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~ •- · PART I: Introduction
■ Goals
■ Clearly define financial goals
■ Time horizon for·each
■ Buckets
■ Divide your financial needs into buckets to be filled with
money you earn
■ Examples
■ Emergency fund
■ College
■ Retirement
■ Buy property

■ Debt
■ Be careful in taking debt (see rule below)
■ Debt means compounding is working against you
■ Eliminate Credit card debt
■ Do not invest with borrowed money

■ Rule:
■ Borrow only for long lived assets
■ Home, education
■ NOT for consumables

Savings Plan
~ PART I: Introduction
■ Goals
■ Clearly define financial goals
■ Time horizon for -each
■ Buckets
■ Divide your financial needs into buckets to be filled with
money you earn
■ Examples
a Emergency fund
■ College
■ Retirement
■ Buy property

■ Debt
■ Be careful in taking debt (see rule below)
■ Debt means compounding is working against you
■ Eliminate Credit Card debt
■ Do not invest with borrowed money

■ Rule:
■ Borrow only for long lived assets
■ Home, education
■ NOT for consumables

Savings Plan
 Compounding
■ The magic of compounding
■ What is compounding?

11 Time is your ally

• Starting early means less savings to get to goal
(see handout)
■ Note that unnecessary debt means that
compounding works against you

-~ Incentives
■ Many individuals you may interact with in the
financial arena

■ Have different incentives and agendas

■ Fund managers
■ Corporation executives
■ Financial planners
■ Banks

■ Want to get individuals whose incentives are in line

with yours
 PART II: Asset Classes
.,.,_ Overview
I. Assets:
■ Cash
11 Bonds

., Stocks

~ A. Asset Allocation
A. Allocation of wealth
A. How to allocate your wealth between different assets

a. This is a strategic decision and crucial to investment

perfomance

c. Decisions about asset mix has a a much greater influence on

investment results than decisions about specific funds

o. Source: Brinson, Hood and Beebower: "Determinants of

Portfolio Perfomance" Financial Analysts Journal (1986, 1991)
 ■ Criteria:
■ Liquidity
■ Risk
a Return

±B. Liquidity
Liquidity: is the ease with which you can
access your money

Cash is most liquid

Bonds next
equity less liquid

[ what is property?]
C. Returns
1. Think of returns in annual terms

w Some funds report cumulative returns

ia Misleading
al Annual returns are a better measure
■ Better measure of comparison
■ Useful in calculating how much a lump sum amount would
be worth
Example! : A fund earned 250% over 20 years
Implies annual returns of 6%/year

Example 2: annual returns of 11 %/year results in 706%

cumulative return

■ 2. Differences in returns add up over

time
■ Recall compounding
■ See handout
 ■ 3. Dollar amount and percentages
■ Easy rule of thumb: simply translate into dollars

m a. Example:
■ 100% gain: Price goes from $25 to 50
" 50% loss ➔ 50 back to 25.
Note the bigger the fall, the longer the recovery

b. Example 2:
Pay broker 5% sales commission on $10,000
This means pay broker $500

~I~-=Time: Gains and Losses

■ 40% Gain at the beginning of investing
career vs. near the end
■ 40% of $800,000 = $320,000
■ 40% of $8,000 = $3200

■ Losses: Reverse
■40% loss of $8,000
■40% loss of $800,000
Moral:
Higher risk when younger/earlier in the investing
career
Lower the risk exposure as one gets closer to the
goal
~ ·Rule of 72
111
72/annual return = # of years for money to double
• The magic of compounding

■ Example!:
■ Want to double in two years
■ What return/year?

■ Example 2:
■ Get 10% return/year
■ How many years for money to double?

Trading Seccurities
■ 1. Long:
■ Buying a stock with own money

■ 2. Margin
Buying an asset borrowing money

3.Short
 / .
- -•r; Marg1n
,I

I Investors
■ have easy access to a source of debt financing called
brokers' call loans.
■ Taking advantage of the brokers' call loans is called buying on
margin

■ Process:
■ Investor borrows part of the purchase price of the stock from the
broker
■ The broker borrows money from the banks at the call money rate
to finance the purchases and charges its clients that rate plus a
service charge
11 All securities purchased on margin must be left with brokerage firm
because the securities are used as collateral for the loan.

■ Fed sets margin requirements

■ Limits on the extent of stock purchases that may be financed by
margin
■ Currently 50%

■ Reasons for Margin:

■ Greater upside potential than own money
■ But also Greater downside risk.

Example:
Investor has $10,000.
HSBC current price is $100. No dividends
Suppose HSBC price rises to $130
 LONG ONLY rate of return is 30%

■ Margin:
■ Borrows $10,000
Total investment: $20,000
Assume interest rate on margin is 9%

Rate of return:
End of year the shares are worth: $26,000
Paying off $10,900 (principal and interest) leaves: $15,100

1~,100 - 10,000/10,000 = 51 %

Stock price value Repayment ROR

30% increase $26,000 $10,900 51°/o

No change $20,000 10,900

30°/o decrease 14,000 10,900 -69

 -.,'-'II I II 11\.,,11,

~ 1. Long only vs Leverage returns not

equivalent

■ 2. Property: Leveraged bet?

I ' ~~
- -.l IL
SHORT
■ A short sale allows investors to profit from a
decline in a security' s price.

■ Process:
■ An investor borrows a share of stock from a
broker
■ Sells it
■ Later, the short seller must purchase a share of
the same stock in the market: Covering the short
position
/ Shorts: Restrictions
lil Shares loaned out by brokerage house (from other clients
accounts)

■ Exchange rules:
■ NYSE: permit short sales only after an uptick
■ HK: more restrictions

■ Proceeds from short sales must be kept in brokers account

■ So, short seller cannot invest these funds to generate income

■ Short sellers must post margin (collateral)

■ To ensure that the trader can cover any losses sustained
should the price rise

~ Issues
■ 1. Base currency
■ 2. Annual vs cumulative
■ 3. Nominal vs Real returns
■ 4. Long vs. Leverage
Conclusions
■ 1. Base currency: USD

■ 2. Annual returns

■ 3. Nominal returns

■ 4. Long only

D. Risks
■ Risk: 'likelihood of losing'
■ Cash is least risky
■ Bonds more than cash
■ Equity most risky

■ Skewed attitude towards risk

■ Loss affects people more than gain
■ Check to see how much you are comfortable
losing first
• Standard Deviation (one measure of risk)
• Measures how a f d' .
return un s returns have deviated around its average

■ FundYl Y2 Y3 AR SD
■ ABC -5% +10% +25% +10% 15
■ XYZ +5% +10% +15% +10% 5

■ R-Squared:
■ Measures the degree to which a fund's return go up and down at
the same time as the market (an appropriate index)
■ Ranges from 0.00 to 1.00
■ 0: Does not match market movement
■ 1: Exactly matches market movement