✓
~ •- · PART I: Introduction
■
Goals
■ Clearly define financial goals
■ Time horizon for·each
■
Buckets
■
Examples
■ Divide your financial needs into buckets to be filled with
money you earn
■
■
■
■
■
Debt
■
■
■
■
■
Emergency fund
College
Retirement
Buy property
Be careful in taking debt (see rule below)
Debt means compounding is working against you
Eliminate Credit card debt
Do not invest with borrowed money
Rule:
■
■
■
Borrow only for long lived assets
Home, education
NOT for consumables
Savings Plan
~ PART I: Introduction
■
Goals
■
Clearly define financial goals
■ Time horizon for -each
■
Buckets
■
■
Divide your financial needs into buckets to be filled with
money you earn
Examples
Emergency fund
■ College
■ Retirement
■ Buy property
a
■
Debt
■ Be careful in taking debt (see rule below)
■ Debt means compounding is working against you
■ Eliminate Credit Card debt
■ Do not invest with borrowed money
■
Rule:
■ Borrow only for long lived assets
■ Home, education
■ NOT for consumables
Savings Plan
Compounding
■ The magic of compounding
■ What is compounding?
11
Time is your ally
• Starting early means less savings to get to goal
(see handout)
■ Note that unnecessary debt means that
compounding works against you
-~ Incentives
■
Many individuals you may interact with in the
financial arena
■
Have different incentives and agendas
■
■
■
■
Fund managers
Corporation executives
Financial planners
Banks
■ Want to get individuals whose incentives are in line
with yours
PART II: Asset Classes
.,.,_ Overview
I. Assets:
■
Cash
11 Bonds
., Stocks
~ A. Asset Allocation
Allocation of wealth
A.
A.
How to allocate your wealth between different assets
a.
This is a strategic decision and crucial to investment
perfomance
c.
Decisions about asset mix has a a much greater influence on
investment results than decisions about specific funds
o.
Source: Brinson, Hood and Beebower: "Determinants of
Portfolio Perfomance" Financial Analysts Journal (1986, 1991)
■
Criteria:
■
■
a
Liquidity
Risk
Return
±B. Liquidity
Liquidity: is the ease with which you can
access your money
Cash is most liquid
Bonds next
equity less liquid
[ what is property?]
C. Returns
1.
Think of returns in annual terms
w
Some funds report cumulative returns
Misleading
al
Annual returns are a better measure
■
Better measure of comparison
■
Useful in calculating how much a lump sum amount would
be worth
Example! : A fund earned 250% over 20 years
Implies annual returns of 6%/year
ia
Example 2: annual returns of 11 %/year results in 706%
cumulative return
■
2. Differences in returns add up over
time
■
■
Recall compounding
See handout
■
3. Dollar amount and percentages
■ Easy rule of thumb: simply translate into dollars
m
a. Example:
■
100% gain: Price goes from $25 to 50
" 50% loss ➔ 50 back to 25.
Note the bigger the fall, the longer the recovery
b. Example 2:
Pay broker 5% sales commission on $10,000
This means pay broker $500
~I~-=Time: Gains and Losses
■
40% Gain at the beginning of investing
career vs. near the end
■
■
■
40% of $800,000 = $320,000
40% of $8,000 = $3200
Losses: Reverse
■
■
40% loss of $8,000
40% loss of $800,000
Moral:
Higher risk when younger/earlier in the investing
career
Lower the risk exposure as one gets closer to the
goal
~ ·Rule of 72
111
72/annual return = # of years for money to double
• The magic of compounding
■
Example!:
■
Want to double in two years
■ What return/year?
■
Example 2:
■
■
Get 10% return/year
How many years for money to double?
Trading Seccurities
■
1. Long:
■ Buying a stock with own money
■
2. Margin
Buying an asset borrowing money
3.Short
-
/ .
-•r; Marg1n
I Investors
have easy access to a source of debt financing called
brokers' call loans.
,I
■
■
■
Taking advantage of the brokers' call loans is called buying on
margin
Process:
■
Investor borrows part of the purchase price of the stock from the
broker
■ The broker borrows money from the banks at the call money rate
to finance the purchases and charges its clients that rate plus a
service charge
11
All securities purchased on margin must be left with brokerage firm
because the securities are used as collateral for the loan.
■
Fed sets margin requirements
■
■
■
Limits on the extent of stock purchases that may be financed by
margin
Currently 50%
Reasons for Margin:
■
Greater upside potential than own money
■ But also Greater downside risk.
Example:
Investor has $10,000.
HSBC current price is $100. No dividends
Suppose HSBC price rises to $130
LONG ONLY rate of return is 30%
■
Margin:
■ Borrows $10,000
Total investment: $20,000
Assume interest rate on margin is 9%
Rate of return:
End of year the shares are worth: $26,000
Paying off $10,900 (principal and interest) leaves: $15,100
1~,100 - 10,000/10,000 = 51 %
Stock price
value Repayment
30% increase $26,000
No change
$10,900
$20,000
10,900
30°/o decrease 14,000
10,900
ROR
51°/o
-69
-.,'-'II I II
11\.,,11,
~ 1. Long only vs Leverage returns not
equivalent
■
I
'
~~
- -.l IL
2. Property: Leveraged bet?
SHORT
■
A short sale allows investors to profit from a
decline in a security' s price.
■
Process:
■ An investor borrows a share of stock from a
broker
■ Sells it
■ Later, the short seller must purchase a share of
the same stock in the market: Covering the short
position
/ Shorts: Restrictions
Shares loaned out by brokerage house (from other clients
accounts)
lil
■
Exchange rules:
■
■
■
NYSE: permit short sales only after an uptick
HK: more restrictions
Proceeds from short sales must be kept in brokers account
■
So, short seller cannot invest these funds to generate income
■
Short sellers must post margin (collateral)
■
To ensure that the trader can cover any losses sustained
should the price rise
~ Issues
■
■
■
■
1.
2.
3.
4.
Base currency
Annual vs cumulative
Nominal vs Real returns
Long vs. Leverage
Conclusions
■ 1. Base currency: USD
■
2. Annual returns
■
3. Nominal returns
■
4. Long only
D. Risks
■ Risk: 'likelihood of losing'
■
■
■
■
Cash is least risky
Bonds more than cash
Equity most risky
Skewed attitude towards risk
■
Loss affects people more than gain
■ Check to see how much you are comfortable
losing first
• Standard Deviation (one measure of risk)
• Measures how a f d'
.
return
un s returns have deviated around its average
■
FundYl
■
■
ABC
XYZ
■
R-Squared:
Y2
-5%
+5%
Y3
AR
SD
+10% +25% +10% 15
+10% +15% +10% 5
■ Measures the degree to which a fund's return go up and down at
the same time as the market (an appropriate index)
■ Ranges from 0.00 to 1.00
■ 0: Does not match market movement
■ 1: Exactly matches market movement