FMT – IPM

Lecture 1:
The investment environment (1, 2)
Lecture outline
• Investment philosophy
• Investment attributes
• Investment steps
• Life cycle investing
• Financial instruments
What is an investment?
1 Subject
information
 Subject information

The subject is about the investment activity of institutional

investors and individuals.

Subject content:
• The investment environment
• Investment funds
• Equity market
• Debt market
• Company analysis
• Derivatives market
• Portfolio formulation and management
Subject information
Assessment

Items Weight Time

Participation 10% All classes

2 Progress Tests 20% TBA

Midterm test 20% Week 8

Final exam 50%

2 Attributes of
Investments
 What
constitutes
a successful
investment?
A successful investment

Right time è Market timing

Right assets è Asset selection
Right amount è Capital allocation
 Attributes of investments
• Securities or Property
– Securities: stocks, bonds, options
– Real Property: land, buildings
– Tangible Personal Property: gold, artwork, antiques,
collectables
• 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 or properties
• Low Risk or High Risk
– Risk: the uncertainty surrounding the return that a particular
investment will generate
 Attributes of investments
• Short-Term or Long-Term
– Short-Term: mature within one year
– Long-Term: maturities of longer than a year
• Domestic or Foreign
– Domestic: Vietnam-based companies
– Foreign: foreign-based companies
 Suppliers and Demanders of
Funds
• Government
– Federal, state and local projects & operations
– Typically net demanders of funds è Need: Raise funds
• Business
– Investments in production of goods and services
– Typically net demanders of funds è Need: Raise funds
• Individuals
– Some need for loans (house, auto)
– Typically net suppliers of funds
– Primary need: Invest funds
– Different level of risk considerations
The Investment Process
 Types of Investors

• Individual Investors
– Invest for personal financial goals
(retirement, house)

• Institutional Investors
– Paid to manage other peopleʼs money
– Trade large volumes of securities
– Include: banks, life insurance companies, mutual funds,
pension funds
 Types of Markets
• Primary Market: the market in which new issues of securities
are sold to the public
– Initial Public Offering (IPO)
• First public sale of a company’s stock
• Requires SEC approval
– Three Choices to Market Securities in Primary Market
• Public offering
• Rights offering
• Private Placement
• Secondary Market: the market in which securities are traded
after they have been issued
3 Steps in
Investing
 Steps in Investing
• Step 1: Meeting Investment Prerequisites
– Adequately provide for necessities of life, including funds for
meeting emergency cash needs
– Adequate protection against various common risks, such as
death, illness, disability
• Step 2: Establishing Investment Goals
– Examples: Accumulating retirement funds, enhancing income,
saving for major expenditures
• Step 3: Adopting an Investment Plan
– Develop a written investment plan
– Specify target date and risk tolerance for each goal
• Step 4: Evaluating Investments
– Assess potential return and risk
 Steps in Investing
• Step 5: Selecting Suitable Investments
– Research and gather information on specific investments
– Make investment selections
• Step 6: Constructing a Diversified Portfolio
– Use portfolio comprised of different investments
– Diversification can increase returns or decrease risks
• Step 7: Managing the Portfolio
– Compare actual behavior with expected performance
– Take corrective action when needed
 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
– Growth-oriented investments
– 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

• Retirement Stage
– Ages 60 and older
– Preservation of capital becomes primary goal
– Highly conservative investment portfolio
– Income needed to supplement retirement income
 Investing Over the Life Cycle

• What are 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, high quality corporate bonds,
bank certificates of deposit
4 The Financial
Instruments
Measures of risk
Return
 The financial instruments

• Money Market
– Debt Instruments
– Derivatives

• Capital Market
– Bonds
– Equity
– Derivatives
 Money Market Instruments

• Treasury bills
– Most marketable of all money market instruments
– Maturities of 28, 91 and 182 days
– Minimum denomination of $10,000

• Certificates of deposit (CD) = time deposits

– May not be withdrawn on demand
– The bank pays interest and principal at term end
– Can be sold before maturities
 Money Market Instruments

• Commercial Paper
– Short term unsecured debt notes issued by companies
– Maturities of up to 270 days require no registration
– Issued in multiples of $100,000

• Bankers Acceptances
– An order to a bank by a bank’s customer to pay a sum of
money at a future date
– Often within 6 months
– The acceptance can be traded in secondary markets
 Money Market Instruments

• Eurodollars
– Dollar-denominated deposits at foreign banks or foreign
branches of US banks
– Can be time deposits or CDs.
– Eurodollar CDs can be sold before maturity
– Eurodollar time deposit can not be sold.
– Less liquid and riskier than domestic CDs.
 Money Market Instruments

• Repurchase Agreements & Reverse repos

– The dealer sells Gov. securities to an investor overnight
– Buy back the securities the next day at a higher price
– One day loan with securities as collateral

• A term repo: Maturities can be ³ 30 days

• A reverse repo: buy securities and resell to the
investor at a higher price on a future date.
 Money Market Instruments

• Federal Funds (fed funds)

– Funds in the bank’s reserve account
– Excess funds banks lend to shortage ones
– Overnight transactions at fed funds rate
– Fed funds rates = rate on very short term loans among
financial institutions.
• Brokers’ Calls
– Brokers borrow funds from banks
– Repay on call
• LIBOR Market
– Large banks in London lend among each other
Capital Market - Bond Markets

– US Treasury Bonds and Notes

• T-notes: maturities up to 10 years
• T-bonds: 10 – 30 years
• Denomination of $1,000 or more
• Semi-annual interest payments

– Agency Issues (Fed Agency Debt)

• Gov. issues securities to finance a particular sector of the
economy
Bond Markets

– International Bonds
• Eurobonds
• Foreign bonds
Bond Markets

– Municipal Bonds
• Issued by State and local governments
• Interest income is tax-exempted
• Lower yield
– General obligation bonds
– Revenue bonds
– Industrial development bonds
 Bond Markets - exercise
Which would you prefer if tax bracket = 30%?
1. a 6% taxable return or
2. a 4% tax-free return

• After tax return 1:

– 6 * (1-0.3)=4.2%
è 1 offers higher after tax return than 2.

• Equivalent taxable yield of 2:

– 4/(1-0.3)=5.71%
è 2 offers lower taxable yield than 1.
è 1 is preferred to 2.
Bond Markets

– Corporate Bonds
• Private firms borrow directly from the public
• Default risk is considerable
• Secured bonds vs. unsecured bonds (debentures)
• Bonds with options (callable, convertible)
 Bond Markets

CUR NET
BONDS VOL CLOSE
YLD CHG
ATT7¾21 7.3 65 106 0.50
1. Bonds of ATT mature in 2021
2. Annual Coupon rate = 7¾% of par value = $77.50
3. 65 bonds were traded on that day.
4. Closing price = 106% of par = $1060.
5. Current yield = Annual coupon income/Price
= $77.50/1060 = 7.3%
 Capital market - Equities
• Common stock
– Residual claim
– Limited liability
• Preferred stock
– Fixed dividends – limited, cumulative
– Priority over common stock
– Tax treatment: not tax deductible
– Preferred stock is issued in variations:
• Redeemable
• Convertible
• Adjustable-rate preferred stock
 Equity market indices

• Dow Jones Industrial Average (30 Stocks)

• Standard & Poor’s 500 Composite
• NASDAQ Composite
• NYSE Composite
• Wilshire 5000
• Dax
• Nikkei
• FTSE
• Hang Seng
 Lecture summary

• Financial revision
• Attributes of investments
• Steps in investment
• Life cycle investment
• Financial instruments
 Investment
information
websites
 Vietnamese terms

• Capital market: TT vốn

• OTC market: TT phi tập trung
• Bid: Giá rao mua
• Asked: Giá chào bán
• Securitization: Chứng khoán hoá
• Preferred stock: Cổ phiếu ưu đãi
• Common stock: Cổ phiếu phổ thông
• Mutual fund: Quỹ tương hỗ đầu tư
• Prospectus: Bản cáo bạch
• Treasury bonds: Trái phiếu kho bạc dài hạn
• Treasury notes: Tín phiếu kho bạc
 Vietnamese terms

• Mortgage bond Trái phiếu thế chấp

• Debenture Trái phiếu tín chấp
• Zero-coupon bond Trái phiếu chiết khấu khống
• Adjustable bond Trái phiếu điều chỉnh
• Revenue bond Trái phiếu lợi tức
• Stock split Tách cổ phiếu
• Municipal bond Trái phiếu đô thị
• Secured bond Trái phiếu bảo đảm
• Convertible bond Trái phiếu chuyển đổi
• Callable bond Trái phiếu có thể thu hồi