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75 Cards in this Set
- Front
- Back
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Social Interaction and Investments
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*Your success depends on the friends you keep
- what do they discuss and in what do they invest *Our tendency to herd magnifies phycological biases *Pleasure you expect is greater than the pleasure you experience *The money you spend on acquisitions tends to feel more like a mistake as time passes *Money you spend on experiences is more apt to grow in value |
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Emotions
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*Trauma or experiences involving great stress may be stored in our memories for life
*Those who lived through the Great Depression tended to be more frugal *If you experience a deep recession at 18-25 years are more frugal *Emotions are good and can help us make rational decisions *BUT our feelings can be dangerous *Good (bad) moods will increase (decrease) our willingness to take risks *Optimistic people are greater risk takers *Sunshine affects our moods |
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Conclusions and Recommendations
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*Success in the market requires self-control
*Develop strategies to beat the biases -understand the biases -know why you're investing -diversify -check stocks once a month -review portfolio annually -trade on the same day each month or have a plan, rule or strategy |
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Bonds vs. Stocks
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*Bonds are lower returns (historically)
*Main benefits of bonds -lower risk/less volatility -higher levels of current income -diversification *Bonds add an element of stability |
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What are bonds?
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*Debt, liability, "publicly traded IOU"
*Called "fixed income securities" since payments are fixed amounts |
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Why invest in bonds?
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*Provide current income for conservative investors
*Primary investment objective-preservation and long term accumulation of capital |
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Interest rates and bonds
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*the behavior of interest rates is the single most important force in the bond market
*Interest rates and bond prices move in opposite directions *when interest rates rise, bond prices fall *when interest rates drop, bond prices rise |
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Bonds and risk
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*Interest rate risk
*Purchasing power risk-lag behind inflation rate *Business/financial risk-default *Liquidity risk-difficult to sell *Call risk-"called" (retired) before its scheduled maturity rate trade off *Always remember risk/return trade off |
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Measuring return
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Required return: The rate of return an investor must earn on an investment to be fully compensated for its risk
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RROI
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Real rate of return + expected inflation premium + risk premium for investment
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Risk premium depends on...
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1. the default
2. the term-to-maturity 3. any call risk, if applicable |
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Essential features of a bond
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1. Coupon
2. Principle(par value) 3. Maturity date 4. Term bond 5. Serial bond 6. Call feature 7. Call premium 8. Sinking fund |
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Coupon
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The amount of annual interest income
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Principal (par value)
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the amount of capital that must be repaid at maturity
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Maturity date
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the date when a bond matures and the principal must be paid
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Term bond
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has a single maturity date
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Serial bond
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series of different maturity dates
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Call feature
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allows the issuer to repurchase the bonds before the maturity date
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Sinking fund
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stipulates how a bond will be paid off over time
-applies only to term bonds -issuer is obligated to pay off the bond systematically over time |
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Types of secured debt
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*Secured debt is backed by pledged collateral
-mortgage bonds are backed by real estate -equipment -other assets |
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Types of unsecured debt
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*Unsecured debt is backed only by the promise of the company to pay
-debenture is an unsecured (junior) bond -subordinated debentures are unsecured bonds whose claim is secondary to other claims -income bonds requires interest to be paid only after a specified amount of income has not been earned |
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US Treasuries
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*Considered risk free-no risk of default
*interest is exempt from state and local taxes *Sold in $1000 denominations -bills: mature in 1 year or less -notes: mature in 2-10 years -bonds: mature in 20-30 years *treasury inflation-index obligations -protected against inflation by adjusting investor returns -interest rates are very low |
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Agency bonds
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*issued by government agencies
-federal home loan bank -Federal National Mortgage Association -small business administration *high quality securities with low risk of default |
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Municipal Bonds
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*issued by states, counties, cities, counties and any other political subdivisions to fund projects
*Not risk free *exempt from federal tax and sometimes state and local taxes |
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Corporate bonds
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*issued by corporations
*provide higher returns due to higher risk of default |
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Zero-coupon bonds
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*do not pay any interest
*sold a deep discount from par-value *subject to tremendous price volatility *interest must be reported as it is accrued for tax purposes even though no interest is received *treasury strips are zero-coupon bonds created from US treasury securities |
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Mortgage-backed securities
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*bonds backed by a pool of residential securities
*government agencies are major issuers -gov't national mortgage association -fed home loan mortgage corporation *self-liquidating investment since a portion of the principal is received each month |
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Junk bonds
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*Highly speculative (might be in default)
*Have low, sub investment grade ratings *Typically offer high yields |
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Global bonds
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*Potentially higher returns than US bonds
-Interest rate trends in other countries may not follow US rates *Currency exchange rate can fluctuate US dollars |
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Convertible securities
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*Allows holder to convert the security into a specified number of shares of common stock
*two major types of convertible securities -convertible bonds -convertible preffered stock *Equity kicker: another name for the conversion feature that allows the holder to convert the security into a specified number of common stock |
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Bond quotes
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*bonds quotes are a percentage of par value
*97 means 97% of par value, would sell for $970 *below 100; trading at a discount *above 100; trading at a premium |
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Bond strategies
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*What should we do and when?
-two types of yield curves >upward sloping curve >downward sloping curve |
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Basic bond investing strategy
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*If you expect interest rates to increase, buy short term bonds
*If you expect interest rates to decrease, buy long term callable bonds *Ladder bonds for protection against interest changes |
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The pricing of bonds
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*Bonds are priced according to the present value of their future cash flow streams
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Bond Price
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present value of the annuity of annual income + present value of the bond's par value
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Bond duration
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*A measure of price volatility
*Indicate how a bond will react *Average amount of time that it takes to receive the interest and principal *If a bond has a duration of 6 then a 1% increase in interest rates will result roughly a 6% decline in the value of a bond |
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The concept of duration
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*General properties
-bonds with higher coupon rates have shorter durations -bonds with longer maturities have long durations -bonds with higher YTM lead to shorter maturities *bond duration is a better indicator than bond maturity of impact on IR on bond price volatility -if IR increases, hold bonds with short durations -if IR are going down, hold bonds with long durations |
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Characteristics of preffered stock
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*hybrid security: characteristics of stocks and bonds
-provides fixed income -trade like stocks -no fixed face value -default doesn't bring bankruptcy *Investment quality rate like bonds |
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Advantages of preffered stock
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*dividend income is highly predictable
*dividend yields are similar to yields on high credit quality bonds *corporations are able to exclude 70% of preffered dividends from income taxes *generally safe *low unit cost |
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Disadvantages of preffered stock
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*many preffered stock dividends do not quality for the new preferential tax rate of 15%
*Behave like a bond -if inflation and interest rates rise, the value of preffered stock drops -vice versa *investors don't participate in the capital gains that common stock holders receive *preffered stock doesn't have the safety of a bond |
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Valuing a preffered stock
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*Value is a function of dividend yield provided
*the lower the investment quality, the higher the yield *risk exposure of preffered stocks includes: -business risk -interest rate risk |
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Price of preffered stock
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Annually dividend yield (income) / prevailing market yield
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Issue characteristics of preffered stock
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*Conversion feature
*Cumulative provision: all past unpaid dividends must be paid before common stock dividends are paid |
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Key measures of preffered stock
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*Dividend yield
*Book value *Agency ratings *Ability of the company to cover the dividend |
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Dividend yield
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annual dividend income / current market price of preffered stock
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Investment strategies using preffered stock
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*Two major strategies
-going after higher levels of current income -seeking capital gains when market rates are falling *looking for high yields |
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Classification of mutual funds
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*Closed end funds
-limit the number of investors *open end funds -permit an unlimited number of investors |
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Types of funds-fee structure
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*Load funds
-approximately 5.5% fee charged at initial investment *Light load funds -approximately 2-3% fee charged at initial investment *No load *Expense charge (ratio) -annually 0-3% |
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Why choose a mutual fund?
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*Immediate diversification
*Liquidity *Professional management *Continuous supervision *Easy record keeping *Automatic reinvestment of dividends *Easy to change your investment strategy |
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Mutual fund categories
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*Stocks or equity funds
-large cap -mid cap -small cap -equity income -science and technology -emerging market -international fund -balanced |
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Bond funds
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-US gov't (treasuries, zero coupin)
-municipal (short, general, high yield) -corporate A-rated -short and intermediate investment grade -international income -junk bonds -GNMA |
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Money market fund
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-Cash substitute
-Highly liquid -Usually have check writing privileges -Not risk free -Constant NAV of $1 -Type and maturity determines returns |
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Sector or specialty funds
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*focus on an industry or investment vehicle
-transportation -healthcare, biotech -computers -internet -gold -utilities |
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Ethically or socially responsible funds
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*Avoid investments in the "four sins"
-smoking, drinking, gambling, pornography *Biblically responsible investments -4 sins, abortion, lifestyle issues, and others *Green/Environmental funds -make money, not war -weapons, nuclear energy -politically correct *Global (includes US) *International (non-US) -country -region -emerging markets |
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Selecting a mutual fund
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*Investment objectives
-does the fund meet your strategies and goals? *Fund performance -1yr, 3yr, 5yr, 10yr -review an entire market cycle -compare to an appropriate benchmark -consider the risk >look at beta >watch for use of speculative techniques *Management continuity *Fees and charges -load -12b-1 charges >cover marketing and distributions -expense ratio -redemption fees *Age and size -especially important for stock funds *Services -minimum investment - $1000-2500 -telephone exchange -internet exchange -IRAs *Turnover ratio -how actively the fund is being monitored -may have tax implications |
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Mutual Fund diversification
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*basic
-domestic stock -international stock -intermediate bond -money market *Enhanced diversification -large cap funds -small cap -emerging market |
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What are ETFs?
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*Combines elements of stocks and mutual funds
*You own shares that track specific indexes *Your stock represents an entire portfolio *They are bought and sold as individual shares of stock |
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Benefits of ETFs
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*Index performance except for actively traded ETFs and other employing speculative techniques
*Some track specific market sectors *Immediate diversification *Liquidity-traded any time during US market hours *Flexibility-traded just like stocks through market or limit orders, bought on margin or sold short *Cost effective; low fees (usually < .5%) *Tax efficient |
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Risks of ETFs
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*Pricing-shares could be priced at premium NAV
*tracking error *expense ratios *low volume can increase the bid/ask spread *watch for speculative techniques *proliferation ETFs |
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Your investment profile
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*tolerance for risk
*return needs-income vs. growth *time horizon *tax exposure |
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Coefficient of variation
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standard deviation / average annual return
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The investment pyramid
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*Speculation
-options, futures *Growth -large company stocks -small company stocks *Foundation -emergency fund -real estate |
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Ultimate goal for an efficient portfolio
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*A portfolio that provides the highest return for any given level of risk (rate of return)
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Traditional approach
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*emphasizes "balancing" the portfolio using a wide variety of stocks and/or bonds
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Modern portfolio theory
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Emphasizes statistical measures to develop a portfolio plan
*Focus on -expected returns -Standard deviation of returns -correlation between returns *Combines securities that have negative (or low-positive) correlations between each others rate of return |
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Key aspects if MPT
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*Beta: a measure of non-diversifiable risk or volatility
*Portfolio beta -the weighted averages of the betas of the individual assets -to earn more returns, one must bear more risk -build a portfolio of only non-diversifiable risk |
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Sharpe ratio
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Tells us whether a portfolio's returns are due to smart investment decisions or a result of excess risk
-higher-better its risk adjusted performance 1 is good 2 is very good 3 is excellent |
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Alpha
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the excess return of the fund relative to the return of the benchmark
-the value that a portfolio manager adds or subtracts from the return |
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International diversification
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*Advantages of international diversification
-broader investment choices -potentially greater than US -reduction of overall portfolio risk *disadvantages -currency exchange risk -less convenient -more expensive to invest |
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Reconciling the tradition and modern approaches
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*recommended portfolio management
-determine how much risk you are willing to bear -pay attention to risk measures -try to achieve the highest return for the given level of accepted risk |
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Constructing a portfolio using asset allocation
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*The process of dividing an investment portfolio into various asset classes
-stocks -bonds -cash -int. securities |
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Personal factors
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*investor characteristics to consider
-personal goals -level and stability of income and net worth -age -stage in family life cycle -attitude to risk -tax considerations -interest and ability in administration |
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Evaluating portfolio performance
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*compare returns with broad based market measures
*compare performance to investment vehicles -risk vs return -do i have a problem investment ? *Determine appropriate action on each investment -keep, sell, or monitor |
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Periodic revision
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*periodic reallocation and rebalancing
*reasons to revise -major life event -proportion of one asset class increases or decreases substantially -expect to achieve a major life goal in the next few years -% allocation of asset class varies from original allocation of 10% or more |
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Timing transactions
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*dollar cost averaging
-fixed dollar amount of fixed intervals -discipline to invest on regular basis is vital -purchase more shares when prices are low, less when they're high |
