FE445 Investment Analysis and Portfolio Management

Spring 2020

Yunjeen Kim

Boston University | Questrom School of Business

Lecture 1: Introduction and
Investment Process
Objective of the Course

The objective of this course is to teach you

1. How to invest your money

• How to make money (?)
• How not to lose money
2. How to value assets
3. Understand the basics of financial economics

Most of all, it should give you the confidence to ask hard questions!

1
What would you do? Retirement

• You just started your first day of work and you need to determine
your retirement account contributions.
• The company matches every dollar you invest up to 3% of your
salary.
• You can contribute up to $14,000 per year.
• Your beginning salary is $60,000.
• How much should you contribute? How do you allocate your funds?

2
Investor Objectives: Individual Investors

• Balance risk and return: Test your risk tolerance

• Life Cycle is critical in determining risk/return trade-off.

• Younger investors: Willing to bear more risk for higher returns.

• Older investors: Want to plan retirement: lower risk.

3
Investing for Retirement

Example:
http://personal.vanguard.com/us/funds/vanguard/TargetRetirementList

4
Investor Constraints

• Liquidity:
• Speed and ease of converting asset into cash.
• Normally entails sacrifice in return.
• Investment Horizon
• Planned liquidation date.
• Taxes: maximize after-tax returns.
• Regulations:
• Professional and institutional investors

5
Professional Investors

• Mutual Funds
• Pension Funds:
1. Defined contribution pension fund:
• Employee and employer contribute a set amount.
• Benefit depends on investment performance.
• Risk borne by the individual.
• Investment earnings are usually not taxed until the funds are
withdrawn, usually after retirement.
2. Defined benefit pension fund:
• Retirement benefit depends on years and salary.
• Return assumption important.
• Risk born by the company.

• Insurance Companies, Banks

• Personal Trusts and Endowments

6
Investment Process

1. Asset Class Allocation:

• Money market assets → liquidity needs
• Fixed-income securities (mostly bonds)
• Stocks: value, size, sector, dividend yield
• Real estate
• Commodities

Asset class is the main determinant of your risk-return profile

2. Security Selection:
• What exact asset do you invest in, e.g. stock-picking

7
Investment Policy: Active versus Passive

• Active:
• Try to enhance performance
• Active asset/security allocation
• Must balance with costs
• Trading costs
• Time or paying advisors
• Passive (indexing)
• Trying to get average returns at low cost
• Mix of Passive and Active

8
Summary

This class:

• Overview of the class.

• Investment Process
• Asset allocation decision is the main driver of the risk characteristic.

Next class:

• Real vs. financial assets

• Roles of financial markets
• Classes of financial assets and securities
• Money market instruments
• Investment companies: e.g. mutual funds