Professional Documents
Culture Documents
Cover
Table of Contents
Guidelines ………………………………………………………………………….……………………………………………….………………………… 3
References …………………………………………………………………………………………………………………………………………………..… 69
Evaluation of the Course ………………………………………………………………………………………………………….……………….. 70
Syllabus …………………………………………………………………………………………………………………………………………..………… 71
GUIDELINES
Each chapter in this module is based on the approved FNMNGT4 syllabus. In short, whether you choose to learn with the
use of this module or online, or both, you basically get the same lessons. What will differentiate you from the other learners will be
how much time and effort you spend to learn more about each and every topic at hand.
The objectives indicated in each chapter can only be achieved if and when the learner actively involves himself/herself in
this learning process. There are three icons that you have to watch out for:
There are links provided that you should access so that you
can read the articles that will help you better understand the
concepts presented in each chapter.
To assess how much you have learned, quizzes will be given regularly. Likewise, to supplement what you learn via this
module, assignments will be given from time to time. To access your quiz and/or assignment, you have to go online and check what
are posted on your Canvas Account.
You may get in touch with me through the following contact details:
OBJECTIVES:
1. Determine the objectives of investment.
2. Identify profitable investment vehicles.
Investment is the employment of funds on assets with the aim of earning income or capital appreciation
Investment has two attributes namely time and risk. Present consumption is sacrificed to get a return in the future. The
sacrifice that has to be borne is certain but the return in the future may be uncertain. This attribute of investment
indicates the risk factor. The risk is undertaken with a view to reap some return from the investment.
In an economic sense, an investment is the purchase of goods that are not consumed today but are used in the
future to create wealth. In finance, an investment is a monetary asset purchased with the idea that the asset will provide
income in the future or will later be sold at a higher price for a profit.
CHARACTERISTICS OF INVESTMENT
RETURN
Investments are made with the primary objective of deriving a return. The return may be received in
the form of yield plus capital appreciation. The difference between the sale price and the purchase price is
capital appreciation. The dividend or interest from the investment is the yield.
RISK
Risk is inherent in any investment. This risk may relate to loss of capital, delay in repayment of capital,
non-payment of interest, or variability of returns. While some investments like government securities and bank
deposits are almost riskless, others are riskier.
SAFETY
The safety of investment implies the certainty of return of capital without loss of money or time. Safety
is another feature which an investor desires for his investments. Every investor expects to get back his capital
on maturity without loss and without delay.
An investor generally prefers liquidity for his investments, safety of his funds, a good return with
minimum risk or minimization of risk and maximization of return.
OBJECTIVES OF INVESTMENT
Maximization of return
Minimization of risk
INVESTMENT VS SPECULATION
Investment involves the allocation of money towards the purchase of an asset which is not to be consumed in
the present but hoping it will generate stable income or is expected to appreciate in the future. The term is used very
widely since it has an impact on every individual in life who desire to establish their financial future.
Speculation does not have a precise definition but involves the purchase of an asset to make profits from
subsequent price change and possible sale. The speculators indulge in marketable assets that do not have a long life.
The speculation involves a relatively higher level of risk and more uncertainty of returns though it can be on the same
lines as an investor. These speculators are generally trained and take action when the game of probabilities is high in
their favor.
INVESTMENT VS GAMBLING
In investing, one attempts to carefully plan, evaluate and allocate funds to various investment outlets which
offer safety of principal and moderate continuous return over a long period of time. Gambling on the other hand,
consists of taking high risks not only for high returns, but also for thrill and excitement.
TYPES OF INVESTORS
Individual Investors
They are large in number but their investable resources are comparatively smaller. The size of the
portfolio of each investor is usually quite small. They are sometimes referred to as retail investors. However, it
is common to use the term to refer to individual investors with modest resources to invest. Many investment
firms make a distinction between their retail clients, more affluent clients with larger amounts, and high- and
ultra-net-worth investors with the largest amounts of investable assets.
Institutional Investors
Institutional investors are organizations that hold and manage portfolios of assets for themselves or
others. There are many different types of institutional investors with varying investment requirements and
constraints. Institutional investors may invest to advance their mission or they may invest for others to meet
the others’ needs. The following are examples of institutional investors:
a. Mutual Funds
A mutual fund is a pool of money from the public that is invested with an expectation of a profit.
Because of the way it invites people to invest, it is also called pooled or managed fund. The money
List the 10 Best Mutual Funds (2020) in the Philippines in terms of Return
-use pesolab.com
Reference:
b. Pension Funds
Pension funds are created (either by employers or employee unions) to manage the retirement
funds of the employees of companies or the government. Funds are contributed by the employers
and employees during the working life of the employees and the objective is to provide benefits to
the employees post their retirement. The management of pension funds may be in-house or
through some financial intermediary. Pension funds of large organizations are usually very large and
form a substantial investor group for various financial instruments.
The Philippine Pension System: New Buttresses for the Old Multi-Pillar Architecture
http://www.nomurafoundation.or.jp/en/wordpress/wp-content/uploads/2019/03/NJACM3-2SP19-
05.pdf
c. Endowment Funds
An endowment fund is an investment fund established by a foundation that makes consistent
withdrawals from invested capital. The capital in endowment funds, often used by universities,
nonprofit organizations, museums, churches and hospitals, is generally utilized for specific needs or
to further a company's operating process.
Company Assets
Reference:
Reference:
e. Banks
Assets of banks consist mainly of loans to businesses and consumers and their liabilities
comprise of various forms of deposits from consumers. Their main source of income is from what is
called as the interest rate spread, which is the difference between the lending rate (rate at which
banks earn) and the deposit rate (rate at which banks pay). Banks generally do not lend 100% of
their deposits. They are statutorily required to maintain a certain portion of the deposits as cash and
another portion in the form of liquid and safe assets.
INVESTMENT VEHICLES
These are assets offered by the investment industry to help investors move money from the present to the
future, with the hope of increasing the value of their money. These assets include securities, such as shares, bonds, and
warrants; real assets, such as gold; and real estate. Many investment vehicles are entities that own other investment
vehicles. For example, an equity mutual fund is an investment vehicle that owns shares.
Investors make indirect investments when they buy the securities of companies, trusts, and partnerships
that make direct investments. The following are examples of indirect investment vehicles:
Shares in mutual funds and exchange-traded funds
Limited partnership interests in hedge funds
Asset-backed securities, such as mortgage-backed securities
Most indirect investment vehicles are pooled investments (also known as collective investment
schemes) in which investors pool their money together to gain the advantages of being part of a large group.
The resulting economies of scale can significantly improve investment returns.
Indirect investment vehicles provide many advantages to investors in comparison with direct
investments:
Indirect investments are professionally managed. Professional management is particularly
important when direct investments are hard to find and must be managed.
Indirect investments allow small investors to use the services of professional managers, whom
they otherwise could not afford to hire.
Indirect investments allow investors to share in the purchase and ownership of large assets,
such as skyscrapers. This advantage is especially important to small investors who cannot afford
to buy large assets themselves.
Indirect investments allow investors to own diversified pools of risks and thereby obtain more
stable, although not necessarily better, investment returns. Many indirect investment vehicles
represent ownership in many different assets, each of which typically is subject to specific risks
not shared by the others. For example, a risk of investing in home mortgages is that the
homeowners may default on their mortgages. Defaults on individual mortgages are highly
unpredictable, which makes holding an individual mortgage quite risky. In contrast, the average
default rate among a large set of mortgages is much more predictable. Investing an amount in
shares of a large mortgage pool is much less risky than investing that same amount in a single
mortgage.
Indirect investments are often substantially less expensive to trade than the underlying assets.
This cost advantage is especially significant for publicly traded investment vehicles that own
highly illiquid assets; recall from the Alternative Investments chapter that liquidity is one of the
benefits of real estate investment trusts compared with real estate limited partnerships or real
estate equity funds. Although the assets in which traded investment vehicles invest may be
difficult to buy and sell, ownership shares in these vehicles can trade in liquid markets.
Direct investments also present some advantages to investors compared with indirect investments:
Investors exercise more control over direct investments than over indirect investments.
Investors who hold indirect investments generally must accept all decisions made by the
investment managers, and they can rarely provide input into those decisions.
Investors choose when to buy or sell their direct investments to minimize their tax liabilities. In
contrast, although the managers of indirect investments often try to minimize the collective tax
liabilities of their investors, they cannot simultaneously best serve all investors when those
investors have diverse tax circumstances.
Investors can choose not to invest directly in certain securities—for example, in securities of
companies that sell tobacco or alcohol. In contrast, indirect investors concerned about such
issues must seek investments with investment policies that include these restrictions.
Investors who are wealthy can often obtain high-quality investment advice at a lower cost when
investing directly rather than indirectly.
A company that sells securities to the public for the first time makes an initial public offering (IPO), sometimes
also called a placing or placement. The shares offered consist of new shared issued by the company and may also
include shares that the founders and other early investors in the company want to sell. The IPO provides founders and
other early investors with a means of converting their investments into cash, a process called monetizing.
Investors also trade securities, such as shares and bonds, as well as contracts, such as futures and options.
These trades take place in secondary markets. Trading in secondary markets is the successful outcome of searches in
which buyers look for sellers and sellers look for buyers. Secondary markets are organized either as call markets or as
continuous trading markets. In a call market, participants can arrange trades only when the market is called, which is
usually once a day. In contrast, in a continuous trading market, participants can arrange and execute trades any time
the market is open. Most markets, including alternative trading venues, are continuous.
Generally, the HPR is expressed in percentages. Frequently, it is annualized to determine the rate of
return per year.
Examples:
1. In January 1, the price of an ordinary share in Company B was P100. On December 31 of the same
year, an ordinary share of Company B was selling for P125. HPR is calculated as follows:
125−100
HPR=
100
5+25
HPR=
100
30
HPR=
100
Sometimes the HPR is converted to an annualized rate for comparison purposes. In such case, the
following formula is used:
Example:
1. Consider an investment that cost P2000 and is worth P2500 after being held for 2 years. The
investment earned a dividend of P100 over the 2-year period. Compute for HPR and annualized
HPR.
100+(2500−2000)
HPR=
2000
100+ 500
HPR=
2000
600
HPR=
2000
(r 1 +r 2 + …+ r n )
Arithmetic Mean=
n
Geometric Mean provides a more accurate representation of the portfolio value growth than an
arithmetic return.
Geometric Mean=¿
Example:
Consider an investment with the following data:
Beginning Value Ending Value HPR
1 100 115 .15
2 115 138 .20
3 138 110 -.20
(.15+.20−.20)
Arithmetic Mean=
3
Arithmetic Me an=0.05∨5 %
Geometric Mean=¿
= 1.03353 – 1
Variance
= [(0.15)(0.20-0.07)2 + (0.15)(-0.20-0.07)2+(0.70)(0.10-0.07)2]
= 0.0141
Standard Deviation
σ =√ 0.0141
σ = 0.11874 or 11.87%
0.11874
CV =
0.07000
Risk Premium
An investor typically is not completely certain of the income to be received or when it will be received.
Most investors require higher rates of return on investments if they perceive that there is any uncertainty about
the expected rate of return. This increase in the required rate of return over the NRFR is the risk premium (RP).
Although the required risk premium represents a composite of all uncertainty, it is possible to consider several
fundamental sources of uncertainty.
CHAPTER 2
Asset allocation decision
OBJECTIVES:
1. Illustrate the individual investor life cycle.
2. Explain the portfolio management
process.
3. Create a portfolio for virtual trading.
Risk drives return. Thus, the practice of investing funds and managing portfolios should focus primarily on
managing risk rather than on managing returns.
ASSET ALLOCATION
This is the process of deciding how to distribute an investor’s wealth among different asset classes for purposes
of investment. An asset class is made up of securities that have similar characteristics, attributes, and risk/return
relationships.
The asset allocation decision is a component of a portfolio management process. Much of an asset allocation
strategy depends on the investor’s policy statement, which includes the investor’s goals or objectives, constraints, and
investment guidelines.
Top-Down Analysis
A top down analysis begins with consideration of macroeconomic conditions. Based on the current and
forecasted economic environment, analysts evaluate markets and industries with the purpose of investing in
those that are expected to perform well. Finally, specific companies within these industries are considered for
investment.
Bottom-Up Analysis
Rather than emphasizing economic cycles or industry analysis, a bottom up analysis focuses on
company-specific circumstances, such as management quality and business prospects. It is less concerned with
broad economic trends than is the case for top down analysis, but instead focuses on company specifics.
Insurance
Life insurance should be a component of any financial plan. Life insurance protects loved ones
against financial hardship should death occur prematurely. The death benefit paid by the insurance
company can help pay medical bills and funeral expenses and provide cash that family members can use
to maintain their lifestyle, retire debt, or invest for future needs.
There are several types of life insurance contracts/policies: term life insurance, universal life
insurance, and variable life insurance. The insurance coverage provides protection against other
uncertainties: health, disability, automobile, home, etc.
Cash Reserve
Emergencies, job layoffs, and unforeseen expenses happen, and good investment opportunities
emerge. When any of these happen, having an ample cash reserve will be helpful. One need not be
forced to sell their investments or other valuable properties to cover unexpected expenses.
Most experts recommend having a cash reserve equivalent to about six months of living
expenses. Cash reserves need not always be in the form of cash. It can also be in liquid investments
and/or bank accounts that can easily be converted into cash with little chance of a loss in value.
Accumulation Phase. This refers to the time in the in the life cycle of an investment when an individual
or an investor builds up the value of their annuity or investment. This phase essentially begins when a
person starts saving money for retirement. Experts state that the sooner an individual begins the
accumulation phase, the better.
Consolidation Phase. In this stage of the cycle, many of life’s large expenses (house deposits, weddings
etc) will be out of the way. Earnings are likely to be higher too, and therefore, one should have more
capacity to save and invest.
Spending Phase. This typically begins when individuals retire. Living expenses are covered by social
security income and income from prior investments, including employer pension plans.
Gifting Phase. In this stage, individuals believe they have sufficient income and assets to cover their
expenses while maintaining a reserve for uncertainties. Excess assets can be used to provide financial
assistance to relatives or friends, to establish charitable trusts, or to fund trusts as an estate planning
tool to minimize estate taxes.
Long-term, high-priority goals typically include some form of financial independence such as the ability
to retire at a certain age.
Lower-priority goals are just that but are not too critical.
Other benefits
A person’s return objective may be stated in terms of an absolute or a relative percentage return. It
may also be stated in terms of a general goal like capital preservation, current income, capital appreciation, or
total return.
Investment Constraints
Liquidity Needs
A liquid asset is cash on hand or an asset that can be easily converted to cash. In terms of
liquidity, cash is king since cash as legal tender is the ultimate goal.
Time Horizon
Investors with shorter time horizons generally prefer more liquid and less risky investments
because losses are harder to overcome during a short time frame.
Tax Concerns
Taxes vary depending on the nature of the investment made and the investor may find this a
constraint since taxes may impact the possible returns.
OBJECTIVES:
1. Interpret the basic assumptions behind
the Markowitz portfolio theory.
2. Discuss the importance of a diversified
investment portfolio.
Creating an optimum investment portfolio is not simply a matter of combining a lot of unique individual
securities that have desirable risk-return characteristics. Specifically, it has been shown that one must consider the
relationship among the investments if the goal is to create a portfolio that will meet his investment objectives.
RISK
Risk, in most financial literature, is defined as the uncertainty of future outcomes. Another alternative definition
is the probability of an adverse outcome.
RISK AVERSION
Portfolio theory assumes that investors are basically risk averse. A risk averse investor is someone who prefers
lower returns with known risks rather than higher returns with unknown risks. In other words, among various
investments giving the same return with different level of risks, this investor always prefers the alternative with least
interest. This does not imply though that everybody is risk averse or that investors are completely risk averse in all
financial commitments.
Markowitz theorized that investors could design a portfolio to maximize returns by accepting a quantifiable
amount of risk. In other words, investors could reduce risk by diversifying their assets and asset allocation of their
investments using a quantitative method.
Under these assumptions, a single asset or portfolio of assets is considered to be efficient if no other
asset or portfolio of assets offers higher expected return with the same (or lower) risk, or lower risk with the
same (or higher) expected return.
Another measure of risk is the range of returns. It is assumed that a larger range of expected returns,
from the lowest to the highest return, means greater uncertainty and risk regarding future expected returns.
Although there are numerous potential measures of risk, we will use the variance or standard deviation
of returns because (1) this measure is somewhat intuitive; (2) it is a correct and widely recognized risk measure;
and (3) it has been used in most of the theoretical asset pricing models.
Segurista
http://bworldonline.com/content.php?section=Opinion&title=Segurista&id=67701#:~:text=FILIPINOS%20ARE
%20generally%20risk%2Daverse%20when%20it%20comes%20to%20their%20money.&text=That%20is
%20what%20%E2%80%9Csegurista%E2%80%9D%20means,resources%20and%20bring%20down%20status.
where:
Wi = the percent of the portfolio in asset i
E(Ri) = the expected rate of return for asset i
Example:
where
Pi is the probability of the possible rate of return, R i
Example:
Possible Rate Expected
Ri - E(Ri) [Ri - E(Ri)]2 Pi [Ri - E(Ri)]2Pi
of Return (Ri) Return E(Ri)
0.08 0.11 -0.03 0.0009 0.25 0.000225
0.10 0.11 -0.01 0.0001 0.25 0.000025
0.12 0.11 0.01 0.0001 0.25 0.000025
0.14 0.11 0.03 0.0009 0.25 0.000225
0.000500 Variance
(σ ) = .00050
2
A positive covariance means that the rates of return for two investments tend to move in the
same direction relative to their individual means during the same time period.
MONTHLY RETURN
DATE COCA-COLA HOME COCA-COLA HOME DEPOT [Ri-E(Ri)]x [Rj-E(Rj)]
(Ri) DEPOT (Rj) Ri-E(Ri) Rj-E(Rj)
Jan-01 -4.82 5.50 -3.01 4.03 -12.13
Feb-01 -8.57 -11.83 -6.76 -13.29 89.81
Mar-01 -14.50 1.51 -12.69 0.04 -0.49
Apr-01 2.28 9.28 4.09 7.81 31.98
May-01 2.62 4.65 4.43 3.18 14.11
Jun-01 -4.68 -4.08 -2.87 -5.54 15.92
Jul-01 -0.89 6.63 0.92 5.16 4.76
Aug-01 9.13 -8.70 10.94 -10.16 -111.16
Sep-01 -3.37 -16.50 -1.56 -17.96 27.97
Oct-01 2.20 -0.36 4.01 -1.83 -7.35
Nov-01 -1.55 22.16 0.27 20.69 5.52
Covariance and Correlation. Covariance is affected by the variability of the two individual
return series.
Covij
rij =
σi σ j
where:
rij = the correlation coefficient of returns
σi = the standard deviation of Rit
σj = the standard deviation of Rjt
Example:
COCA-COLA HOME DEPOT
DATE
Ri-E(Ri) [Ri-E(Ri)]2 Rj-E(Rj) [Rj-E(Rj)]2
Jan-01 -3.01 9.05 4.03 16.26
Feb-01 -6.76 45.65 -13.29 176.69 Coca-Cola
Mar-01 -12.69 161.01 0.04 0.00
Home Depot
Apr-01 4.09 16.75 7.81 61.06
May-01 4.43 19.64 3.18 10.13
Jun-01 -2.87 8.24 -5.54 30.74 Variancei = 404.34/12
Jul-01 0.92 0.85 5.16 26.61 Variancej = 1240.90/12
Aug-01 10.94 119.64 -10.16 103.28 = 33.69
Sep-01 -1.56 2.42 -17.96 322.67
Oct-01 4.01 16.09 -1.83 3.36
Nov-01 0.27 0.07 20.69 428.01
Dec-01 2.22 4.92 7.88 62.08 =
=404.34 =1240.90 103.41
Standard Deviationi = (33.69)1/2 Standard Deviationj = (103.41) 1/2
= 5.80 = 10.17
cov ij
correlation coefficient=
σi σ j
= 0.108
where:
rport = the standard deviation of the portfolio
wi = the weights of the individual assets in the portfolio, where weights are determined by the
proportion of value in the portfolio
2
r i = the variance of rates of return for assets i
Covij = the covariance between the rates of return for assets i and j, where Covij = rijrirj
Consider the following alternative correlation coefficients and the covariances they yield. The
covariance term in the equation will be equal to r1,2 (0.10)(0.10) because both standard deviations are
0.10.
σ port =√ ¿ ¿
σ port =√( 0.25 )( 0.01 ) + ( 0.25 )( 0.01 ) +2(0.25)(0.01)
σ port =√(0.01)
σ port =0.10
Covij = rijσiσj
= (0.50)(0.07)(0.10)=0.0035
CASE W1 W2 E(RI)
f .00 1.00 .20
g .20 .80 .18
h .40 .60 .16
i .50 .50 .15
j .60 .40 .14
k .80 .20 .12
m 1.00 .00 .10
A Three-Asset Portfolio
Example:
Assume the following data:
RS,B = 0.25
RS,C = -0.08
RB,C = 0.15
E(Rp) = (0.60)(0.12)+(0.30)(0.08)+(0.10)(0.04)
= 10.00%
The mean-variance portfolio theory says that any investor will choose the optimal portfolio from the set of portfolios
that:
Maximize expected return for a given level of risk; and
Minimize risks for a given level of expected returns.
Again, consider a situation where you have two stocks to choose from: A and B. You can invest your entire wealth in
one of these two securities. Or you can invest 10% in A and 90% in B, or 20% in A and 80%in B, or 70% in A and 30% in B,
or... There are a huge number of possible combinations even in the simple case of two securities. Imagine the different
combinations you have to consider when you have thousands of stocks.
The minimum-variance frontier shows the minimum variance that can be achieved for a given level of expected
return. To construct the minimum-variance frontier of a portfolio:
Use historical data to estimate the mean, variance of each individual stock in the portfolio, and the correlation of
each pair of stocks.
Use a computer program to find the weights of all stocks that minimize the portfolio variance for each pre-
specified expected return.
Calculate the expected returns and variances for all the minimum-variance portfolios determined in step 2 and
then graph the two variables.
Investors will never want to hold a portfolio below the minimum variance point. They will always get higher returns
along the positively sloped part of the minimum-variance frontier.
The efficient frontier is the set of mean-variance combinations from the minimum-variance frontier where, for a
given risk, no other portfolio offers a higher expected return.
Any point beneath the efficient frontier is inferior to points above. Moreover, any points along the efficient frontier
are, by definition, superior to all other points for that combined risk-return tradeoff.
The concept of efficient frontier narrows down the options of the different portfolios from which the investor may
choose. For example, portfolios at points A and B offer the same risk, but the one at point A offers a higher return for the
same risk. No rational investor will hold the portfolio at point B and therefore we can ignore it. In this case, A dominates
B. In the same way, C dominates D.
In theory, the optimal portfolio is the best portfolio, but in reality, the optimal is often far from the best for any given
investor.
CHAPTER 4
Introduction to asset pricing models
OBJECTIVES:
1.Explained the assumptions behind the
Capital Market Theory.
2.Determined an appropriate expected rate
of return on a risky asset.
Asset pricing models describe the prices or expected rates of return of financial assets, which are claims traded
in financial markets. The asset pricing models of financial economics are based on two central concepts. The first is the
”no arbitrage principle,” which states that market forces tend to align the prices of financial assets so as to eliminate
arbitrage opportunities. An arbitrage opportunity arises if assets can be combined in a portfolio with zero cost, no
2. Investors can borrow or lend any amount of money at the risk-free rate of return (RFR). Clearly, it is always
possible to lend money at the nominal risk-free rate by buying risk-free securities such as government T-
bills. It is not always possible to borrow at this risk-free rate, but we will see that assuming a higher
borrowing rate does not change the general results.
3. All investors have homogeneous expectations; that is, they estimate identical probability distributions for
future rates of return. Again, this assumption can be relaxed. As long as the differences in expectations are
not vast, their effects are minor.
4. All investors have the same one-period time horizon such as one month, six months, or one year. The model
will be developed for a single hypothetical period, and its results could be affected by a different
assumption. A difference in the time horizon would require investors to derive risk measures and risk-free
assets that are consistent with their investment horizons.
5. All investments are infinitely divisible, which means that it is possible to buy or sell fractional shares of any
asset or portfolio. This assumption allows us to discuss investment alternatives as continuous curves.
Changing it would have little impact on the theory.
6. There are no taxes or transaction costs involved in buying or selling assets. This is a reasonable assumption in
many instances. Neither pension funds nor religious groups have to pay taxes, and the transaction costs for
most financial institutions are less than 1 percent on most financial instruments. Again, relaxing this
assumption modifies the results, but it does not change the basic thrust.
7. There is no inflation or any change in interest rates, or inflation is fully anticipated. This is a reasonable initial
assumption, and it can be modified.
8. Capital markets are in equilibrium. This means that we begin with all investments properly priced in line with
their risk levels.
Risk-Free Asset
The major factor that allowed portfolio theory to develop into capital market theory is the concept of a risk-free
asset. Following the development of the Markowitz portfolio model, several authors considered the implications of
assuming the existence of a risk-free asset, that is, an asset with zero variance. The assumption of a risk-free asset in the
economy is critical to asset pricing theory.
The formula for calculating the expected return of an asset given its risk is as follows:
where
ERi = expected return on investment
Rf = risk-free rate
βi = beta of the investment
(ERm-Rf) = market risk premium
Investors expect to be compensated for risk and the time value of money. The risk-free rate in the CAPM
formula accounts for the time value of money. The other components of the CAPM formula account for the investor
taking on additional risk.
The beta of a potential investment is a measure of how much risk the investment will add to a portfolio that
looks like the market. If a stock is riskier than the market, it will have a beta greater than 1. If a stock has a beta of less
than 1, the formula assumes it will reduce the risk of a portfolio.
A stock’s beta is then multiplied by the market risk premium, which is the return expected from the market
above the risk-free rate. The risk-free rate is then added to the product of the stock’s beta and the market risk premium.
The result should give an investor the required return or discount rate they can use to find the value of an asset.
The goal of the CAPM formula is to evaluate whether a stock is fairly valued when its risk and the time value of
money are compared to its expected return.
For example, imagine an investor is contemplating a stock worth Php100 per share today that pays a 3% annual
dividend. The stock has a beta compared to the market of 1.3, which means it is riskier than a market portfolio. Also,
assume that the risk-free rate is 3% and this investor expects the market to rise in value by 8% per year.
ERi = 9.5%
The security market line is an investment evaluation tool derived from the CAPM—a model that
describes risk-return relationship for securities—and is based on the assumption that investors need to be
compensated for both the time value of money (TVM) and the corresponding level of risk associated with any
investment, referred to as the risk premium.
The security market line is commonly used by money managers and investors to evaluate an investment
product that they're thinking of including in a portfolio. The SML is useful in determining whether the security
offers a favorable expected return compared to its level of risk.
Expected or Forecasted
Required Return Valuation
Return
(10.5−10+0.5)
`X =10 % 0.05 + 0.7 (0.16 – 0.05) = 12.7% Overvalued
10
(226−200+6)
Y =16 % 0.05 + 1 (0.16 – 0.05) = 16% Fairly Valued
200
(18−16+2)
Z =25 % 0.05 + 1.3 (0.16 – 0.05) = 19.3% Undervalued
16
Appropriate strategies:
Sell X
Ignore Y
Buy Z
CHAPTER 5
Macroeconomic environment and Industry analysis
Macroeconomic conditions affect stock market performance. However, macroeconomic conditions do not
affect industries and firms in the same degree. The macro-environment refers to the broader condition of an economy
as opposed to specific markets. The amount of the macro environment's influence depends on how much of a
company's business is dependent on the health of the overall economy. Cyclical industries are heavily influenced by the
macro environment, while basic staple industries are less influenced.
Industry analysis, for an entrepreneur or a company, is a method that helps to understand a company’s position
relative to other participants in the industry. It helps them to identify both the opportunities and threats coming their
way and gives them a strong idea of the present and future scenario of the industry. The key to surviving in this ever-
changing business environment is to understand the differences between yourself and your competitors in the industry
and use it to your full advantage.
INDUSTRY ANALYSIS
Industry analysis is a market assessment tool used by businesses and analysts to understand the competitive
dynamics of an industry. It helps them get a sense of what is happening in an industry, e.g., demand-supply statistics,
degree of competition within the industry, state of competition of the industry with other emerging industries, future
prospects of the industry taking into account technological changes, credit system within the industry, and the influence
of external factors on the industry.
Some companies do well partly because their relevant external environment is extremely favorable; others do
poorly because their environment is hostile. The relevant environment refers to the industry environment to which a
firm belongs. An industry is a group of firms producing a similar product or service, such as soft drink or pharmaceuticals.
The industry environment in which a company operates also determines its performance.
The Philippine Standard Industrial Classification (PSIC) is a detailed classification of industries prevailing in the
country according to the kind of productive activities undertaken by establishments. The 2009 PSIC was patterned after
the UN International Standard Industrial Classification (ISIC) Rev. 4, but with some modifications to reflect national
situation and requirements. The PSIC was revised to (1) reflect changes in economic activities, emergence of new
industries, and the structure of the economy (2) to take into account the new technologies employed which affect the
organization of production and shifting of economic activities and (3) to realign with the ISIC revisions for purposes of
international comparability. It serves as a guide in the classification of establishments according to their economic
activity useful for economic analysis. It serves as a framework for data collection, processing and compilation to ensure
uniformity and comparability of industrial statistics produced by various entities in both government and private sectors.
It provides an effective mechanism for the integration and aggregation of data being collected for decision-making and
Structure-Conduct-Performance Paradigm
The structure–conduct–performance model refers to an analytical framework that explains the
connection between economic or market structure, market conduct and its performance. In the SCP paradigm,
good performance is what investors ultimately seek from an industry choice.
SCP Paradigm
Life After Lockdown: Return of mobility to aid industries' recovery, but road still rocky for
struggling sectors
https://www.philstar.com/business/2020/05/26/2012678/life-after-lockdown-return-mobility-aid-
industries-recovery-road-still-rocky-struggling-sectors
Evaluate the Philippine BPO industry using Porter’s Five Forces Model.
References:
MACROECONOMIC ENVIRONMENT
Macro environment is the remote environment of the firm, i.e the external environment in which it exists. As a
rule this environment is not controllable by the firm, it is too huge and too unpredictable to control.
BUSINESS CYCLE
Economic trends can and do affect industry performance. By identifying and monitoring key assumptions and
variables, we can monitor the economy and gauge the implications of new information on our economic outlook and
industry analysis.
Economic trends can take two basic forms: cyclical changes that arise from the ups and downs of the business
cycle, and structural changes that occur when the economy is undergoing a major change in how it functions.
Business Cycle
Most observers believe that industry performance is related to the stage of the business cycle.
What makes industry analysis challenging is that every business cycle is different and those who look only at history miss
the evolving trends that will determine future market performance. Switching from one industry group to another over
the course of a business cycle is known as a rotation strategy. When trying to determine which industry groups will
Sector Rotation
OBJECTIVES:
1. Explain the assumptions that underlie
technical analysis.
2. Observe trends and patterns in graphs.
Technical analysis provides a framework for informing investment management decisions by applying a supply
and demand methodology to market prices. Underlying principles of the study of technical analysis are derived from the
assumption that changes in the supply and demand of traded securities affect their current market prices. Tools of
technical analysis are built into a framework that seeks to gain insight from the changes in supply and demand. This
framework has evolved over time from a purely visual analysis to more quantitative techniques.
Technical analysis operates from the assumption that past trading activity and price changes of a security can be
valuable indicators of the security's future price movements when paired with appropriate investing or trading rules.
Unlike fundamental analysis, which attempts to evaluate a security's value based on business results such as
sales and earnings, technical analysis focuses on the study of price and volume. Technical analysis tools are used to
scrutinize the ways supply and demand for a security will affect changes in price, volume and implied volatility. Technical
analysis is often used to generate short-term trading signals from various charting tools, but can also help improve the
evaluation of a security's strength or weakness relative to the broader market or one of its sectors. This information
helps analysts improve their overall valuation estimate.
Technical analysis can be combined with fundamental analysis or used independently of each other. At each
extreme, there are traders who solely use technical analysis and others who are purely fundamental traders.
Professional analysts typically accept three general assumptions for the discipline:
The market discounts everything – it is the major premise of technical analysis. Anything that can
influence/affect the price of a security is reflected on its price, thus, the need to understand price actions
that essentially reflect the shift in supply demand.
Price moves in trends – prices over a period of time move in a particular direction until it is reversed. This is
further expounded in each respective subtopic.
History tends to repeat itself – as prices move in trends, recognizable patterns unfold along the way. Over
the long run, these repeat itself.
In addition, technical analysts claim that a major advantage of their method is that it is not heavily dependent on
financial accounting statements—the major source of information about the past performance of a firm or industry.
The graph begins with the end of a declining (bear) market that finishes in a trough followed by an upward trend
that breaks through the declining trend channel. Confirmation that the trend has reversed would be a buy signal. The
technical analyst would buy stocks that showed this pattern. The analyst would then look for the development of a rising
trend channel. As long as the stock price stayed in this rising channel, the technician would hold the stock(s). Ideally, you
want to sell at the peak of the cycle, but you cannot identify a peak until after the trend changes.
Charts
These are graphical displays of price information of securities over time. Often, such charts also show volume.
Besides allowing the technical analyst to easily spot patterns and trends, the main benefits of charts are the concise
presentation of price and volume information over a duration, which can be used by fundamentalists to study how the
market has reacted to specific events. Market volatility can also be easily gleaned from charts. Charts also help technical
analysts to decide on entrance and exit points, and at what prices to place stops to reduce risk.
Line charts are the simplest form of charts depicting price changes over an interval of time. Usually, only the
closing price is graphed, depicted by a single point. The series of these points constitutes a line — hence, the name.
However, intraday price changes can also be plotted, either by plotting each trade, or by selecting the last price of a
given interval, such as an hour or 15 minutes. Because line graphs are simple, it is easier to compare the prices of
multiple securities or indexes on the same graph.
Bar Chart is one of the basic tools of technical analysis. The open, close, high, and low prices of stocks or other
financial instruments are embedded in bars which are plotted as a series of prices over a specific time period. Bar charts
allow traders to see patterns more easily. In other words, each bar is actually just a set of 4 prices for a given day, or
some other time period, connected by a bar in a specific way — called a price bar.
Candlestick chart is known as such because the main component of the chart representing prices looks like a
candlestick, with a thick body, called the real body, and usually a line extending above and below it, called the upper
shadow and lower shadow, respectively. The top of the upper shadow represents the high price, while the bottom of
the lower shadow represents the low price. Patterns are formed both by the real body and the shadows. Candlestick
patterns are most useful over short periods of time, and mostly have significance at the top of an uptrend or the bottom
of a downtrend, when the patterns most often signify a reversal of the trend.
While the candlestick chart shows basically the same information as the bar chart, certain patterns are more
apparent in the candlestick chart. The candlestick chart emphasizes opening and closing prices. The top and bottom of
the real body represents the opening and closing prices. Whether the top represents the opening or closing price
depends on the color of the real body — if it is white (or green), then the top represents the close; black (or red), or
some other dark color, indicates that the top was the opening price. The length of the real body shows the difference
between the opening and closing prices. Obviously, white real bodies indicate bullishness, while black real bodies
indicate bearishness, and their pattern is easily observable in a candlestick chart.
In a point and figure chart, X represents an increase in price and O represents a decline in price. Neither time
nor volume are represented on this type of chart, and the horizontal axis represents the number of changes in price, not
time. Movement along the horizontal axis does reflect the passage of time, but not in any uniform fashion.
Trends
A trend is a general direction in which prices, or the market, are moving. Prices randomly move on a day-to-day
basis, thus a trend is identified by taking into account the overall direction taken by a series of price data. This direction
may either be up, down, or sideways (rangebound). An uptrend is represented by higher highs (peaks) and lows
(troughs). A downtrend is represented by lower highs and lows. A higher movement is represented by horizontal highs
and lows.
To recognize the trend better and to decide at what prices to enter and exit a trade, traders often draw
trendlines. A trendline starts at the beginning of the trend and terminates at the end or wherever the market happens
to be currently. To maintain accuracy, trendlines should be updated as new prices become available. When the trend
changes, then a new trendline must be drawn to represent the new trend.
There are, however, several ways of drawing trendlines that will have slightly different directions for the same
trend depending on how the trendline is drawn and what type of chart is used. A trendline can be drawn so that:
A lowest low at the beginning of the trend is connected to the low of the highest high at the end of the trend,
which is usually how trendlines are drawn for uptrends. This also forms a resistance line.
A prominent high or low at the beginning of the trend can be connected to a prominent low or high at the end
of the trend.
Sometimes a low or high can be abnormally large compared to neighboring lows or highs, so trendlines are often
drawn using closing prices to give a more accurate picture of the trend.
Support, or a support level, refers to the price level that an asset does not fall below for period of time. An
asset's support level is created by buyers entering the market whenever the asset dips to a lower price. In technical
analysis, the simple support level can be charted by drawing a line along the lowest lows for the time period being
considered. The support line can be flat or slanted up or down with the overall price trend. Other technical indicators
and charting techniques can be used to identify more advanced versions of support.
SUPPORT
SUPPORT
RESISTANCE
RESISTANCE
Graph showing resistance line (upward) of Metropolitan Bank and Trust Company (MBT)
investagrams.com
Patterns
Another indispensable tool in technical analysis is pattern identification. These patterns are reversal,
continuation, or consolidation.
Reversal patterns are those that signal or identify a change in the direction of the trend. This is a price pattern
that signals a change in the prevailing trend is known as a reversal pattern. These patterns signify periods where either
the bulls or the bears have run out of steam. The established trend will pause and then head in a new direction as new
energy emerges from the other side (bull or bear).
Continuation patterns are those that signal the occurrence with the same trend patterns. A continuation pattern
is especially confirmed when a series of prices closes at the high, or its downtrend counterpart, when a series of prices
closes at the low. A price pattern that denotes a temporary interruption of an existing trend is known as a continuation
pattern. This can pattern can be thought of as a pause during a prevailing trend—a time during which the bulls catch
their breath during an uptrend, or when the bears relax for a moment during a downtrend. While a price pattern is
forming, there is no way to tell if the trend will continue or reverse.
Consolidation patterns are those that identify minor countertrends or corrections within an unfolding trend.
Consolidation is a technical analysis term referring to security prices oscillating within a corridor and is generally
interpreted as market indecisiveness. Said another way, consolidation is used in technical analysis to describe the
movement of a stock's price within a well-defined pattern of trading levels. Consolidation is generally regarded as a
period of indecision, which ends when the price of the asset moves above or below the prices in the trading pattern. The
consolidation pattern in price movements is broken upon a major news release that materially affects s security's
performance or the triggering of a succession of limit orders.
Technical Indicators
Technical indicators are heuristic or pattern-based signals produced by the price, volume, and/or open interest
of a security or contract used by traders who follow technical analysis. Technical indicators, also known as "technicals,"
are focused on historical trading data, such as price, volume, and open interest, rather than the fundamentals of a
business, like earnings, revenue, or profit margins. Technical indicators are commonly used by active traders, since
they're designed to analyze short-term price movements, but long-term investors may also use technical indicators to
identify entry and exit points.
b. Oscillators: Technical indicators that oscillate between a local minimum and maximum are plotted
above or below a price chart.
OBJECTIVES:
1. Differentiate equity portfolio
management strategies .
2. Propose asset allocation strategies.
Equity portfolio management styles fall into either a passive or an active category. Unlike the immunization of
bond portfolios, no middle ground exists between active and passive equity management strategies. Some argue that
“hybrid” active/passive equity portfolio management styles exist (e.g. enhanced indexing), but such styles really are
variations of active management philosophies. Similar to traditional active management, hybrid-style managers invest to
find undervalued sectors or securities.
Passive Management
Passive equity portfolio management is a long-term buy-and-hold strategy. Usually, stocks are purchased so the
portfolio’s returns will track those of an index over time. Because of the goal of tracking an index, this approach to
investing is generally referred to as indexing. Occasional rebalancing is needed as dividends must be reinvested and
because stocks merge or drop out of the target index and other stocks are added. Notably, the purpose of an indexed
portfolio is not to “beat” the target index but to match its performance. A manager of an equity index portfolio is judged
on how well he or she tracks the target index—that is, minimizes the deviation between portfolio and index returns
similar to the bond index portfolio manager.
The goal of a passive portfolio is to match the returns to the index as closely as possible; but, because of cash
inflows and outflows and company mergers and bankruptcies, securities must be bought and sold, which means that
there inevitably will be differences between portfolio and benchmark returns over time. In addition, even though index
funds generally attempt to minimize turnover and the resultant transactions fees, they necessarily have to do some
rebalancing, which means that the long-run return performance of index funds will lag the benchmark index. Certainly,
substantial or prolonged deviations of the portfolio’s returns from the index’s returns would be a cause for concern.
There are three basic techniques for constructing a passive index portfolio: full replication, sampling,
The second technique, sampling, addresses the problem of numerous stock issues. Statistical theory teaches us
that we don’t need to ask everyone in the United States for his or her opinion to determine who may win an election.
Thus, opinion pollsters query only a small sample of the population to gauge public sentiment. Sampling techniques also
can be applied to passive portfolio management. With sampling, a portfolio manager would only need to buy a
representative sample of stocks that comprise the benchmark index. Stocks with larger index weights are purchased
according to their weight in the index; smaller issues are purchased so their aggregate characteristics (e.g., beta,
industry distribution, and dividend yield) approximate the underlying benchmark. With fewer stocks to purchase, larger
positions can be taken in the issues acquired, which should lead to proportionately lower commissions. Further, the
reinvestment of dividend cash flows will be less problematic because fewer securities need to be purchased to rebalance
the portfolio. The disadvantage of sampling is that portfolio returns will almost certainly not track the returns for the
benchmark index as closely as with full replication.
Rather than obtaining a sample based on industry or security characteristics, quadratic optimization or
programming techniques can be used to construct a passive portfolio. With quadratic programming, historical
information on price changes and correlations between securities are input to a computer program that determines the
composition of a portfolio that will minimize tracking error with the benchmark. A problem with this technique is that it
relies on historical price changes and correlations, and, if these factors change over time, the portfolio may experience
very large tracking errors.
Some passive portfolios are not based on a published index. Sometimes customized passive portfolios, called
completeness funds, are constructed to complement active portfolios that do not cover the entire market. For example,
a large pension fund may allocate some of its holdings to active managers expected to outperform the market. Many
times, these active portfolios are overweighted in certain market sectors or stock types. In this case, the pension fund
sponsor may want the remaining funds to be invested passively to “fill the holes” left vacant by the active managers. The
performance of the completeness fund will be compared to a customized benchmark that incorporates the
characteristics of the stocks not covered by the active managers.
Still other passive portfolios and benchmarks exist for investors with certain unique needs and preferences.
Some investors may want their funds to be invested only in stocks that pay dividends or in a company that produces a
product or service that the investor deems socially responsible. Benchmarks can be produced that reflect these desired
attributes, and passive portfolios can be constructed to track the performance of the customized benchmark over time
so investors’ special needs can be satisfied.
Active Management
Active equity portfolio management is an attempt by the manager to outperform, on a risk-adjusted basis, a
passive benchmark portfolio. A benchmark portfolio is a passive portfolio whose average characteristics (including such
factors as beta, dividend yield, industry weighting, and firm size) match the risk-return objectives of the client.
The goal of active equity management is to earn a portfolio return that exceeds the return of a passive
benchmark portfolio, net of transaction costs, on a risk-adjusted basis. The job of an active equity manager is not easy.
Proponents of active management argue that good active managers can more than cover their costs and thus
deliver net benefit to investors.
Value Stocks
These are stocks in which the current stock prices are different from the perceived value of the stock and with
the expectation that value is realized, the stocks are invested. These are stocks of large organizations that have been
traded below its worthy value. In simple words, value stocks are stocks that are undervalued for a reason. The reasons
behind the under-valuation can be any scandal, flawed perception of the public, or any setback at the company.
Value stocks may look more attractive to you if you seek these characteristics:
You want current income from your portfolio. Many value stocks pay out substantial amounts of cash as
dividends to their shareholders. Because those businesses lack significant growth opportunities, they
have to make their stock attractive in other ways. Paying out attractive dividend yields is one way to get
investors to look at a stock.
You prefer more stable stock prices. Value stocks don't tend to see very large movements in either
direction. As long as their business conditions remain within predictable ranges, stock price volatility is
usually low.
You're confident that you can avoid value traps. In many cases, stocks that look cheap are value traps, or
cheap for a good reason. It could be that a company has lost its competitive edge, or can't keep up with
the pace of innovation. You'll have to be able to look past attractive valuations to see when a company's
future business prospects are poor.
You want a more immediate payoff from your investment. Value stocks don't turn things around
overnight. If a company's successful in getting its business moving in the right direction, however, its
stock price can rise quickly. The best value investors identify and buy shares of those stocks before other
investors catch on.
Growth Stocks
These are stocks where the increase in stock price is expected because of capital appreciation or the growth in
net income. These are stocks that can outperform any other stocks of competitors. These growth stocks can be of small,
medium, or large-sized organizations. The emphasis on growth stocks is “potential”. The prediction of these stocks is
given by the financial analysts and they feel due to the great operations or efficient management, these stocks are
growing super-fast, faster than any of its competitors.
Growth stocks are more likely to be appealing if the following things apply to you:
You're comfortable with big stock price moves. The price of a growth stock tends to be extremely
sensitive to changes in future prospects for a company's business. When things go better than expected,
growth stocks can soar in price. When they disappoint, higher-priced growth stocks can fall back to Earth
just as quickly
You're confident that you can pick out winners in emerging industries. You'll often find growth stocks in
fast-moving areas of the economy, such as technology. It's common for many different growth
companies to compete against each other. You'll need to pick as many of the eventual winners in an
industry as you can, while avoiding losers.
You have plenty of time before you'll need your money back. Growth stocks can take a long time to
realize their full potential, and they often suffer setbacks along the way. It's critical that you have a long
enough time horizon to give the company a chance to grow.
Jinny Lee is responsible for the investment of a new Php4 billion contribution to the
LSJ Bank’s pension fund. The mandate is to invest with active managers. The equity portion of
the pension plan has a broad equity market benchmark.
Discuss the advantages and disadvantages of hiring a single manager in either a growth or value
style, one manager in each style, or one manager in a market-oriented style.
Advantage:
Advantage:
Advantage:
One manager with a market-oriented
style
In such situations, the portfolio manager must consider more than just the composition of the equity or the
bond component of the portfolio. The manager also must determine the appropriate mix of asset categories in the
entire portfolio. There are four general strategies for determining the asset mix of a portfolio: the integrated, strategic,
tactical, and insured asset allocation methods.
Unlike an investor’s strategic allocation, which is set with a long-term focus and modified infrequently, a
tactical approach to asset allocation constantly adjusts the asset class mix in the portfolio in an attempt to take
advantage of changing market conditions. With tactical asset allocation, these adjustments are driven solely by
perceived changes in the relative values of the various asset classes; the investor’s risk tolerance and investment
constraints are assumed to be constant over time.
OBJECTIVES:
1. Differentiate bond portfolio
management strategies.
Bond portfolio management strategies are based on managing fixed income investments in pursuit of a
particular objective – usually maximizing return on investment by minimizing risk and managing interest rates. The
management of the portfolio can be done by professional investment managers or by investors themselves.
Passive investing is for investors who want predictable income, while active investing is for investors who want
to make bets on the future; indexation and immunization fall in the middle, offering some predictability, but not as
much as buy-and-hold or passive strategies.
Passive Management
Passive strategies emphasize buy-and-hold, low energy management
Try to earn the market return rather than beat the market return
Buy-and-Hold Strategy
The simplest fixed-income portfolio management strategy is to buy and hold. This approach involves finding
securities with the desired levels of credit quality, coupon rate, term to maturity or duration, and other important
indenture provisions, such as call and sinking fund features. Buy-and-hold investors do not consider active trading as
a viable alternative to achieve abnormal returns but look for bond issue whose maturity/duration characteristics
approximate their investment horizon in order to reduce price and reinvestment risk. Many successful bond
investors and institutional portfolio managers follow a modified buy-and-hold strategy wherein they invest in an
issue with the intention of holding it to maturity, but still look for opportunities to trade into a more desirable
position should the occasion arise. Of course, if the buy-and-hold approach is modified too much, it becomes an
active strategy.
Whether the manager follows a strict or modified buy-and-hold approach, the critical concept is finding
investment vehicles that possess the appropriate maturity, yield, and credit quality attributes. The strategy does not
restrict the investor to accept whatever the market has to offer, nor does it imply that selectivity is unimportant.
Finally, recognize that there is an important fundamental difference between managing a bond portfolio and a
stock portfolio on a buy-and-hold basis. Since bonds eventually mature with the passing of time whereas stock
shares do not, the bond manager is faced with the need to periodically reinvest the funds from a matured issue.
However, the stock manager can employ a “pure” buy-and-hold strategy in which he never adjusts the portfolio’s
composition once it is formed. Fixed-income portfolio managers often address this concern by forming a bond
ladder, in which they divide their investment funds evenly across the portfolio into instruments that mature at
regular intervals. For instance, a manager with an intermediate- term investment focus, instead of investing all of
her funds in a five-year zero coupon security—which would become a four-year security after one year had passed—
could follow a laddered approach and buy equal amounts of bonds maturing in annual intervals between one and
nine years. The idea would then be to hold each bond to maturity, but to reinvest the proceeds from a maturing
bond into a new instrument with a maturity at the far end of the ladder (that is, to reinvest a maturing bond in a
brand-new nine-year issue). In this way, the desired maturity/duration target for the portfolio can be maintained
over time without having to continually adjust the investment weights for the remaining positions.
Indexing Strategy
Numerous empirical studies were cited that have demonstrated that the majority of money managers have not
been able to match the risk-adjusted return performance of common stock and bond indexes. As a result, many
investors have chosen to invest at least some of the funds dedicated to these asset classes on a passive basis. Rather
than forming their own buy-and-hold portfolios, many investors prefer to hold a bond portfolio designed to mimic a
selected fixed-income index. In such a case, the bond index manager is judged not on the basis of his ability to
produce abnormal returns, but by how closely his portfolio produces returns that match those of the index.
As with stock index funds, when designing a bond portfolio to mimic a hypothetical index, managers can follow
two different paths: full replication or stratified sampling. While it is quite common when constructing stock index
funds to fully replicate the underlying index, the bond index fund manager often follows a sampling approach,
wherein a smaller number of instruments are held in the actual portfolio than appear in the index. One reason for
this is that bond indexes often contain several thousand specific issues and are adjusted frequently, making them
both impractical and expensive to replicate precisely in practice. The goal of the stratified sampling approach is to
create a bond portfolio that matches the important characteristics of the underlying index—such as credit quality,
industry composition, maturity/duration, or coupon rate—while maintaining a portfolio that is more cost effective to
manage. To the extent that the manager is not able to match these characteristics over time, the tracking
error of the indexed portfolio will typically increase.
When initiating an indexing strategy, the selection of an appropriate market index is clearly a very important
decision, chiefly because it directly determines the client’s risk-return results.
Active Management
Active management strategies attempt to beat the market
Mostly the success or failure is going to come from the ability to accurately forecast future interest rates
and increasing the portfolio duration when a decline in yields is anticipated). Thus, the risk in such portfolio
restructuring is largely a function of these duration alterations. When durations are shortened, substantial income
could be sacrificed and the opportunity for capital gains could be lost if interest rates decline rather than rise.
Similarly, portfolio shifts prompted by anticipated rate declines are also risky. Assuming that we are at a peak in
interest rates, it is likely that the yield curve is downward sloping, which means that bond coupons will decline with
maturity. Therefore, the investor is sacrificing current income by shifting from high-coupon short bonds to longer-
duration bonds. At the same time, the portfolio is purposely exposed to greater price volatility that could work
against the portfolio if an unexpected increase in yields occurs. Note that the portfolio adjustments prompted by
anticipation of an increase in rates involve less risk of an absolute capital loss. When you reduce the maturity, the
worst that can happen is that interest income is reduced and/or capital gains are forgone (opportunity cost).
Once future (expected) interest rates have been determined, the procedure relies largely on technical matters.
Assume that you expect an increase in interest rates and want to preserve your capital by reducing the duration of
your portfolio. A popular choice would be high yielding, short-term obligations, such as Treasury bills. Although your
primary concern is to preserve capital, you would nevertheless look for the best return possible given the maturity
constraint. Liquidity also is important because, after interest rates increase, yields may experience a period of
stability before they decline, and you would want to shift positions quickly to benefit from the higher income and/or
capital gains.
Valuation Analysis
With valuation analysis, the portfolio manager attempts to select bonds based on their intrinsic value, which is
determined based on their characteristics and the average value of these characteristics in the marketplace.
Credit Analysis
A credit analysis strategy involves detailed analysis of the bond issuer to determine expected changes in its
default risk. These rating changes are affected by internal changes in the entity (e.g., changes in important financial
ratios) and by changes in the external environment (i.e., changes in the firm’s industry and the economy). During
periods of strong economic expansion, even financially weak firms may survive and prosper. In contrast, during
severe economic contractions, normally strong firms may find it very difficult to meet financial obligations.
Therefore, historically there has been a strong cyclical pattern to rating changes: typically, downgrades increase
during economic contractions and decline during economic expansions.
To use credit analysis as a bond management strategy, it is necessary to project rating changes prior to the
announcement by the rating agencies. This can be quite challenging because the market adjusts rather quickly to
bond rating changes, especially to downgrades. Therefore, you want to acquire bond issues expected to experience
an upgrade and sell or avoid those bond issues expected to be downgraded.
and expansion.
References:
The core portion of a portfolio following this combination approach is effectively managed as an index fund
based on the belief that the designated core sectors of the bond market are efficient to where it is not worth the time
and cost to attempt to derive substantial excess returns from them.
A core-plus approach to bond management can also be considered a form of enhanced indexing, depending on
how much of the portfolio is placed in the core portion and how actively the plus sectors are managed.
Dedicated Portfolios
Dedication refers to bond portfolio management techniques that are used to service a prescribed set of
liabilities. Such a “dedicated” portfolio can be created in several ways. We will discuss two alternatives. A pure
cash-matched dedicated portfolio is the most conservative strategy. The objective of pure cash matching is to
develop a portfolio of bonds that will provide a stream of payments from coupons, sinking funds, and maturing
principal payments that exactly match the specified liability schedules.
Dedication with reinvestment is similar to the pure cash-matched technique except it allows that the
bonds and other cash flows do not have to exactly match the liability stream. Any inflows that precede liability
claims can be reinvested at some reasonably conservative rate. This assumption lets the portfolio manager
consider a substantially wider set of bonds that may have higher return characteristics. In addition, the
assumption of reinvestment within each period and between periods also will generate a higher return for the
asset portfolio. As a result, the net cost of the portfolio will be lower, with almost equal safety, assuming
the reinvestment rate assumption is conservative.
Immunization Strategies
Immunization techniques attempt to derive a specified rate of return (generally quite close to the
current market rate) during a given investment horizon, regardless of what happens to the future level of
interest rates.
Horizon Matching
Horizon matching is a combination of two of the techniques just discussed: cash-matching dedication
and immunization. In the first segment, the portfolio is constructed to provide a cash match for the liabilities
during this horizon period (e.g., the first five years). The second segment is the remaining liability stream
following the end of the horizon period. During this second time period, the liabilities are covered by a duration
matched strategy based on immunization principles.
Central to the implementation of Contingent Immunization is an effective system for monitoring and risk
control. Contingent immunization requires that the client be willing to accept a potential return below the
current market return. This is referred to as a cushion spread, or the difference between the current market
return and some floor rate. This cushion spread in required yield provides flexibility for the portfolio manager to
engage in active portfolio strategies.
What Do Investors Need To Know About Passive Versus Active Bond Funds?
https://www.forbes.com/sites/karlkaufman/2018/12/30/what-do-investors-need-to-know-about-
passive-versus-active-bond-funds/#5d370a325d1c
OBJECTIVES:
1. Illustrate how cryptocurrencies work.
2. Determine the ethical issues related to the
use of cryptocurrencies.
Over the last few years, the idea of cryptocurrencies has exploded, and more people than ever have invested in
currencies like Bitcoin. Cryptocurrencies are digital currencies not backed by real assets or tangible securities. They are
traded between consenting parties with no broker and tracked on digital ledgers. Cryptocurrencies have shown
relatively low correlation to economic fundamental data and other markets, leaving technical analysis and crypto-
specific news as the main drivers for analyzing them.
While a majority of Filipinos had been aware of cryptocurrencies, actual holdings remained low due to perceived
risks from these digital assets.
CRYPTOCURRENCY
Cryptocurrency is a unique, virtual medium for exchanging money. It uses special cryptographical functions and
blockchain technology to conduct online transactions.
Cryptocurrencies are totally decentralized. They’re not controlled by any one entity and— in theory—they’re
immune to government control. However, many governments have recently started working to regulate them.)
Individuals can also exchange cryptocurrencies online with very few (if any) processing fees. This advantage
makes them much more appealing than traditional currencies and financial institutions for exchanges.
People might use cryptocurrencies for quick payments and to avoid transaction fees. Some might get
cryptocurrencies as an investment, hoping the value goes up. You can buy cryptocurrency with a credit card or, in some
cases, get it through a process called “mining.” Cryptocurrency is stored in a digital wallet, either online, on your
computer, or on other hardware.
cryptocurrency in a digital wallet provided by a company, and the company goes out of business or is hacked,
the government may not be able to step and help get your money back as it would with money stored in banks
or credit unions.
INVESTING IN CRYPTOCURRENCY
As with any investment, before you invest in cryptocurrency, know the risks and how to spot a scam. Here are
some things to watch out for as you consider your options.
You don’t have the same legal protections when you pay with cryptocurrency.
Credit cards and debit cards have legal protections if something goes wrong. For example, if you need to
dispute a purchase, your credit card company has a process to help you get your money back. Cryptocurrency
payments typically are not reversible. Once you pay with cryptocurrency, you only can get your money back if
the seller sends it back.
Before you buy something with cryptocurrency, know a seller’s reputation, where the seller is located,
and how to contact someone if there is a problem.
CRYPTOCURRENCY SCAMS
As more people get interested in cryptocurrency, scammers are finding more ways to use it. For example,
scammers might offer investment and business “opportunities,” promising to double your investment or give you
financial freedom.
Cryptojacking
Cryptojacking is when scammers use your computer or smartphone’s processing power to “mine”
cryptocurrency for their own benefit, and without your permission. Scammers can put malicious code onto your
device simply by your visiting a website. Then they can help themselves to your device’s processor without you
knowing.
If you notice that your device is slower than usual, burns through battery power quickly, or crashes, your
device might have been cryptojacked. Here is what to do about it:
Close sites or apps that slow your device or drain your battery.
Use antivirus software, set software and apps to update automatically, and never install
software or apps you do not trust.
Do not click links without knowing where they lead, and be careful about visiting unfamiliar
websites.
Consider a browser extension or ad blockers that can help defend against cryptojacking. But do
your research first. Read reviews and check trusted sources before installing any online tools.
Some websites may keep you from using their site if you have blocking software installed.
A. BOOKS
B. JOURNALS:
Harvard Business Review
C. ELECTRONIC SOURCES:
Acidre, J. (2020, August 10). The Best Investments for Millennials in the Philippines (Under 100K). Retrieved
Avadhut. (2020, July 8). How to Do Industry Analysis: The Complete Guide. Retrieved July 24, 2020 from
https://www.financewalk.com/industry-analysis/.
https://www.fidelity.com/learning-center/trading-investing/technical-analysis/introduction-technical-
analysis/overview.
Kenton, W. (2020, April 30). Capital Asset Pricing Model. Retrieved July 23, 2020 from
https://www.investopedia.com/terms/c/capm.asp#:~:text=The%20Capital%20Asset%20Pricing%20Model
%20(CAPM)%20describes%20the%20relationship%20between,assets%20and%20cost%20of%20capital.
Pfau, W. (2020, February 20). Modern Portfolio Theory. Retrieved July 23, 2020 from
https://www.forbes.com/sites/wadepfau/2020/02/20/modern-portfolio-theory/#69e8ffee52d3.
Shaikat, N. (2020). Individual Investor Life Cycle. Retrieved July 23, 2020 from
https://ordnur.com/academic-study/finance/individual-investor-life-cycle/.
D. OTHERS
www.investagrams.com
www.pse.com.ph
2. What is the most important lesson which I can apply in my daily life?