FMT – IPM

Lecture 1:
The investment environment

Ms. Pham My Phuong, MSc

Lecture outline

• Class administration
• 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
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 people s 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
• 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, 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 G 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)

• G 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

• Interest income on most municipals is not subject to

tax
• To compare the yields on municipals to other bonds
use equivalent taxable yield
(municipal return) / (1 – tax rate)
• Or solve for the tax rate that equates the two yields
Tax rate = 1 – (municipal rate/taxable rate)
 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
• 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
• Nikkie
• 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 hỗ tương 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