Samenvatting Investment Analysis
Chapter 1 The Investment Environment
An investment is the current commitment of money or other resources in the expectation of
reaping future benefits.
1.1 Real Assets versus Financial Assets
The material wealth of a society is ultimately determined by the productive capacity of its
economy, that is, the goods and services its member can create. This capacity is a function of
the real assets of the economy (land, buildings, machines)
In contrast to real assets are financial assets such as stocks and bonds. Such securities are no
more than sheets of paper and they do not contribute directly to the productive capacity of
the economy. Instead, these assets are the means by which individuals in well-developed
economies hold their claims on real assets. Financial assets are claims to the income
generated by real assets.
While real assets generate net income to the economy, financial assets simply define the
allocation of income or wealth among investors.
1.2 Financial Assets
It is common to distinguish among three broad types of financial assets: fixed income, equity
and derivatives. Fixed-income or debt securities promise either a fixed stream of income or
a stream of income determined by a specified formula.
Unlike debt securities, common stock, or equity in a firm represents an ownership share in
the corporation. Equity holders are not promised any particular payment. They receive any
dividends the firm may pay and have prorated ownership in the real assets of the firm. If the
firm is successful, the value of equity will increase. The performance of equity investments is
tied directly to the success of the firm and its real assets.
Derivative securities such as options and future contracts provide payoffs that are
determined by the prices of other assets such as bond or stock prices.
1.3 Financial Markets and the Economy
Stock prices reflect investors’ collective assessment of a firm’s current performance and
future prospects. When the market is more optimistic about the firm, share prices will rise.
The higher price makes it easier for the firm to raise capital and therefore encourages
investments. In this manner, stock prices play a major role in the allocation of capital in
market economies.
Financial markets and the diverse financial instruments traded in those markets allow
investors with the greatest taste for risk, to bear that risk, while other, less-risk tolerant
individuals can, to a greater extent, stay on the sidelines.
Potential conflicts of interest are called agency problems because managers, who are hired
as agents of the shareholders, may pursue their own interest instead of the interest of the
shareholders.
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,1.4 The Investment Process
An investors’ portfolio is simply his collection of investment assets. Once the portfolio is
established, it is updated or rebalanced by selling existing securities and using the proceeds
to buy new securities, by investing additional funds to increase the overall size of the
portfolio, or by selling securities to decrease the size of the portfolio.
The asset allocation decision is the choice among these broad asset classes, while the
security selection decision is the choice of which particular securities to hold withing each
asset class. Top-down portfolio construction starts with asset allocation.
Security analysis involves the valuation of particular securities that might be included in the
portfolio. Both bonds and stocks must be evaluated for investment attractiveness, but
valuation is far more difficult for stocks because a stock’s performance usually is far more
sensitive to the condition of the issuing firm.
In contrast to top-down portfolio management is the ‘bottom-up’ strategy. In this process,
the portfolio is constructed from securities that seem attractively priced without as much
concern for the resultant asset allocation. Such a technique can result in unintended bets on
ore or another sector of the economy.
1.5 Markets Are competitive
Financial markets are highly competitive. Thousands of intelligent and well-backed analysts
constantly scour securities markets searching for the best buys.
Investors invest for anticipated future returns, but those returns rarely can be predicted
precisely. There will almost always be risk associated with investments. Actual or realized
returns will almost always derivate from the expected return anticipated at the start of the
investment period. If all else equal, investors would prefer investments with the highest
expected return. However, the no-free-lunch rule tells us that all else cannot be held equal. If
you want higher expected return, you will have to pay a price in term of accepting higher
investment risk.
We conclude that there should be a risk-return trade off in the securities market, with
higher-risk assets priced to offer higher expected returns that lower risk-assets.
Diversification means that many assets are held in the portfolio so that the exposure to any
particular asset is limited.
Another implication of the no-free-lunch proposition is that we should rarely expect to find
bargains in the security markets. One interesting implication of this ‘efficient market
hypothesis’ concerns the choice between active and passive investment-management
strategies. Passive management calls for holding highly diversified portfolios without
spending effort of other resources attempting to improve investment performance through
security analysis. Active management is the attempt to improve performance either by
identifying mispriced securities of by timing the performance of broad assets classes. If
markets are efficient and prices reflect all relevant information, perhaps it is better to follow
passive strategies instead of spending resources in a futile attempt to outguess your
competitors in the financial markets.
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,1.6 The Players
- Firms are net demanders of capital. They raise capital now to pay for investments in
plant and equipment. The income generated by those real assets provides the returns
to investors who purchase securities issued by the firm
- Household typically are net suppliers of capital.
- Governments can be borrowers or lenders, depending on the relationship between
tax revenue and government expenditures.
Corporations and governments do not sell all or even most of their securities directly to
individuals.
Financial intermediaries have evolved to bring the suppliers of capital (investors) together
with the demanders of capital (primarily corporations and the federal government). These
financial intermediaries include banks, investments companies, insurance companies and
credit unions. Financial intermediaries issue their own securities to raise funds to purchase
securities of other corporations.
Investment companies, which pool and manage the money of many investors, also arise out
of economies of scale. Here, the problem is that most household portfolios are not large
enough to be spread across a wide variety of securities. Mutual funds have the advantage of
large-scale trading and portfolio management, while participating investors are assigned a
prorated share of the total funds according to the size of their investment.
Like mutual funds, hedge funds also pool and invest the money of many clients, but they are
open only to institutional investors such as pension funds, endowment funds or wealthy
individuals. Economies of scale also explain the proliferation of analytic services available to
investors.
Investment bankers advise the issuing corporation on the prices it can charge for the
securities issued, appropriate interest rates and so forth. Ultimately, the investment banking
firm handles the marketing of the security in the primary market, where new securities
among themselves in the so-called secondary market.
Equity investment in young companies is called Venture Capital (VC). Sources of venture
capital are dedicated venture capital funds, wealthy individuals known as angel investors and
institutions such as pension funds. Most venture capital funds are set up as limited
partnerships.
Private equity -> firms that are not traded on the public market.
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, 1.7 The financial Crisis of 2008
Credit default swap (CDO) is in essence an insurance contract against the default of one or
more borrowers. The purchaser of the swap pays an annual premium for protection from
credit risk.
Chapter 2 Asset Classes and Financial Instruments
2.1 The Money Market
The money market is a subsector of the fixed-income market. It consists of very short-term
debt securities that usually are highly marketable.
U.S. Treasury bills are the most marketable of all money market instruments. T-bills represent
the simplest form of borrowing: the government raises money by selling bills to the public.
Investors buy the bills at a discount from the stated maturity value. At the bills’ maturity, the
government pays the investor the face value of the bill. The difference between the purchase
price and ultimate maturity value constitutes the investors’ earnings.
The ask price is the price you would have to pay to buy a T-bill from a securities dealer. The
bid price is the slightly lower price you would receive if you wanted to sell a bill to a dealer.
The bid-ask spread is the difference in these prices.
A certificate of deposit, is a time deposit with a bank. Time deposits may not be withdrawn
on demand. The bank pays interest and principal to the depositor only at the end of the fixed
term of the CD.
Large, well-known companies often issue their own short-term unsecured debt notes rather
than borrow directly from banks. These notes are called commercial paper. Very often,
commercial paper is backed by a bank line of credit, which gives the borrower access to cash
that can be used to pay off the paper at maturity.
A banker’s acceptance starts as an order to a bank by a bank’s customer to pay a sum of
money at a future date, typically within 6 months.
Eurodollars are dollar-denominated deposits at foreign banks or foreign branches of
American banks. By locating outside the US, these banks escape regulation by the Federal
Reserve.
Dealers in government securities use repurchase agreements as a form of short-term
borrowing. The dealer sells government securities to an investor on an overnight basis, with
an agreement to buy back those securities the next day at a slightly higher price.
Funds in the bank’s reserve account are called federal funds. At any time, some banks have
more funds than required at the Fed. In the federal funds market, banks with excess funds
lend to those with a shortage. These loans, which are usually overnight transactions, are
arranged at a rate of interest called the federal funds rate.
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