Portfolio Theory and Investment Analysis

Portfolio Theory and Investment Analysis
Group Members :
Afdal Syarif Alvin Putra Dedet Afrinata Sandisa Putra
0910534134 0910534135 09105320 09105320
Chapter 1
Understanding Investments
Investments Defined
Investments is the study of the process of committing funds to one or more assets
Emphasis on holding financial assets and marketable securities Concepts also apply to real assets Foreign financial assets should not be ignored
Investment Objectives
Primary Objectives
Safety of principal Income Growth of capital
Secondary Objectives
Liquidity Tax minimization
Investment Constraints
Possible constraints for investors include:

Legal Moral / Ethical Emotional including investment knowledge and risk tolerance Basic minimum income to be provided by the portfolio Realism an understanding that some objectives are unrealistic (e.g., high returns with low risk) Other (e.g., illness, pending divorce, etc.)
Primary and Secondary Objectives

Objectives and constraints must be related to the three primary investment objectives of safety, income, and growth, and to the secondary objectives of liquidity and tax minimization.

The importance of safety relates to: risk, market timing, inflation, return, and emotion The importance of income relates to: taxation, return, risk, inflation, and basic minimum income The importance of growth relates to: taxation, risk, return, market timing, and emotional considerations
The Investment Process

A description of the process is:
1. Set investment policy

Objectives Amount Choice of assets Examine securities (identify those which are mispriced?) a. Technical analysis the examination of past prices for trends b. Fundamental analysis true value based on future expected returns
2. Conduct security analysis
Use
The Investment Process
3. Portfolio Construction

Identify assets Choose extent of diversification Assess the performance of portfolio Repeat previous three steps
4. Portfolio Evaluation
5. Portfolio Revision
Why Study Investments?

Most individuals make investment decisions sometime
Individuals need sound framework for managing and increasing wealth Security analyst, portfolio manager, investment advisor, financial planner, Chartered Financial Analyst
Essential part of a career in the field
Investment Decisions
Underlying investment decisions: the tradeoff between expected return and risk Return: expected return is not usually the same as realized return Risk: the possibility that the realized return will be different than the expected return
The Tradeoff Between ER and Risk

Investors manage risk at a cost lower expected returns (ER) Any level of expected return and risk can be attained
Stocks ER Bonds
Risk-free Rate Risk
Typical Chart
RT
RISK- EXPECTED RETURN RELATIONSHIPS

12
RELATION
RISQUE-RENDEME
High
10
Options/Futures Art objects Coins and stamps Real estate (commercial) Common shares Real estate (residential) Preferred shares Corporate bonds Government bonds Treasury bills
Rendement
Expected Return 6
4
0 Low
Risk
10
12
High
The Investment Decision Process

Two-step process:
Security analysis
Necessary to understand security characteristics and applied to these securities to estimate their price or value Selected securities viewed as a single unit How and when should it be revised? How should portfolio performance be measured?
Portfolio management

Factors Affecting the Process

Uncertainty in ex post returns dominates decision process
Future unknown and must be estimated
Foreign financial assets opportunity to enhance return and/or reduce risk Investors must now cope with a changed investing environment Internet changes investments environment Institutional investors are important How efficient are financial markets in processing new information?
Return and Risk

The risk inherent in holding a security is the variability, or the uncertainty, of its return Factors that affect risk are
1. Maturity
Underlying factors have more chance to change over a longer horizon Maturity value of the security may be eroded by inflation or currency fluctuations Increased chance of the issuer defaulting the longer is the time horizon
Return and Risk
2. Creditworthiness
The governments of the US, UK and other developed countries are all judged as safe since they have no history of default in the payment of their liabilities Some other countries have defaulted in the recent past Corporations vary even more in their creditworthiness. Some are so lacking in creditworthiness that an active ''junk bond'' market exists for high return, high risk corporate bonds that are judged very likely to default
Return and Risk
3. Priority

Bond holders have the first claim on the assets of a liquidated firm Bond holders are also able to put the corporation into bankruptcy if it defaults on payment Liquidity relates to how easy it is to sell an asset The existence of a highly developed and active secondary market raises liquidity A security's risk is raised if it is lacking liquidity
4. Liquidity

Risk and Return
5. Underlying Activities
The economic activities of the issuer of the security can affect how risky it is Stock in small firms and in firms operating in hightechnology sectors are on average more risky than those of large firms in traditional sectors
Return and Risk
The greater the risk of a security, the higher is expected return Return is the compensation that has to be paid to induce investors to accept risk Success in investing is about balancing risk and return to achieve an optimal combination The risk always remains because of unpredictable variability in the returns on assets

Portfolio Theory and Investment Analysis

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Portfolio Theory and Investment Analysis

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Portfolio Theory and Investment Analysis

0910534134 0910534135 09105320 09105320

Primary and Secondary Objectives

The Investment Process

1. Set investment policy

2. Conduct security analysis

The Investment Process

Why Study Investments?

Essential part of a career in the field

The Tradeoff Between ER and Risk

Risk-free Rate Risk

RISK- EXPECTED RETURN RELATIONSHIPS

The Investment Decision Process

Factors Affecting the Process

Future unknown and must be estimated

Return and Risk

Return and Risk

Return and Risk

Risk and Return

Return and Risk

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