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Investments

Investments. BSC Winter Semester 2010. Chap 3. Indirect Investing. Chapter 3 Indirect Investing Learning Objectives. What is Indirect Investing? Direct Investing Indirect Investing What is an Investment Company? What are Types of Investment Companies? What are Types of Mutual Funds?

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Investments

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  1. Investments BSC Winter Semester 2010

  2. Chap 3 Indirect Investing

  3. Chapter 3Indirect InvestingLearning Objectives • What is Indirect Investing? • Direct Investing • Indirect Investing • What is an Investment Company? • What are Types of Investment Companies? • What are Types of Mutual Funds? • What are the mechanics of Investing Indirectly? • What is Investment Company Performance? • What are Exchange Traded Funds?

  4. What are major types of Financial Assets? • DIRECT INVESTING • Non-Marketable securities • Money Markets • Capital Markets • Derivatives Markets • INDIRECT INVESTING • Investment Companies • Mutual Funds • Stock, Bond Funds • Exchange Traded Funds

  5. What are major types of Financial Assets? In-direct Investing • Buying & Selling of shares of investment companies, which then hold portfolios of securities. • Funds are given to professional money managers to make decisions on an investors behalf (for better or worst) • Fees are charged for this service

  6. What are major types of Financial Assets?In-direct Investing • Investment Company?

  7. What are major types of Financial Assets?In-direct Investing • Investment Company? A financial company which sells shares in itself to the public & uses these funds to invest in a portfolio of securities • Investment Company Regulations • Investment Company Taxation

  8. Types of Investment Companies • Exchange Traded Funds (ETF) • Unit Investment Trusts(UIT) • Closed-End Investment Companies • Open-end Investment Companies (Mutual Funds)

  9. Exchange Traded Funds

  10. Exchange Traded Funds • An exchange traded fund is a basket of stocks that tracks a particular index, sector, investment style, geographical area or the market as a whole. • ETFs unlike mutual funds can be bought on margin & sold short. • Tax Efficient • Very small premiums & discounts from NAV • Unlike mutual Funds, can be traded anytime during the day. • Lower Expenses

  11. Unit Investment Trusts

  12. Unit Investment Trusts • Unit Investment Trust is an unmanaged portfolio of tax exempt securities put together by a sponsor & handled by an independent trustee. • Redeemable trust certificates representing claims against the assets of the trust are sold to investors at Net Asset Value plus commission.

  13. Closed-End Investment Companies

  14. Closed-End Investment Companies • Closed Investment Company offers investors an actively managed portfolio of securities. Its capitalization is fixed unless a new public offering is made. • Shares of closed-end Funds trade on Stock exchanges & hence their prices are determined by forces of supply & demand.

  15. Closed-End Investment Companies- Mechanics of Investing Indirectly • Net Asset Value- NAV is per share value of portfolio of securities held by the investment company on a given day. • If NAV > Market price Discount • If NAV < Market price Premium • NAV = (Market Value of Fund’s Securities – Liabilities) Total Number of shares outstanding

  16. Open-End Investment Companies (Mutual Funds)

  17. Open-End Investment Companies (Mutual Funds) • Mutual Funds are either corporations or Business trusts formed by an investment advisory firm that selects the board of trustees (Directors) for the company. • The trustees, in turn, hire a separate management company, normally, the investment advisory firm to manage the fund. • The number of shares outstanding of an open end investment company is continually changing.

  18. Mutual Funds - Types There are four basic types of Mutual Funds: • Money Market Mutual Funds • Equity Funds • Bond Funds • Hybrid Funds

  19. Mutual Funds - Types • Money Market Mutual Funds • No Load Funds • Taxable Vs Tax Exempt Funds • Equity Funds • Capital Appreciation Fund • Total Return fund • World Equity Fund • Bond Funds • Hybrid Funds

  20. Mutual Funds • Value Funds Vs Growth Funds • Index Funds

  21. Mutual Funds- Trading Mechanics Mutual Fund Share prices • Owners of shares can sell them back to the company anytime they choose; the mutual fund is legally obligated to redeem them.

  22. Mutual Funds- Trading Mechanics Fees Vs Expenses • Front-End Load • Back-end Load • Management Fee • Distribution Fee (12b-1) • Load & No load Funds

  23. Mutual Funds- Trading Mechanics Mutual Fund Share Classes • Class A Shares • Class B Shares • Class C shares

  24. Hedge Funds

  25. Hedge Funds • Hedge Funds are unregulated companies that seek to exploit various market opportunities & thereby earn larger returns than are ordinarily available. • As hedge funds are unregulated, they may invest in assets not typically available to mutual Funds. • A high water markprovision

  26. Hedge Funds - Classifications • Long/Short Funds: These funds take long & short common stock positions, use leverage & are invested in markets world wide. • Market-neutral Funds: These funds take long & short positions, but the positions will offset each other so that the effect is a net zero exposure to the market. • Global Macro Funds: These funds are typically highly leveraged & rely heavily upon derivatives.

  27. Fund of Funds • Fund of Funds investing involves creating a fund open to both individual & institutional investors, which in turn invests in hedge funds. • Benefits for investors with limited capital? • Benefits for investors with more capital? • Drawbacks?

  28. Hedge fund performance measurement There are numerous hedge fund indices designed to measure historical performance. Some general conclusions regarding hedge funds can be derived: • Hedge Funds have demonstrated a lower risk profile than traditional equity investments as measured by a standard deviation. • In recent years, the Sharpe Ratio has been consistently higher for hedge funds than for most equity investments. • There is a low correlation between the performance of hedge funds & conventional investments.

  29. Hedge fund performance measurement - Biases • Self selection Bias • Backfilling Bias • Survivorship Bias • Smoothed pricing of infrequently traded assets

  30. Alternative Investments • Closely held companies • Distressed Securities • Venture Capital Investing

  31. Alternative Investments – Closely held companies • The equity shares of closely held companies are not publicly traded & are not subject to the same SEC regulations as public companies regarding reporting & disclosure. • The Cost approach • The comparables approach • The income approach

  32. Alternative Investments – Distressed Securities • When companies are on the brink of bankruptcy or have already filed for bankruptcy protection, their securities are considered Distressed.

  33. Alternative Investments – Venture Capital Investing • Venture Capital Investments are private, non exchange traded equity investments in business venture. • Investments may be made at any point of the business cycle of the company, from the initial planning stage of a new venture to an established firm ready to go public. • Long term investment horizon • Difficulty in valuation • Requirement for extensive operation analysis

  34. Valuing a Venture Capital Investment - Example A venture capital fund manager is considering investing 2.5 million in a new project that he believes will pay $12 million at the end of five years. The cost of equity for the investor is 15% & the estimated probability of failure is presented in the figure below.

  35. Valuing a Venture Capital Investment - Example • The probability that Venture Capital survives for five years is calculated as: (1-0.20)*(1-0.20)*(1-0.17)*(1-0.15)*(1-0.15) =0.3838 • NPV if the project survives: [-2.5 m + {12m/(1.155)}] = $3.466121 Million • NPV if the project fails: = - $2.5 million (Initial Investment) • Expected NPV of the project (Probability weighted average): = (0.3838*3,466,121) + (0.6162* (-2,500,000)) =- $210,203

  36. Assignment # 3 Q1: A venture capital fund manager is considering investing 3.5 million in a new project that he believes will pay $30 million at the end of five years. The cost of equity for the investor is 13% & the estimated probability of failure is presented in the figure below.

  37. Assignment # 3 Q2: A venture capital fund manager is considering investing 1.75 million in a new project that he believes will pay $25 million at the end of six years. The cost of equity for the investor is 12% & the estimated probability of survival is presented in the figure below.

  38. Chapter 3Indirect InvestingSummary • What is Indirect Investing? • Direct Investing • Indirect Investing • What is an Investment Company? • What are Types of Investment Companies? • What are Types of Mutual Funds? • What are the mechanics of Investing Indirectly? • What is Investment Company Performance? • What are Exchange Traded Funds?

  39. Thank you for your time & patience 

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