Lecture 6-Investments

Question 1

What is a saving?

Answer 1

-Means the act of setting aside money today to use at some time in future.

Question 2

What are savings?

Answer 2

-often means the stock of cash products
that you have built up.

-However, sometimes
people refer to a stock of investments as ‘savings’
too.

Question 3

What are investments?

Answer 3

-refer to those assets whose value can go up and down and which are usually bought in the hope of a rise in their value.

-It is a good advice to choose savings for short term
goals and investment for long term goals

Question 4

What is risk?

Answer 4

-refers to the probability of occurrence of an (mostly unfavourable) event.

Question 5

What are the 3 types of risk?

Answer 5

• Capital risk
• Inflation risk
• Shortfall risk

Question 6

What is capital risk?

Answer 6

• the risk that investor may lose some of the invested money

- At the value of the investments can go up and down.

Question 7

What is inflation risk?

Answer 7

Losing buying power because of rising prices.

Question 8

What is shortfall risk?

Answer 8

-the risk you might fail to reach your
goal because the return you are getting on
investment is too low

Question 9

How to reduce inflation and shortfall risk?

Answer 9

• The investor needs a higher return
• Taking on a higher return increase capital risk

-A higher return reduces inflation risk but
increases capital risk

Question 10

Low risk and high risk returns

Answer 10

• Low risk, low rewards
• High risk, high reward
• Capital risk

Question 11

How are attitudes towards risk assessed?

Answer 11

Psychometric risk profiling assessments are a useful tool.
• The aim of these tests is to assess how much risk they
might be willing to take given their goals and how
comfortable they feel about capital risk.

• Risk profiling tests produce a report which includes a
risk score.

• The higher the score, the more risk the investor is
comfortable to take.

• Purpose is to match investors risk profile with their goal

Question 12

Capacity for loss

Answer 12

-The need for income or financial goals
determine capacity for loss

• A person who needs a regular income every
month to sustain monthly living expenses will
prefer a low risk low return savings account
rather than a high risk investment.

• A person with no immediate need for cash
may invest in a highly risky venture.

Question 13

4 asset classes

Answer 13

– Cash
– Fixed-interest / Bonds
– Property
– Equities

Question 14

Cash as an asset class

Answer 14

-Cash includes various cash products used for
savings. It also includes money market
products.

• Money market: Banks lend cash to each other
in money market.

• Examples include saving accounts, notice
accounts, Individual Saving Accounts.

Question 15

What are fixed-interest/bonds?

Answer 15

Fixed-interest investments actually represent loans from investors to either the government or companies.

-Government bonds: issued by government and also
called gilts. UK Government bonds are considered to
have low risk because they are issued by UK
government which is very unlikely to default. This may
not be true for all countries’ governments.

-Corporate bonds: Issued by companies. They carry
relatively higher risk as they are not as safe as
government bond.

-The lender (investor) will eventually get the money back and in the mean time receives interest.

Question 16

The problems with fixed-interest/bonds?

Answer 16

Fixed-interest securities also involve capital
risk due to fluctuations in their stock-market
price. However, they have low risk compared
to shares/stock.

• Their value fluctuates considerably especially
during periods of interest-rate volatility and
inflation

Question 17

What are bonds?

Answer 17

-When you buy a bond, you are lending money to the government or company that issued the bond, and in return, the government or company that issued the bond is agreeing to pay your money back, with interest, at some point in the future.

Question 18

Property as an asset class

Answer 18

-commercial property, for example an office, retail including shops and retail parks, and industrial property such as factories and warehouses

-An advantage of commercial property in the UK is that it
gives a relatively stable return from rental income.

• There is also a possibility of profit/loss when property is sold.

• Private investors do not normally invest directly in a
commercial property. They normally buy shares of a
property company.

Question 19

What is the drawback of property company?

Answer 19

-The main drawback of property company is that, if it needs to be sold, it can be illiquid. So investors will have to wait a long time before they can get their money back

Question 20

Equities/shares as an asset class

Answer 20

-Equities are shares in companies
• By buying a share investor becomes a part-owner
of the company along with all other shareholders.
• You can invest either by buying new shares when
they are first issued or existing shares through
the stock market.
• Unlike corporate bonds, this is not a loan. You are
rather buying a portion of the company’s assets

-Shares can be sold on stock market.
• You can make a profit or loss by sale of shares.
• The company may pay a profit to shareholders
if it makes a profit. However, there is no
guarantee that dividends will be paid. The
amount of dividends can go up or down

Question 21

Risks with equities

Answer 21

-Equities fluctuate in relation to supply and demand.

Question 22

The purpose of building a portfolio

Answer 22

All money could simply be put in one asset class.

• However, it will expose to a lot of risk in case of a
down in the market for that particular asset class.

• Asset Allocation: Risk can be managed effectively
by building a portfolio that combines different asset
classes.

• Cash and fixed-interest securities provide a hedge
through their low risk, while equities and property
brings excessive returns.

-Thus diversify.

Question 23

What is dynamic diversification?

Answer 23

-A shift in the asset allocation in response to changing economic and financial conditions.

Question 24

Behavioural finance

Answer 24

-Research suggests that people do not always
make rational decisions, but are driven by their
emotions and frequently rely on short-cuts and
rules of thumb.

-This characteristic of investors influences financial markets.

Question 25

The types of biases which are particularly influential in investment markets

Answer 25

-Herd Behaviour: Following what others are doing.

– Hot Hand fallacy: Assumption that winners of the past will always win.

Question 26

What are the different types of investment strategies?

Answer 26

• Rules of thumb
• Rebalancing
• Active vs passive investing
• Pound cost averaging

Question 27

What is rule of thumb as an investment strategy?

Answer 27

• Using rules of thumb rather than processing
  data rationally.

• Even financial analytics use such rules of thumb in the beginning of their financial decision making through showing people the effect on different investment strategies i.e.low, medium and high risk.

Question 28

What is rebalancing as an investment strategy?

Answer 28

An investor following traditional approach to asset allocation will want to maintain the same allocation
over time.

• However, without regular adjustment, the make up of
the portfolios will change.

• High risk investments grow at a rapid rate, while low risk investments grow steadily. So the proportion of high risk investments increases in portfolio.
• A periodic review of portfolio will be necessary to revert back to original asset allocation and level of risk.

Question 29

What is active versus passive investing as an investment strategy?

Answer 29

Active investing- involving
ongoing buying and selling actions by the
investor. Active investors purchase investments and
continuously monitor their activity in order to
exploit profitable conditions.

-Passive investing: Passive investing methods seek to avoid the fees and limited performance that may occur with frequent trading. Passive investing’s goal is to build wealth gradually. Reap the benefits

Question 30

What is pound-cost averaging?

Answer 30

-Pound Cost Averaging: involves investing
relatively small fixed sum of money in a very
regular way. The purpose is to smooth out the impact of highs and lows in the price of an investment.

• This technique reduces the risk of investing at
the worst time, though it equally reduces the
chance of investing at the best time.

Question 31

Taxes on investments

Answer 31

-Taxes are to be paid on income and gains
including those from your savings and
investments.

• Wealth taxes are levied annually on wealth or in
inheritance.

• Government may provide some tax incentives for
promoting investment in certain growing
business sectors.

Question 32

Charges on investments

Answer 32

-There is a myriad of charges on investments, not
all of which are openly disclosed despite
regulations designed to improve the transparency
of charging.

• It is important for investors to be aware about full
effect of charges on investments, which can be
large especially over the longer run.

• The higher the charges, the harder your
investment will have to work to achieve your
financial goals.

Question 33

Types of charges on investmets

Answer 33

Annual Management charges: This pays for the investment
management and is typically higher for active funds than
for passive funds.

• Fund administration charges: including the costs forholding the investments safely, paying for regulation,
valuation of fund’s investments etc.

• Some charges are incurred on a one off basis

• Platform fees: Costs incurred in provision of an online platform for management of funds. It may include a regular fee along with transaction charges (to be paid on each
transaction)