Week 4/5 Lecture 4 Investment Decision

Question 1

Defensive and Aggressive Investors

Answer 1

Defensive investors: Are more risk-averse and are focused on preserving capital

Aggressive investors: Have more tolerance towards risk and focus on capital growth

Question 2

Standard Deviation

Answer 2

A measure applied to the annual rate of return of an investment to measure the investment volatility, it is a measure of risk that an investment will not meet the expected return in a given period. Every time you buy a stock or mutual fund, you’re weighing its expected return and risk. The smaller an investments SD, the less volatile (hence risky) it is and the larger the SD, the more dispersed those returns are and thus riskier the investment is.

Question 3

Diversification

Answer 3

Portfolio risk is not simply a weighted average of the standard deviation of individual shares in the portfolio. Weights used are not simply the fraction of the total portfolio invested in each share. It is necessary to understand the concept of correlation between the returns on shares, correlation is the relationship between the return of one share compared to the other share.

Question 4

Correlation coefficient

Answer 4

The correlation coefficient shows the extent of correlation amount shares. It has a numerical value of -1 to +1 which indicates the extent of risk reduction within a portfolio.

Negative correlation means large risk reduction
Positive correlation means no risk reduction

On average the correlation coefficient for returns on two randomly selected shares would be in the range of +0.5 to +0.7

Question 5

Nominal vs real cash rate

Answer 5

Nominal cash flow is the true dollar amount of future revenues the company expects to receive and expenses it expects to pay out without any adjustments for inflation.

Real cash flow is adjusted for inflation in order to reflect the change in the value of money over time.

Question 6

Money market and capital market

Answer 6

Both the money market and the capital market are the two different types of the financial markets where in the money market it used for the purpose of short term borrowing and lending whereas the capital market is used for the long term assets.

Money market: markets generally deals in promissory notes, bulls of exchange, commercial paper, T bills, call money etc

Capital market: capital market deals in equity shares, debentures, bonds, preference shares etc.

Question 7

Fixed interest investments

Answer 7

Term deposits: from one month to several years are available from ADIS

Commercial bills: are visually of 90-180 days duration and are often provided by banks in return for a facilitation fee

Corporate bonds or debentures: are long term securities that pay regular interest at fixed rates on their face value, they are usually secured over a group of assets that need by the issuer.

Question 8

Primary market and secondary market

Answer 8

The primary market: is where securities are created, it is in this market that firms sell (float) new stocks and bonds to the public for the first time. An initial public offering. These trades provide an opportunity for investors to buy securities from the bank that did the initial underwriting for a particular stock. The IPO occurs when a private company issues stick to the public for the first time.

Secondary market: commonly referred to as the stock market. The defining characteristic of the secondary market is that investors trade aiming themselves.

Question 9

Security

Answer 9

Security, in a financial context, is a certificate or other financial instrument that has monetary value and can be traded. security is generally classified as equity (stock) security and debt security (bonds and debentures).

First, we will consider the bonds that do not pay a coupon or interest payment but are referred to as discount securities.

Second, we need to consider the form of fixed-interest security that pays a coupon or interest payment at predetermined times. These are known as coupon securities.

Question 10

Shares

Answer 10

Fraction ownership of a company. Shares are generally high risk and return and therefore suitable for long term investors. In the long term, Australian shares have provided long term growth well above inflation. Returns can be both capital growth and dividends

Question 11

Fundamental analysis

Answer 11

Uses objective measures to analyse a company’s current financial situation. It also attempts to forecast the effects of future events on those measures.
E.g. risk analysis/market valuation

Question 12

Technical analysis

Answer 12

More concerned with how recent market perception of the worth of investment has been translated into market prices.
E.g. graph to identify patterns and trends that are expected to reproduce in the future.

Question 13

Price Earning ratio P/E Ratio

Answer 13

The ratio for valuing a company that measures its current share price relative to its per-share earnings (EPS).
P/E = price per share / earnings per share
Shows the return on investment (ROI) for shares.

Question 14

Property investment

• Direct ownership
• Indirect ownership

Answer 14

Direct Ownership: registered on the title of the property

Indirect Ownership: increasing the proportion of property held by managed funds.

Question 15

Managed funds

Answer 15

One type of managed investment scheme. in a managed fund your money is pulled together with other investors and an investment manager will buy and sell shares or other assets on your behalf.

Question 16

Managed funds

Answer 16

One type of managed investment scheme. in a managed fund your money is pulled together with other investors and an investment manager will buy and sell shares or other assets on your behalf. 
Example:
- Superannuation fund
- Public unit trusts
- Managed investment schemes

Question 17

Advantages and Disadvantages of managed funds

Answer 17

Advantages:

• Provide investors with greater choice of assets than direct investing
• Can access a broad range of assets or markets with a relatively small amount of cash
• Effectively buy the expertise of the fund manager

Disadvantages:

• May be charged higher fees than other investment types
• may not be able to convert the investment to cash when you want to.
• You rely on the skills of other people and do not control investment decisions

Question 18

Indirect cost ratio

Answer 18

Is an estimate of the costs for investing in the funds assets which are deducted from investment rather than paid directly by the fund. It varies from 0.1% to 3 percent. Sometimes referred to management cost.

Question 19

Unlisted managed fund

Answer 19

Unlisted:
means that they are not directly traded on ASX. Instead purchase and sales of units in the fund are made between the investor and the managed fund issuers unit registry. Investors do not trade units with other investors rather the process is facilitated by a settlement system owned by ASX. Price of units is set by the fund managers.
Net asset value = fund assets - fund liabilities / number of units issued.

Listed managed funds: investors buy or sell units or share on the ASX

Question 20

Active and passive management style

Answer 20

Active equity portfolio management:
- attempts to outperform a benchmark portfolio or widely publicised index. Involves regular trading of assets within the fund to establish the best asset mix for current and projected market conditions.

Passive management style:
- attempts to replicate a benchmark or widely publicised index rather than attempt to outperform it.  Long term buy and hold strategy. The performance of managed fund is determined by the asset class invested in.