Chapter 1: Introduction

Question 1

Describe the main difference between an investment narrative and investment analysis.

Give three properties of a good investment narrative.

Answer 1

Narrative vs analysis

A narrative is a story.
It describes a** ‘big picture’ **or a framework from which all future analysis will take place.

Investment analysis refers to the work that is carried out, which may lead to forecasts and predictions about investment markets and investment returns. The narrative will often have a dominating impact on any analysis that is carried out.

Properties of a good narrative:
1. deep enough and bright enough to show the big picture

2. it should **not take sides **or incorporate a bias in any way
3. it should have no inconsistencies within itself

Question 2

List the main participants of financial and investment markets.

Answer 2

The main participants in financial and investment markets.

1. individuals and groups of individuals
2. companies (not operating in the financial sector)
3. financial organisations such as banks, insurance companies, hedge funds, as well as charities, sovereign wealth funds and endowment funds (sometimes referred to as non-financial organisations)
4. government and regulatory bodies
5. financial intermediaries (brokers, market makers and dealers)
6. exchanges and online platforms
7. clearing houses

It is also possible to include some people working within these bodies as separate ‘participants’, such as:
8. investment analysts, traders and strategists, consultants and advisors
9. custodians.

Question 3

Differentiate between the roles that exist in the financial world which are classed as ‘back office’, ‘middle office’ and ‘front office’.

Answer 3

**Back office:
Back office roles are concerned with settlement, and compliance or regulatory issues.
There are more roles in back office than elsewhere in the organisation.

Middle office:
Middle office roles are often concerned with risk management and risk reporting.
They often involve more judgement and strategic thinking than those of back office roles.

Front office:
Front office roles involve taking action on behalf of an organisation.
They include traders, dealers, market makers and fund managers.
These roles also involve a great deal of judgement and strategic thinking.

Question 4

Give examples of the inefficient actions and decisions that are observed in individual investment portfolios, which are attributed to behavioural issues.

Answer 4

Examples of inefficient investment decisions:
1. Hanging on to losing investments
2. Inertia by not changing portfolios over time as situations change
3. Taking default options when there may be special requirements
4. Naive diversification, when many invesments may be correlated
5. Investing in familiar investments and familiar companies
6. Selling winning investments and holding on to losing investments
7. Home bias, whereby too much is invested in the home currency.