of interest, dividend, premium or
pension benefits et.
Examples: purchase of shares, debentures and insurance
policies
 Economic investment is an expectation of increasing the current
economy's capital stock that consists of goods and services.
Example: Capital Stock
Investment as a Profession:
 Investment Bankers
 Bond Traders
 Security Analyst
 Portfolio Managers
 Stock Brokers
 Financial Planners
 Chartered Financial Analyst (CFA)
3. Investment Alternatives.
There are two forms of investing:
 Direct Investing:

It involves securities that investors not only buy and

sell themselves but also have direct control over.
 Indirect Investing:

It refers to the buying and selling of the shares of

investment companies that, in turn, hold portfolios of
securities.
Direct Investing
We can divide direct investing into the
following broad categories:
A. Nonmarketable
B. Money Market
C. Capital Market
D. Derivatives Market
A. Nonmarketable Financial Assets
 Those assets which represent personal transactions
between the owner and the issuer e.g. bank account
etc.
 These are “safe” investments, occurring at insured
financial institutions or issued by the U.S.
government.
 At least some of these assets offer the ultimate in
liquidity.
Types of Nonmarketable Financial Assets

1. Savings Accounts
2. Nonnegotiable Certificates of deposit
3. Money market deposit accounts
4. U.S. government savings bonds
 1. Savings Account
 Savings accounts are held at commercial banks or at “thirft”
institutions such as savings and loan associations and credit
unions.
 Savings accounts in insured institutions offer a high degree of
safety on both the principal and the return on that principal.
 2. Nonnegotiable Certificates of deposit (CDs)
 Commercial banks and other institutions offer a variety of
savings certificates known as certificates of deposit.
 These certificates are available for various maturities, with
higher rates offered as maturity increases.
 In effect, institutions are free to set their own rates and terms
on most CDs.
 3. Money Market Deposit Accounts (MMDAs)
 Financial institutions offer money market deposit
accounts with no interest rate ceilings.
 Money market “investment” accounts have a
required minimum deposit to open, pay competitive
money market rates and are insured.
 4. U.S. Government Savings Bonds
 The nontraded debt of the governments, savings
bonds, are nonmarketable, nontransferable, and
nonnegotiable, and cannot be used for collateral.
 They are purchased from the Treasury, most often
through banks and savings institutions.
B. Money Market Securities
 Money markets include short-term, highly liquid,
relatively low risk instruments sold by governments,
financial institutions, and corporations to investor
with temporary excess funds to invest.

 This market is dominated by financial institutions,

particularly banks, and governments.
 Major Money Market Securities
Following are the major money market
securities:
1. Treasury bills
2. Negotiable Certificates of Deposit (CDs)
3. Commercial Paper
4. Eurodollars
5. Repurchase Agreement (RPs)
6. Banker’s Acceptance
 1. Treasury Bills

 The premier money market instrument, a fully

guaranteed, very liquid IOU from the government
treasury.
 They are sold on an auction basis every week at a
discount from face value, therefore, the discount
determines the yield.
 The greater the discount at time of purchase, the
higher the return earned by investors.
 2. Negotiable Certificates of Deposit (CDs)

 Issued in exchange for a deposit of funds by most

banks, the CD is a marketable deposit liability of the
issuer, who usually stands ready to sell new CDs on
demand.
 The deposit is maintained in the bank until maturity,
at which time the holder receives the deposit plus
interest.
 3. Commercial Paper

 A short-term unsecured promissory note issued by

large, well-known and financially strong
corporations.

 It is usually sold at a discount either directly by the

issuer or indirectly through a dealer, with rates
comparable to CDs.
 4. Eurodollars
 Dollar-denominated deposits held in foreign banks
or in offices of U.S. banks located abroad.
 Although this market originally developed in
Europe, dollar-denominated deposits can now be
made in many countries, such as those of Asia.
 5. Repurchase Agreement (RPs)
 An agreement between a borrower and a lender to
sell and repurchase government securities.
 The borrower initiates an RP by contracting to sell
securities to a lender and agreeing to repurchase
these securities at a prespecified price on a stated
date.
 6. Banker’s Acceptance
 A time draft drawn on a bank by a customer,
whereby the bank agrees to pay a particular amount
at a specified future date.
 These are negotiable instruments because the holder
can sell them for less than face value in the money
market.
 It is normally used in international trade.
C. Capital Market Securities
 Capital Market:
The market for long-term securities such as stocks
and bonds.

 There are two types:

 Fixed Income Securities

 Equity Securities
 Fixed Income Securities
 All of these securities have a specified
payment schedule, such as bond. In most
cases the amount and date of each payment
are known in advance. Some of these
securities deviate from the traditional bond
format, but all fixed-income securities have a
specified payment or repayment schedule-
they must mature at some future date.
 Types of Fixed-Income Securities
1. Federal Government Securities
2. Government Agency Securities
3. Municipals Securities
4. Corporates
 Bonds
 Bonds can be described as long-term debt
instruments representing the issuer’s contractual
obligation,
 The buyer of a newly issued coupon bond is lending
money to the issuer who, in turn, agrees to pay
interest on this loan and repay the principal at a
stated maturity date.
 Specified interest payment and the principal
repayment.
 Bonds are Fixed-income securities
Bond Characteristics
 Coupon Bonds
 Zero Coupon Bond
 Call Provision: The right to call in a security and
retire it by paying off the obligation.
 Non Callable Bonds
 Legal Liability to pay interest and repay
principal amount.
 1. Federal Government Securities
 The govt. in the course of financing its operation through the
Treasury Department, issues numerous notes and bonds with
maturities greater than one year.
 Treasury Bonds:
Traditionally have maturities of 10 to 30 years. They are sold at
competitive auctions and are sold at face value.
 Treasury-Inflation-Indexed Securities:
Protect investors against losses resulting from inflation. Based on
the Consumer Price Index (CPI), the value of the bond is
adjusted upward every six months by the amount of inflation.
 2. Government Agency Securities
 The federal government has created various federal
agencies designed to help certain sectors of the
economy through either direct loans or guarantee of
private loans.
 These various credit agencies compete for funds in
the marketplace by selling government agency
securities.
 Types of Govt. Agency Securities
 Federal Agencies:
Legally, federal agencies are part of the federal govt.
and their securities are fully guaranteed by the
Treasury.
 Federally Sponsored Credit Agencies:
These are privately owned institutions that sell their
own securities in the marketplace in order to raise
funds for their specific purposes.
 3. Municipals Securities

 Bonds sold by states, counties, cities and other

political entities (e.g., airport authorities, school
districts) other than the federal government and its
agencies are called municipal bonds. The risk varies
widely, as does marketability.
 4. Corporates
 Long-term debt securities of various types sold by
corporations.
 The typical corporate bond matures in 20 to 40
years, pays semiannual interest, is callable, and is
sold originally at a price close to par value.
What is an Investment Company
 Investment Company is a financial company that
sells shares in itself to the public and uses these
funds to invest in a portfolio of securities.
Types of Investment Companies:
 Unit Investment Trusts

 Closed-End Investment Companies

 Open-End Investment Companies or Mutual Funds

 Unit Investment Trusts
 Unit Investment Trust is an Unmanaged form
of Investment company, typically holding
fixed income securities, offering investors
diversification and minimum operating costs.
 Closed-End Investment Company
 An investment company with a fixed
capitalization whose shares trade on exchange
markets
 It is a type of managed investment company
 Open-End Investment Company
 An investment company whose capitalization
constantly changes as new shares are sold and
outstanding shares are redeemed.
 Open-End Investment Company is the
managed company and are popularly referred
as Mutual Funds
 Mutual Funds are the popular name for an
Open-End Investment Company
 Equity Securities
 Equity securities represent an ownership
interest in a corporation.
 These securities provide a residual claim
 There are two types:
 Preferred Stock
 Common Stock
 Preferred Stock
It is known as hybrid security
An equity security with an intermediate claim
Cumulative & noncumulative
Variable-rate preferred Stock
Auction-rate preferred Stock
Convertible into Common Stock
Mandatory Convertibles
 Common Stock
An equity security representing the ownership
interest in a company
“Closely held” and “go public”
Par Value and Book Value
Market Value & Aggregate Market Value
Dividends
 Derivative Securities
 Securities that derive their value in whole or in part
by having a claim on some underlying security.
 Their value is derived from their connected
underlying security.
 Two types of Derivatives:
 Options
 Futures Contract
 Options
 Options means the rights to buy or sell a stated
number of shares of stock within a specified period
at a specified price.
 The word options refers to puts and calls.
 Options are created not by corporations but by
investors seeking to trade in claims on a particular
common stock.
 Put: An option to sell a specified number
of shares of stock at a stated price within a
specified period.
 Call: An option to buy a specified number
of shares of stock at a stated price within a
specified period.
 Leaps: Puts and calls with longer maturity
dates of up to two years.
 Buyers of calls are betting that the price of the
underlying common stock will rise, making
the call option more valuable.
 Put buyers are betting that the price of the
underlying common stock will decline,
making the put option more valuable.
 Futures Contracts
 Future Contract is a commitment to buy or sell at a
specified future settlement date a designated amount of a
specific commodity or asset.
 Future contracts have been available on commodities such
as corn and wheat for a long time.
 Now they are also available for financial instruments,
including stock market indexes, currencies, Treasury bill
& bonds, bank certificates of deposits.
 Agreement providing for the future exchange of a
particular asset at a currently determined market price.