Course code: FIN 3235

INVESTMENT PROCESS
AND FINANCIAL CONCEPTS
TOPIC :ONE –continued.
Introduction
 Investment media in this study will be considering
various investments such as:
 Bonds ,
 Stocks and
 (Investment in the Bull and Bear Markets)
 Mutual funds.
 Bonds
A bond is an official document promising that a government
or company will pay back money that it has borrowed, often
with interest;

In other words, a bond is a certificate showing that a

borrower owes a specified sum of money.

In order to repay the money, the borrower has agreed to

make interest and principal payments on designed dates.
 Bonds
A Bond, is a debt security.

The authorized issuer owes the holders a debt and,

depending on the terms of the bond, is obliged to pay
interest (the coupon) to use and/or to repay the
principal at a later date, termed as maturity.

Interest is paid at fixed intervals (semi annual,

annual, sometimes monthly).
Each Bond instrument has three main features:
Maturity, coupon and principal.
 Maturity: Maturity of a bond refers to the date,
on which the bond matures, which is the date on
which the borrower has agreed to repay the
principal.
Term-to-Maturity refers to the number of years
remaining for the bond to mature. The Term-to-
Maturity changes everyday, from date of issue of the
bond until its maturity. The term to maturity of a
bond can be calculated on any date, as the distance
between such a date and the date of maturity.
It is also called the term or the tenure of the
bond.
Cont’d (three main features)
 Coupon: Coupon refers to the periodic interest
payments that are made by the borrower (who is
also the issuer of the bond) to the lender (the
subscriber of the bond). Coupon rate is the rate at
which interest is paid, and is usually represented
as a percentage of the par value of a bond.
 Principal: Principal is the amount that has
been borrowed, and is also called the par value or
face value of the bond. The coupon is the product
of the principal and the coupon rate.
Bond features
 Face Value/Par Value
The face value (also known as the par value or
principal) is the amount of money a holder will
get back once a bond matures.
 A newly issued bond usually sells at the par
value. Government bonds normally have a
much greater par value than Corporate bonds .
 When a bond trades at a price above the face
value, it is said to be selling at a premium.
When a bond sells below face value, it is said to
be selling at a discount.
 Bond features
 The coupon is expressed as a percentage of the par
value.
 If a bond pays a coupon of 10% and its par value is
Rwf 1,000,000 then it'll pay Rwf 100,000 of interest
per year.
 A rate that stays as a fixed percentage of the par
value like this is a fixed-rate bond.
 Another possibility is an adjustable interest
payment, known as a floating-rate bond. In this
case the interest rate can be tied to market rates
through an index, such as the rate on Treasury bills
,the LIBOR (London Interbank offer Rate),etc.
Bond features
 A bond that matures in one year is much more
predictable and thus less risky than a bond that
matures in 20 years.

 Therefore, in general, the longer the time to

maturity, the higher the interest rate. Also, all
things being equal, a longer term bond will
fluctuate more than a shorter term bond.
Bond features
 Issuer The issuer of a bond is a crucial factor to
consider, as the issuer's stability is your main
assurance of getting paid back.
 For example, a government bond is far more
secure than any corporation.
 Government default risk (i.e chance of the debt
not being paid back) is extremely small - so
small that government securities are known as
risk-free assets. The reason is that a
government will always be able to bring in
future revenue through taxation.
Bond features
 However ,the debt of many developing
countries, does carry substantial risk. Some,
countries / governments can default on their
payments.

 A company, on the other hand, must make

profits revenue, which is not guaranteed.

 The added risk for investors in companies

means corporate bonds must offer a higher
yield in order to entice investors.
 Bond features
 In addition to the credit quality of the issuer, the
priority of the bond is a determiner of the probability
that the issuer will pay you back your money.
 The priority indicates your place in line should the
company default on payments.

 If you hold an unsubordinated (senior) bond if the

company defaults, you will be first in line to receive
payment from the liquidation of its assets.
 On the other hand, if you own a subordinated
(junior) debt security, you will get paid out only after
the senior debt holders have received their share.
Different types of bonds
 Bonds are issued by public authorities, credit
institutions, and companies in the primary markets.

 Bonds can be classified based on the issuer as

follows:
 Government bond/Treasury bond – these are
issued by the Government.
 Corporate bond- these are issued by companies. The
corporate bonds have a higher interest rate than the
government bonds.
 Different types of bonds
 Municipal bonds -Issued by municipalities.
Municipal bonds can be issued by states, counties,
cities, and other political sub-divisions (e.g., districts,
etc).
 Bonds issued in the local market and denominated in
local currency are domestic bonds.
 International bonds -these types of bonds are issued
within a market that is foreign to the issuer's home
market.
1)Foreign bonds
2)Euro bonds
3)Global bonds
 Different types of bonds
1)Foreign bonds –It refers to bonds issued and
denominated in the currency of a country other than
the one in which the issuer is primarily located.
 In issuing foreign bonds, the issuer must abide by
the rules and regulations imposed by the
government of the country in which the bonds
are issued. Compliance may be relatively easy or
difficult, depending on the country involved.
 A foreign bond is underwritten by a syndicate
composed of members from a single country, sold
principally within that country, and denominated in
the currency of that country.
 Cont…d
 One of the main advantages of purchasing foreign
bonds is the opportunity to obtain international
diversification of the default risk of a bond portfolio
without having to be concerned about foreign
exchange fluctuations.
 Example: An example of such a bond is the samurai
bond, which is a yen-denominated bond issued in
Japan by an American company.
 Other foreign bonds include, Bulldog bonds which
are bonds denominated in British pounds and issued
in Britain by non British companies or government.
 Yankee bonds are foreign bonds denominated in U.S
dollars issued in the U.S by non US company or
government.
Different types of bonds
 2)Eurobonds: A Eurobond refers to any bond that
is denominated in a currency other than that of the
country in which it is issued.
 Bonds in the Eurobond market are categorized
according to the currency in which they are
denominated.
 The definition of the Eurobond market can be
confusing because of its name. Although the euro is
the currency used by countries participating
European Union countries, Eurobonds refer neither
to the European currency nor to a European bond
market.
 Cont’....d
 As an example, a Eurobond denominated in Japanese
yen but issued in the U.S. would be classified as a euro
yen bond.
 Another example, a bond issued by a U.S corporation
that is denominated in Japanese yen (or even in U.S
dollars) and sold in Europe would also be referred to as
a Eurobond. Because it is not denominated in the
currency of the country it is issued in.
 A Eurobond is a bond that is issued in a foreign market
and denominated in currency different from where it is
issued.
 Different types of bonds
 Convertible bonds is another variation of corporate
bonds, which enable the holder to convert the bond into
stock at redemption.
 Callable bonds which allow the issuing
company/government the right (but not obligation) to
(buy back) redeem a bond before its maturity.
 Puttable Bonds These allow the holder of a puttable
bond the right (but not an obligation) to seek
redemption (sell) from the issuer at any time before
the maturity date.
 N.B. All the above are related to the redemption of
bonds.
 Different types of bonds
 Zero-Coupon Bonds
This is a type of bond that makes no coupon
payments but instead is issued at a
considerable discount to par value.
For example, if you take a zero-coupon bond
with a 10,000,000Rwf par value and 10 years
to maturity which is trading at 6,000,000Rwf;
you'd be paying 6,000,000Rwf today for a
bond that will be worth 10,000,000 in 10
years.
Different types of bonds
 Floating Rate Bonds In some bonds,
fixed coupon rate to be provided to the
holders is not specified.
 Instead, the coupon rate keeps fluctuating
from time to time, with reference to a
benchmark rate.
 Such types of bonds are referred to as
Floating Rate Bonds.
Bond rating
 Bond rating: The bond rating system helps
investors determine a company's credit risk.
 A bond rating is like the report card for a
company's credit rating.
 Blue-chip firms, which are safer investments,
have a high rating, while risky companies have a
low rating.
 The different bond rating scales from the major
rating agencies in the U.S. include Moody's,
Standard and Poor's (S&P )and Fitch Ratings.
 Bond rating
Bond Rating by
Moody's S&P/ Fitch Grade Risk
Aaa AAA Investment Highest Quality
Aa AA Investment High Quality
A A Investment Strong
Baa BBB Investment Medium Grade
Ba, B BB, B Junk Speculative

Caa/Ca/C CCC/CC/C Junk Highly Speculative

C D Junk In Default
Different types of stocks
 Common stocks: This represents a commitment on
the part of a corporation to pay periodically
whatever its board of directors deems appropriate as
a cash dividend.
 Although the amount of cash dividends to be paid
during the next year is subject to some uncertainty,
it is generally relatively easy to accurately predict.
 However, the amount for which a stock can be
bought or sold varies considerably, making the
annual return difficult to accurately predict.
Different types of stocks
• Common shares represent ownership in a
company and a claim (dividends) on a portion of
profits.
• Common stock investors get to vote the board
members, who oversee the major decisions made
by management.
Different types of stocks
 Preferred stock- is like perpetual bond. A given
fixed amount is to be paid each year by the issuer
to the investor.
 This amount may be stated as a percent of the
stock’s par value (for example, 8% of 200Frw),
meaning 16Frw per year) or directly as a figure (for
example, 20 Frw per year).
 Because the security is a stock, such payments are
called dividends instead of interest and hence do
not qualify as a tax-deductible expense for the
issuing corporation.
Different types of stocks
• Preferred shareholders always receive their
dividends first before common stock
holders.
• In the event of liquidation, preferred
shareholders are paid off before the
common shareholder (but still after debt
holders).
Different types of stocks
 Participating preferred stock: This entitles the
holder to receive extra dividends when earnings
permit. (In addition to the fixed dividends
entitled).

 Convertible preferred stock: these may, at the

option of the holder, be converted into another
security (usually the firm’s common stock) on
stated terms.
Different types of stocks
 Cumulative preference stock: A cumulative
preferred requires that if a company fails to pay
any dividend or any amount below the stated rate,
it must make up for it at a later time.
 Dividends accumulate with each passed dividend
period, which can be quarterly, semi-annually, or
annually.
Different types of stocks
 Non cumulative preference stock:
The Dividend for this type of preferred stock will not
accumulate if it is unpaid . For noncumulative or
straight preferred stock any dividends passed are lost
forever if not declared.
Different types of stocks
 Put able preferred stock —These stock have a
"put" privilege whereby the holder may, upon
certain conditions, force the issuer to redeem
shares. The holder has the right but not the
obligation to a the issuer to redeem the stock.
 Puttable preference shares allow the holder right
but not obligation to sale the preference issuer.
Bull and Bear markets
 The terms bull market and bear market describe
upward and downward market trends, respectively,
and can be used to describe either the market as a
whole or specific sectors and financial securities.
 Bull Market: A bull market is associated with
increasing investor confidence, and increased
investing in anticipation of future price increases
(capital gains).
 If an investor is optimistic and believes that stocks will
go up, he or she is called a "bull" and is said to have a
"bullish outlook“
 A bullish trend in the stock market often begins
before the general economy shows clear signs of
Bull and Bear markets
 Bear market: is a general decline in the stock market
over a period of time. It is a transition from high
investor optimism to widespread investor fear and
pessimism.
 This is a market condition in which the prices of
securities are falling, and there is widespread
pessimism causes the negative sentiment to be self-
sustaining. The investors anticipate losses in a bear
market.
 If an investor is not optimistic and believes that
stocks will go down, he or she is said to have a
“bearish outlook”.
Bull and Bear markets
MUTUAL FUNDS- DEFINITION
 A Mutual fund is made up of a pool of funds
collected from many investors for the purpose of
investing in securities such as stocks, bonds, money
market instruments and similar assets.

 OR A mutual fund is a professionally managed type

of collective investment that pools money from many
investors to buy stocks, bonds, short-term money
market instruments, and/or other securities.
MUTUAL FUND- FEATURES
 A mutual fund's portfolio is structured and
maintained to match the investment objectives
stated in its prospectus.

 In the United States, a mutual fund is registered

with the Securities and Exchange Commission
(SEC) and is over seen by a board of directors (if
organized as a corporation) or board of trustees (if
organized as a trust).
 Mutual fund features
 The board of a mutual fund is charged with ensuring
that the fund is managed in the best interests of the
fund's investors and with hiring the fund manager
and other service providers to the fund.

 The fund manager, also known as the fund sponsor or

fund management company, trades (buys and sells)
the fund's investments in accordance with the fund's
investment objective.
 A fund manager must be a registered investment
advisor.
Mutual fund features
 To invest in a mutual fund, you have to buy shares
to become a shareholder of the fund.
 Mutual funds invest their owners' money in
securities.
 Each investor owns shares, which represent a
portion of the holdings of the fund.
Mutual fund- features
 A Mutual fund is also referred to as an open –end
investment company.
 Because it is characterized by the continual selling to
its members and the public and redeeming of its
shares.
 In other words, the mutual fund does not have a fixed
capitalization. It sells its shares to the investing
public whenever it can at their net asset value per
share, and it stands ready to repurchase these shares
directly from the investment public for their net asset
value per share.
Mutual fund- features
 Mutual funds sell their shares to the investing public
and their members at the Net Asset Value (NAV).
 NAV=Market value of portfolio-Liabilities
Number of shares outstanding
For example a mutual fund with 10M shares
outstanding and has a portfolio value of 215M and
liabilities of 15M.
 NAV= $215,000,000 -$15,000,000 = $20
10,000,000
 Therefore the mutual fund shares will be sold at $20
each.
 Mutual fund- features
 In the case of a “no-load” mutual fund, the
investment company sells its shares by mail to the
investor. Because no salesperson is involved, there is
no sales commission (load).
 In the case of a “load” mutual fund, the shares are
sold by a salesperson. The salesperson’s entire selling
commission (load) is added to the net asset value,
and a portion of the investor’s equity is removed as
the “load” at the beginning of the contract to
purchase shares. This process is called front-end
loading, and thus, the name load fund.
Mutual fund- features
 Investors can choose different funds based on their
risk-taking profile:
 Stock funds invest more heavily in stocks and
have ups and downs over time;
 Bond funds offer steady current income; and
 Money market funds (investing in short-term
debt) ensure that the invested principal does not
decline in value in the short term.
Mutual fund- features
 A fund pays out nearly all of the income it receives
over the year to fund owners in the form of a
distribution.
 You can make money from a mutual fund in 3
ways:
1) Income is earned from the return on securities –
like dividends on stocks and interest on bonds.

2) If the fund sells securities that have increased in

price, the fund has a capital gain. Most funds also
pass on these gains to investors in a distribution.
continued
3) If mutual fund holdings (shares) increase in
price but are not sold by the fund manager. If the
fund's shares increase in price you can then sell
your mutual fund shares for a profit.

 Funds will also usually give you a choice either to

receive a cheque for distributions or to reinvest the
earnings and get more shares.
Mutual fund- features
 Mutual Funds features
 Mutual funds state specific investment objectives
in their prospectuses.

For example, the main types of objectives are

 Growth,
 balanced,
 income , and
 industry-specialized funds.
In general the above show the types of mutual
funds based on investment objective.
Types of mutual funds
1.)Growth mutual fund- these funds typically
possess diversified portfolios of common stocks in
the hope of achieving large capital gains for their
shareholders.

 Most growth funds offer higher potential of capital

appreciation but usually at above-average risk and
little or no dividend payout expected soon since
such companies are in an expansion phase.
Types of mutual funds
2.) Balanced Mutual fund – these generally holds a
portfolio of diversified common stocks, preferred
stocks, and bonds with the hope of achieving capital
gains and dividend and interest income, while at the
same time conserving the principal.
 A balanced fund is geared toward investors who are
looking for a mixture of safety, income and modest
capital appreciation. The amounts that such a mutual
fund invests into each asset class usually must remain
within a set minimum and maximum.
Types of mutual funds
3.)The industry-specialized mutual funds – These
specialize in investing in portfolios of selected
industries;
 such a fund appeals to investors who are extremely
optimistic about the prospects for these few
industries and are willing to assume the risks
associated with such a concentration of their
investment money.
 Examples of industry specialized mutual funds-
could be in finance, technology, health, etc.
Types of mutual funds
4.) Income funds concentrate heavily on high
interest and high dividend yielding securities.
 It is common for income funds to also be referred
to as bond funds or fixed income funds.
 Bond funds vary also in the average duration of
their holdings.
 Portfolios with low durations are significantly less
sensitive to changes in interest rates than those
with high durations.
Varieties of mutual funds
 Mutual funds are classified by their principal (main)
investments.
 At the fundamental level, there are three varieties of
mutual funds:
1) Equity funds (stocks)
2) Fixed-income funds (bonds)
3) Money market funds

All mutual funds are variations of these three asset

classes.
Varieties of mutual funds
 To start with the safest and then work through to
the more risky:
1.) Money Market Funds –The money market
consists of short-term debt instruments, mostly
Treasury bills.
 The returns are not great but you won't have to
worry about losing your principal.
 A typical return is twice the amount you would
earn in a regular savings account and a little less
than the average certificate of deposit.
 Varieties of mutual funds
 2.) Bond/Income Funds-their purpose is to provide
current income on a steady basis.
 While fund holdings may appreciate in value, the
primary objective of these funds is to provide a steady
cash flow to investors.
 Because there are many different types of bonds, bond
funds can vary dramatically depending on where they
invest.
 For example, a fund specializing in high-yield junk
bonds is much more risky than a fund that invests in
government securities. Furthermore, nearly all bond
funds are subject to interest rate risk.
Varieties of mutual funds
 3.)Equity Funds -Funds that invest in stocks represent
the largest category of mutual funds. Generally, the
investment objective of this class of funds is long-term
capital growth with some income.
 Many investors invest in stock mutual funds because,
historically, stocks have outperformed other types of
investments over the long term.
 However, the value of the stocks in the fund's portfolio
may go up or down as the market rises or declines.
Remember, past performance is no guarantee of future
results.
Types of Stock / equity Funds
A.) Large Cap equity funds: Primarily invests in "Blue-
chip" companies - large, well-known industrials, utilities,
technology, and financial services companies with large
market capitalization.
 Large cap stocks are perceived to be less risky than the
smaller capitalized companies.
B.) Mid Cap: Primarily invests in companies whose market
capitalization is smaller than large caps but larger than
small caps.
 Mid caps are generally considered more risky than large
cap stocks but have a higher return expectation.
 Types of Stock Funds
C.) Small Cap stock funds: Primarily invests in
emerging companies, thought to have potential for
future growth and profit.
 Small caps are generally considered the riskiest
stocks compared to larger capitalized firms but
carry the expectation of higher returns.
 Small cap funds are subject to greater volatility than
those in other asset categories.
Types of Stock Funds
 International stock funds : Primarily
invests in stocks traded on foreign
exchanges but purchased in the United
States by U.S. fund companies.
 International funds are subject to additional
risks such as currency fluctuation, political
instability and the potential for illiquid
markets.
Advantages of mutual funds
1.) Professional investment management
Often investors lack the education, background,
time, foresight, resources, and temperament to
carry out the proper handling of a portfolio.
 Mutual funds are managed by professional
portfolio managers who devote their full time to
the carrying out of the fund’s investment
objectives as specified in its prospectus.
Advantages of mutual funds
2.) Diversification -large amounts of money
entrusted to the fund enable it to be diversified in
investments across industry and security types (that
is, common stocks with various prospects, preferred
stocks, and bonds) to an extent not possibly
achieved by the average investor. When investing
in a mutual fund, an investor is actually
investing in numerous securities.
3.)Liquidity-that is, shares can be readily converted
into cash, because the company stands ready to
redeem its outstanding shares.
Advantages of mutual funds
4.) Lower brokerage commissions - than an
individual small investor.
5.) Ability to participate in investments that may
be available only to larger investors. (large
Numbers of investors and amounts readily available
to invest e.g in bonds).
6.) Service and convenience- the investors can leave
much of the inconvenience of managing their
investments to the mutual fund.
7.)Small and unsophisticated investors can also
invest in securities through mutual funds .
Disadvantages of mutual funds
1) Fees- (e.g Fund accounting fee, management fees
and expenses are paid by the members for the
services provided by the mutual fund management.)
2) Less control over timing of recognition of gains
(An individual investor loses some personal control
on the timing of gains in the investment market).
3) Less predictable income-the income for members
of the mutual fund is dependent on how the mutual
fund is managed.
4) No opportunity to customize- An individual in a
mutual fund is not able to choose their investments
individually, e.g to buy which stocks or bonds.
 MUTUAL FUND IN RWANDA
 An example of a mutual fund in Rwanda is the
Rwandan Diaspora Mutual Fund (RDMF).
 The former Governor of the Central Bank (BNR),
Mr.Francois Kanimba, officially approved the
Rwanda Diaspora Mutual Fund and licensed it to
operate in December 2009.
RDMF VISION
1.)To act as a pool of investments from Rwandans in
Diaspora together for collective investments in
Rwanda.
Mutual Fund in Rwanda
RDMF MISSION
1.)To promote the financial well being of the
Rwandan Diaspora while participating in the
socio-economic growth of the motherland;
2.)To create attractive investment strategies and
diversify portfolios
3.)To ensure effective participation to the fund of
the Rwandan Diaspora communities around the
world.
Mutual Fund in Rwanda
RDMF OBJECTIVES
 Mobilize funds to invest in Rwanda;
 Mobilize funds from foreign investors;
 Tap the various opportunities available in Rwanda;
 Diversify investments and minimize the risk;
 Involve Rwandan Diaspora in the socio-economic
growth of their Country.
Mutual Fund in Rwanda
 RDMF INVESTMENT OBJECTIVES
The Fund has three primary objectives are:
1. Stability (preservation of the principal);
2. Growth (increased value of principal over time);
and
3. Income (generating a stream of payments).
 Mutual Fund in Rwanda
 PROFILE OF TYPICAL INVESTORS IN RDMF
 -Families of all levels, children, students, low and
mid-income levels as well as high income people
planning for the future;
 -Physical and moral persons seeking for domestic
investment opportunities through collective
investment schemes. Monthly income groups (civil
servants, private sector, workers at home and
abroad, business people, students at all levels,
minors,..).
Explain the terms REIT and Hedge funds as used in
investment Finance. (Homework)