Professional Documents
Culture Documents
Introduction to Portfolio
Management and Basic Principles
of Finance
Asst. Prof. Dr. Mete Feridun
1
Fundamental Analysis
Technical Analysis
Security Analysis
A three-step process
1) The analyst considers prospects for the
economy, given the state of the business cycle
2) The analyst determines which industries are
likely to fare well in the forecasted economic
conditions
3) The analyst chooses particular companies
within the favored industries
6
Investors Constraints
Investors Constraints
4.Tax considerations: special considerations
related to tax position of the investor. The
performance of any investment strategy are
always measured by its rate of return after tax.
5.Unique needs: often centre around the
investors stage in the life cycle such as
retirement, housing and childrens education.
Portfolio Management
Literature supports the efficient markets
paradigm
10
Purpose of Portfolio
Management
Portfolio management primarily involves
reducing risk rather than increasing return
$25,937
$23,642
$20,000
$10,000
$10,000
Low
Risk
High
Risk
$0
'92
'94
'96
'98
'00
'02
13
1)
2)
16
Portfolio Management
Passive management has the following
characteristics:
Do nothing
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Measuring Risk
Risk = Probability of incurring harm
For investors, risk is the probability of
earning an inadequate return.
Risk
The range of total possible returns
on the stock A runs from -30% to
more than +40%. If the required
return on the stock is 10%, then
those outcomes less than 10%
represent risk to the investor.
Probability
-30% -20%
-10%
0%
10%
20%
30%
40%
Possible Returns on the Stock
21
-30% -20%
-10%
0%
10%
20%
30%
40%
Possible Returns on the Stock
22
Return
%
Risk Premium
RF
Real Return
Expected Inflation Rate
Ris
k
23
24
Expected return
Rf
0
Risk
25
26
27
Measuring Risk
Annual Returns by Asset Class, 1938 - 2005
28
29
Investment Choices
The Concept of Dominance Illustrated
Return
%
10%
5%
A dominates C
because it offers a
higher return but
for the same risk.
5%
A dominates B
because it offers
the same return
but for less risk.
20%
Risk
30
Risk Aversion
32
Investment A
Investment B
Time
33
34
Types of Risk
Growth of Income
Benefits from time value of money
38
41
Categories of Stock
Blue chip stock
Income stocks
Cyclical stocks
Defensive stocks
Growth stocks
Speculative stocks
Penny stocks
42
Income Stocks
Cyclical Stocks
Defensive Stocks
Growth Stocks
47
Speculative Stocks
Speculative stocks are those that have the
potential to make their owners rich quickly
Speculative stocks carry an above-average
level of risk
Most speculative stocks are relatively new
companies with representation in the
technology, bioresearch, and
pharmaceutical industries
48
Penny Stocks
49
Capitalization
Investment Styles
1-Value investing
2-Growth investing
52
1-Value Investing
Price/Earnings Ratio
Price/Book Ratio
2-Growth Investing
Why Do Individuals
Invest ?
By saving money (instead of
spending it), individuals tradeoff
present consumption for a larger
future consumption.
57
$1.00 4% $1.04
58
Defining an Investment
A current commitment of $ for a
period of time in order to derive
future payments that will
compensate for:
the time the funds are committed
the expected rate of inflation
uncertainty of future flow of funds.
62
Risk Aversion
The assumption that most investors
will choose the least risky
alternative, all else being equal and
that they will not accept additional
risk unless they are compensated in
the form of higher return
63
Probability Distributions
Risk-free Investment
64
Probability Distributions
Risky Investment with 3 Possible Returns
65
Probability Distributions
Risky investment with ten possible rates of return
66
ALL INVESTING
INVOLVES TWO CONCEPTS
Risk
vs
Safety
67
1) As we go down the
Risk list, your return
will decrease
vs
Safety
1) As we go down the
Safety list, your
potential return
increases
No Loss due to
Principal decline
Various Investment
Options
Substantial Track
Record
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vs
Safety
1) Stocks
a) Company risk
b) Market risk
c) Macro risk
d) Historic 11.1% return
2) Mutual Funds
a) Diminished company risk
b) Still has market & macro risk
c) Could return 8-10%
3) Variable Annuities
a) Uses sub-accounts
b) Can be more expensive
c) Returns of 6-9%
4) Long-Term Bonds
a) Subject to interest rate risk
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Risk
1) Stocks
a) Company risk
b) Market risk
c) Macro risk
d) Historic 11.1% return
2) Mutual Funds
a) Diminished company risk
b) Still has market & macro risk
c) Could return 8-10%
3) Variable Annuities
a) Uses sub-accounts
b) Can be more expensive
c) Returns of 6-9%
4) Long-Term Bonds
a) Subject to interest rate risk
vs
Safety
1) CDs
a) Temporary parking spot 4 - 5%
b) After tax and inflation, results
in minimal returns
2) Short Term Medium Term U.S.
Government Bonds
3) Fixed Annuities
a) Tax-deferred
b) Earnings add up
c) Higher interest rates paid
4) Equity Indexed Annuities 5 8
a) Over Time - No Market Risk
b) Links to major indexes
Usually S&P 500
c) With No Risk of Loss of
Principal due to market decline
70
FINAL QUESTION
Which of these three do you want?
PROTECTION
GROWTH
LIQUIDITY
The market only allows you two out of
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three!