Section 1 Chapter 2: Investment Management Flashcards
What is the main focus of investment management in government?
Using available cash to generate income until the cash is needed for operating or other purposes.
Why do governments have available cash?
- The receive large amounts of cash from tax collections and other sources periodically.
- Pension plans, endowment funds, and other fiduciary activities frequently receive contributions and other large sums of monies that will be needed to meet various obligations.
Tax Reform Act of 1986
Codified and clarified regulations dealing with arbitrage by state and local governments.
- Controls virtually every form of debt financing by state and local governments.
Elements of Investing
- Safety (Risk avoidance)
- Liquidity
- Yield
Risk Types
- Safety Risk
- Credit Risk (Default Risk)
- Custodial Credit Risk
- Market Risk
- Interest Rate Risk
- Currency Risk
- Political Risk
Credit Risk
- Risk that the investment will not be paid back.
- Also called default risk.
Market Risk
Risk that the investments will lose money based on the daily fluctuations of the market.
Interest Rate Risk
The risk that a fixed income security’s value will change due to an adjustment in the interest rates. A type of market risk.
Currency Risk
Risk that the value of a foreign currency will fluctuate against the US dollar.
Political Risk
Risk that investments may be adversely affected by nationalization, taxation, war, government instability, or other economic or political actions or factors.
What is Liquidity?
The ease with which financial assets can be converted to cash without suffering from a substantial change in price or value.
What are the most liquid investments?
Money market funds and interest bearing checking accounts.
What is Yield?
The dividend or interest paid by a company expressed as a percentage of the current price.
Yield to Maturity
The total return received on a bond, note, or other fixed income security if the investment is bought and held to its maturity date.
Total Return
A performance measure that takes into account all three components of an investment’s performance - income, capital gains, and price appreciation over time.
Types of Investment Instruments
- Fixed Income Securities
- Short Term
- Long Term
- Equity Securities
- International Securities
- Alternative Investments
- Other Investments
Commercial Paper
Unsecured short-term promissory notes that are used by companies to obtain cash.
Certificate of Deposit
A fixed income security that pays a fixed rate of interest for a specific period of time with a penalty for early withdrawal.
Banker’s Acceptance
Draft drawn by corporate borrowers, and guaranteed (for a fee) by banks, to raise money against future production or sale of goods.
Repurchase Agreements
Short Term (usually overnight) loans.
Short Term Mutual Funds
Offer investors the opportunity to pool money with other investors with similar investment objectives.
Short Term Investment Funds
Large financial institutions and many states (or other large governments) offer pooled short-term investments. Daily basis.
Bond
Debt certificates issued by corporations or governments. The issuer of the bond promises to pay the bondholder a specific amount of interest for a specific length of time. On the maturity date, the loan is repaid. (Long Term)
Debenture
Debt certificate. Backed only by the general credit of the issuer, not its assets. Generally pays a higher rate. (Long Term)
Zero Coupon Bonds
Fixed income securities that do not make interest payments each year like regular bonds. (Long Term)
Separate Trading of Registered Interest and Principal of Securities (STRIPS)
A book entry system operated by the Federal Reserve permitting separate trading and ownership of the principal and coupon portions of selected Treasury securities. This in effect creates zero-coupon Treasury securities from designated whole bonds. (Long Term)
Equity Securities
Often referred to as stocks, equities securities represent and ownership in a corporation.
Mutual Funds
Also called stock funds, they are funds that invest primarily in equities.
Index Funds
Funds that attempt to match the performance of a particular index. The objective is to mirror an index, rather than beat it.
American Depository Receipt
Negotiable registered certificates, issued in the U.S. market, and are evidence of title to non-U.S. investments.
Yankee Bonds
Foreign bonds denominated in U.S. dollars and issued in the United States by foreign banks and corporations.
Alternative Investments
Because of their risk and lack of liquidity, the are appropriate only for entities that can afford a small loss in order to have the opportunity for a sizeable return. Namely, large pension and endowment funds.
Private Equity or Venture Capital
Money provided by investors to privately held companies with perceived long-term growth potential.
Private Equity / Venture Capital Types
- Buyout or takeover investing: Direct purchase of companies with potential.
- Mezzanine investing: Lending money above the amount loaned by financial institutions.
- Fund of fund investing: Investing in a fund that invests in multiple venture capital funds
- Investments of secondary holding: Private equity sold on secondary markets.
Real Estate Investment Trust (REIT)
A corporation or trust that uses the pooled capital of many investors to purchase and manage income property (equity REIT) and/or mortgage loans (mortgage REIT).
Hedge Funds
Similar to mutual funds, except the fund manage is authorized to invest in derivatives and borrow to provide a higher return.
Derivatives
Financial instruments, traded on or off exchange, the price of which is directly dependent upon (“derived from”) the value of a traditional security, asset, or market index.
Most common types of derivatives
- Futures contracts
- Foreign exchange contracts
- Forward contracts
- Interest rate swaps
- Options
Diversification Areas
- Asset allocation (Type of investment)
- Sectors (Financial services, oil and gas, etc.)
- Companies
-Countries
Prudent Person Rule
Those with responsibility to invest for others should act with prudence, discretion, intelligence, and regard for the safety of capital as well as income. (1830, Judge Samuel Putnam)
Brokers
Arrange for the purchase or sale of the investments.
Market Exchanges
Developed in the U.S. to facilitate the sale or purchase of securities.
NASDAQ
National Association of Securities Dealers Automated Quotation; computerized information system that facilitates trading and provides brokers, dealers, and others price quotations on securities traded over the counter.
Depository Trust Company System
DTC. Central repository, through which, members electronically settle trades in corporate, mortgage backed, and municipal securities, and electronically transfer the security certificates.
