Investments Flashcards
Investment risks
- Default
- Inflation
- Liquidity
- Marketability
- Dividends (equities)
Government uses interest rates to
- Control inflation
- Encourage economic growth
- Manage exchange rate
Theories of yield curve
LIME
1. Liquidity theory
* additional yield on less liquid bonds - normally LT
2. Inflation risk premium
*additional yield on long-term conventional bonds
*compensate for inflation
3. Market segmentation theory
*supply a d demand determine yields at each term
*demand comes from matching attempts
4. Expectations theory
*yield reflects future expectations of interest and inflation
Economic factors affecting bonds
FIIERCE
1. Fiscal
2. Interest
3. Inflation
4. Economic growth
5. Perceived riskiest
6. Curreny
7. Exchange rate
Economic factors affecting equity (secure options)
OPERATICS
1. Overseas equities
2. Political climate
3. Economic growth
4. Perceived riskiest
5. Alternative
6. Tax
7. Interest and inflation
8. Currency
9. Supply
Investments selected should be appropriate to
CnUT
1. Currency
2. Uncertainty
3. Nature
4. Term
Nature of benefits
- Guaranteed money
- Guaranteed index linked
- Discretionary
- Investment linked
Matching options
- Pure
- Approximate
- Liability hedging
*approximate
*full - Immunisation
Custodian duties
- Hold investment on behalf of investor
- Independently account for financial transactions
- Ensure financial instruments are housed under proper system
- Bank/regulated inst
- Services
*income collection
*tax recovery
*. Cash management
*securities settlement
*foreign exchange
*stock lending
*voting
Immunisation conditions
- Pv are equal
- Dmt are equal
*weighted average duration of series of cashflow
* measure of sensitivity of PV to small changes in force of interest
*average life of investments - Spread about the Dmt of assets slightly more than of liabilities
*larger convexity = higher spread =less affected by small changes in interest rates
Limitations of immunisation theory
- Profit (rules out equity ans property)
*cut out opp to profit from excess returns - fixed
*ideally for fixed interest
*there might be lag for index Inked - Discounted mean term asset
*not easy to find long term dmt - Curve
*assume whole curve moves by same - Rearrangement/rebalancing
*will require upkeep - Timing
*?unknown timing - Interest
* doesn’t work for big changes
Valuation methods foe individual investments
- Market value
- Smoothed Market value
- Fair value
- Discounted cashflow
- Stochastic models
- Arbitrage value
- Historic book value
- Written up/down
Market value valuation
not readily attained- unwuo
1.varies constantly-known with certainty at transaction date
2. Many quoted figures in open market at any time
3. Objective and easily obtained figure - starting pnt of val
*objective
*realistic
*easy
*well understood and accepted
*can be used for comparison
#volatile
#May not reflect values of future proceeds
#subjective decisions (mid, bid,offer)
#difficult to ensure consistency with liability basis
#value reflects position of marginal investor
#illiquidity-may notbe realised
Smoothed market value
- Where MV is avail smooth by taking some form of average over specified period to rem9ve fluctuations
- Not great for consistent liability valuations - appropriate discount rate is indetermjnate
Fair value
- Market based method of valuation
- Amount for which asset or liability could be excahnged/settled between knowledgeable, willing parties at arms length
- Likely to be market price
4 . Indicative price from brokwr/market maker - Use most recent adjusted for movement in appropriate index
- Use stochastic asset modeling for market consistent value
Discounted cashflow
- Discounting the expected future cashflows from investment using LT assumptions
- Advantage of being easily made consistent with basis of investors liabilities
- Same approach to determine discount rate
*portfolio of assets - use weighted average to get discount rate
*str8 fwd for high quality fixed interest stocks
Stochastic investment model
too complex
- Extention of discounted cashflow
- Future cashflows/ interest rates are stochastic
- Ideal for when future cash flows are complicated- embedded options
*good for derivatives
*better pic of val
*consistent with liability val
#results depend on assumed distributions
Arbitrage valuation
difficult to Replicate many assets I other classes
- Means if obtaining proxy marker value
- Replicate investment with combination of other investments
- Condition - in efficient market all values must be equal
*used in val of derivative
Historic valuation
little merit for other purposes
- Price originally paid for assets
- Used for fixed assets in published accounts
*objective
*Conservative
*well understood
*used for so.e accounting purposes
Written up/down
subjective
1.Historic book value adjusted periodically for movements
2.
#not consistent to liability valuation
#cannot determine appropriate liability discount rate
