Chapter One – Basic Information and Infrastructure Description
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The Investment Process
 Is a set of guidelines required to create the portfolio and sequence of actions involved, from
defining the risk parameters to asset allocations.
 It gives a structure to the investor who helps him implement the strategy customized as per
his goals, objectives, risk tolerance and values that seek to manage risk.
Steps Involved in Investment Process
 Understanding the client involves gathering comprehensive information about the
investor’s financial situation, goals, risk tolerance and preferences.
 Asset allocation decision this step involves decision on how to allocate the investment
across different asset classes, i.e. fixed income securities, equity, real estate etc.
 Select the proper strategy of portfolio creation choosing the right strategy for portfolio
creation is very important as it forms the basis of selecting the assets that will be added in
the portfolio management process.
 Asset selection decision the process of choosing specific investments within each asset
class to include in a portfolio.
 Evaluating portfolio performance this is an important investing process step as it
measures the performance of the investment with respect to a benchmark, in both absolute
and relative terms.
Two Types of Portfolio Strategy
 Passive Management Process refers to the strategy where the purpose is to generate
returns equal to that of the market.
 Active Management Process refers to a strategy where the objective of investing is to
outperform the market return compared to a specific benchmark by either buying securities
that are undervalued or by short selling securities that are overvalued.
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Financial Market Participants and their roles
Financial Markets
 Are a type of marketplace that provides an avenue for the sale and purchase of assets
such as bonds, stocks, foreign exchange and derivatives.
Importance of Financial Markets
 Fair and proper treatment they offer platforms where big companies and regular folks
can invest and borrow money, giving everyone a chance to grow their wealth and
participate in the economy.
 Lower the unemployment rate this helps businesses expand and create more jobs which
means less unemployment and more opportunities for everyone.
 They provide access to capital the financial market is like a lending library where you
can borrow money to build your business.
Main Participants and Their Roles
 Investors is any person or other entity (such as a firm or mutual fund). Investors are those
who purchase shares of a company for the long term with the belief that the company has
strong future prospects.
 Brokers only brokers approved by Capital Market Regulator can operate on stock
exchange. Brokers perform the job of intermediating between buyers and seller of
securities.
 Financial Institutions raise money by issuing long-term bonds and other international
sources and lend to key sectors like agriculture, small industries, housing development,
etc. Financial Institution provide/lend long term funds for industry.
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Regulators financial regulators are in charge of overseeing financial markets to help them
fair and stable. They enforce rules and regulation to protect investors and maintain market
integrity.
Government the largest borrower in the system. It not only collects taxes but also borrows
by issuing bonds to fund development and infrastructure projects. It is the largest issuer of
bonds to which other market participants subscribe.
Borrowers borrow funds from lenders in financial markets by selling those securities
(financial instruments).
Chapter Two – Investment Instruments
Investment Instruments
 Also known as financial instruments, represents any type of financial arrangement that
provides the holder or recipient with the promise of earning some return from that
investment.
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Time value of money
 Is a financial concept that holds that the value of a dollar today is worth more than the value
of a dollar in the future.
 Future value of money refers to the value of the current asset at a future date based on
an assumed growth rate.
 Present value of money refers to the current value of a future amount of money, or a
series of payments, evaluated at an appropriate discount rate.
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Money Market Instruments
 Are short term financing instruments aiming to increase the financial liquidity of businesses.
These instruments are highly liquid and considered safe investments, making them popular
for parking excess cash or meeting short-term financial needs.
Types of Money Market Instrument
 Treasury bills these are financial instruments with highly stable marketability and issued
by the Philippine government.
 Commercial Paper is a short term promissory note issued by a large, established business
firm with a strong credit rating.
 Repurchase agreements involves the temporary sale of high quality, easily liquidated
assets.
 Certificate of deposits time deposits offered by banks that pay a fixed interest rate over
a specified term.
 Certificate of assignment it is an agreement that transfers the right of the seller over a
security in favor of the buyer.
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Bond Market Instruments
 Is any financial tool used to raise capital. It allows capital to be transferred from savers or
investors to issuers who want funds for projects or other operations.
Types of Bond Market Instruments
 Corporate bonds is a bond issued by a corporation in order to raise financing for a variety
of reasons such as to ongoing operations, mergers and acquisitions, or to expand
business.
 Municipal bonds are financial securities issued by municipalities, states, and other
governmental organizations to fund public works projects.
 Government bonds are a financial instrument that a governments and their agencies use
to obtain funds to support their operations.
 Emerging market bonds are debt securities issued by governments, businesses, and
other organizations in developing or underdeveloped nations.
 Mortgage-backed bonds are debt securities secured by a pool of mortgages and primarily
issued by government-sponsored enterprises.
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Share Market Instruments
 Refer to various financial assets traded on stock exchanges. It is a marketplace where
trading of shares of public listed companies is carried out daily.
Types of Share Market Instruments
 Equities represent ownership in a company. When you buy shares of a company’s stock,
you become a partial owner of that company.
 Debt securities represent loans made by investors to governments or corporations.
 Mutual funds pool money from multiple investors to invest in a diversified portfolio of
securities such as stocks, bonds, or other assets.
 Exchange traded fund it is similar to mutual funds in that they hold a diversified portfolio
of assets, but they are traded on stock exchanges like individuals stocks.
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Derivative Market Instruments
 Is a financial instrument whose value or performance is derived from or reliant on the
fluctuations of the value of an underlying group of assets such as commodities, bonds,
stocks, currencies, interest rates, and stock market indices.
Types of Derivative Market Instruments
 Options are financial derivative contracts that give the buyer the right, but not the
obligation, to buy or sell an underlying asset at a specific price during a specific period of
time.
o Call options are typically used by investors who anticipate that the price of the
underlying asset will rise.
o Put options are typically used by investors who anticipate that the price of the
underlying asset will fall.
 Futures contracts are standardized contracts that allow the holder of the contract to buy
or sell the respective underlying asset at an agreed price on a specific date.
 Forwards contracts are similar to futures contracts in the sense that the holder of the
contract possesses not only the right but is also under the obligation to carry out the
contract as agreed.
 Swaps are derivative contracts that involve two holders, or parties to the contract, to
exchange financial obligations.
o Interest rate swap is a financial derivative contract between two parties to
exchange interest rate cash flows.
o Credit default swap is a financial derivative contract that allow an investor to
hedge against the risk of default on particular debt obligation.
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Real Investment
 Refers to money that is invested in tangible and productive assets, such as machinery,
land, or factories. Unlike investments in securities or other financial instruments, real assets
have intrinsic value by themselves.
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Investment Vehicle
 Describes a financial instrument or commodity as an asset, which helps investors choose
the best-fit investment strategies that fit them with the expectation of gaining returns in the
future as income and capital gains.
Two Categories of Investment Vehicle
 Direct investments are specific asset class holdings or securities that generate an
investment return. Examples of direct investments include stocks, bonds, or rental real
estate.
 Indirect investments are investment vehicles that hold direct investments selected by
professional portfolio managers. Investors pay the portfolio managers a management fee
to choose and monitor direct investments.
o Indirect investment Public are exchange traded funds (ETFs), real estate
investment trusts (REITs), mutual funds and closed-end fund.
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Indirect investment Private are hedge fund, private real estate investment trusts,
venture capital and leverage buyouts.
Foreign Investments
 Involves capital flows from one country to another, granting the foreign investors extensive
ownership stakes in domestic companies and assets.
Two Types of Foreign Investment
 Foreign direct investments are physical investments and purchases made by a company
in a foreign country, typically by opening plants and buying buildings, machines, factories,
and other equipment in the foreign country.
 Foreign indirect investments involve corporations, financial institutions, and private
investors buying stakes or positions in foreign companies that trade on a foreign stock
exchange (Foreign portfolio investment).
Chapter Three – Investment Principles
Investment Principles
 Are guidelines or rules that investors follow when making decisions about where to allocate
their capital.
 This principles help investor manage risk, maximize returns, and achieve their financial
goals.
Common Investment Principles
 Risk management is the process of identification, analysis, and acceptance or mitigation
of uncertainty in investment decisions.
 Diversification is spreading investments across different asset classes and within each
asset class to reduce overall portfolio risk.
 Asset allocation is allocating investments among different asset classes such as stocks,
bonds, real estate based on risk tolerance, investment goals, and market conditions.
 Cost management is minimizing investment costs, including fees, commissions, and taxes
to maximize net returns.
 Liquidity management is ensuring that investment can be easily converted into cash
without significant loss of value.
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Risk-free rates
 Is the certainty that an actual outcome will not differ from the expected outcome. It serves
as a benchmark against which other investment returns are compared. Typically, the riskfree rate is associated with the return on a government bond, specifically a short-term
government bond issued by a financially stable government.
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Investment Environment
 Refers to the factors and conditions that influence investment decisions and outcomes.
Understanding the investment environment is crucial for making informed investment
decisions and maximizing returns.
Factors Influencing the Investment Environment
 Cost of capital the cost of acquiring funds for investment.
 Duration of investment the time period for which the investment will be held.
 Probability of success/failure the likelihood of the investment yielding positive or
negative outcomes.
 Regulatory environment the laws and regulations that govern investment activities.
 Macroeconomic outlooks the overall economic conditions that can impact investment
performance.
 Competitive landscapes the level of competition in the market and its impact on
investment opportunities.
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Technological changes the advancements in technology that can create new investment
opportunities.
Fiscal incentives tax reductions, grants, and subsidies that can influence investment
decisions.
Market forecasts short and long term predictions about market trends and potential
returns.
Cash flow budget the analysis of cash flows that helps in selecting the desired investment
project.
Risk and Return
 The concept of risk and return in finance is an analysis of the likelihood of challenges
involved in investing while measuring the returns from the same investment. The
underlying principle is that high-risk investments give better returns to investors and
vice versa.
 However, high-risk investments do not always generate higher revenue. That is
precisely the high risk involved in investing.
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Risk defined as the uncertainty related to the investment, market, or company. It is the
probability of losing a certain amount of an investment over a given period or the return
volatility of an investment over a given period of time.
Two Types of Risks
o Security-specific risk or unsystematic risk is the danger of losing money on an
investment because of a business or sector-specific hazard (business, financial and
liquidity risks).
o Market risk or systematic risk this type of risk impacts everything as it is made up of
risk that are inherent in the financial and economic systems (changes in interest rates,
taxes and inflation).
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Return is usually presented as a percentage relative to the original investment over a given
period. It can be the financial gains from investing in a certain investment. An investment
return can come in a wide range of forms, including capital gains, interest, dividends, or
rental income in the case of real estate.
Investment theories and maxims
 Accelerator Theory of Investment it stipulates that capital investment outlay is a function
of output. When faced with excess demand, the accelerator theory posits that companies
typically choose to increase investment to meet their capital-to-output ratio, thereby
increasing profits.
 Internal Funds Theory of Investment postulates that the profit level determines the
required capital stock. According to this, investment strongly correlates with expected
profits, suggesting that investment depends positively on realized profits.
 Neoclassical Theory of Investment it states that output and the cost of capital services
(cost of capital goods, interest rate, and corporate income taxation) about the cost of output
determine the desirable capital stock.
Chapter Four – Systematic Portfolio Management
Portfolio Management
 The goal of portfolio management is to assemble various securities and other assets into
portfolios that address investor needs and then to manage those portfolios so as to achieve
investment objectives. The investor’s needs are defined in terms of risk, and the portfolio
manager maximizes return for investment risk undertaken.
Systematic Portfolio Management
 Refers to the process of managing an investment portfolio using a systematic and
disciplined approach.
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Involves using predetermined rules and quantitative techniques to make investment
decisions within a portfolio.
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Investment Managers
 Is an individual or organizations who handle activities that are related to financial planning,
investing, and managing a portfolio for their clients.
 Is a professional who is responsible for managing the assets of individuals or institutions
in order to achieve their financial goals. These goals may include maximizing returns,
minimizing risk, or achieving a specific level of income.
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Forces for Change
 Refer to the factors or influences that drive and shape change within organizations,
societies, or industries.
 Refer to factors or influences that influence modifications or improvements in portfolio
management.
o Theoretical breakthroughs a significant advancement or innovation in financial
theories that can influence how investment portfolios are constructed, managed, and
optimized (research, academic studies and innovative thinking).
o Development of data bases improved data infrastructure enables systematic portfolio
managers to efficiently gather, process, and analyze large datasets (Quick Access to
Information, Enhancing Analysis and Decision Making).
o Tools of Analysis encompass the software and technologies that enable
organizations to analyze and interpret data effectively
 Additional forces for change
o Technological advancements technology makes managing investment easier and
more reliable by helping us analyze data faster, trade automatically, understand and
manage risks better.
o Regulatory changes imposed by governing bodies can necessitate adjustment in
portfolio management strategies to ensure compliance and mitigate legal risks.
o Market volatility period of increased market volatility can necessitate revisions to
portfolio management strategies to protect against sudden downturns and capitalize
on emerging opportunities.
o Global economic trends shifts in global economic conditions, such as changes in
interest rates, inflation rates, or geopolitical events, can impact asset prices and require
adjustments in portfolio allocations.
o Demographic shifts changes in demographic trends, such as population aging or
shifts in income distribution, can influence investment preferences and risk profiles.
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Theory and Application
Traditional Approach Theories
 Dow Jones Theory the basis of this theory is a hypothesis by Charles Dow. According to
him, the stock market movements are not random. They determine the current status of
the market and where it will go in the near future.
o Primary movements the primary trend is the overall direction of the market, which
can last for several years.
o Secondary movements it is a short-term fluctuation which can last for several
months.
o Minor movements the minor movements trend which can last for several days
 Random Walk Theory Economists had long argued that asset prices were essentially
random and unpredictable and that past price action had little or no influence on future
changes. By accepting that stock prices are unpredictable and efficient, investors can focus
on long-term planning and avoid making rash decisions based on short-term market
movements.
 Formula Plans are mechanical revision procedures and techniques to minimize losses for
investors. Their main goal is not to maximize profits and returns. These techniques assist
the investors in buying securities when they are at low prices and later selling them when
they are at a higher price.
Modern Approach Theories
 Harry Markowitz’s Modern Portfolio Management Theory focuses on the relationship
between assets in a portfolio in addition to the individual risk that each asset carries. It is a
method for portfolio management to reduce risk.
 Single Index Model is a financial model that investors use to analyze the risk and return
characteristics of individual securities in a portfolio. It aims to measure a stock’s risk and
return.
 Capital Asset Pricing Model helps to correctly price the securities in the capital market,
keeping in mind their risk as well as the cost of capital. The theory assumes that there will
be no change in the risk-free rate in the near future.
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Tools of Analysis
 Holding period return it calculates the overall return during the investment holding
period.
 Arithmetic mean it calculates the average returns of the overall portfolio. The average
return tells an investor or analyst what the returns for a stock or security have been in the
past, or what the returns of a portfolio of companies are.
 Sharpe ratio it helps investors to identify the risk level and adjusted return rate of all
mutual funds. This gives a clear picture to the investors, and they get to know if the risk
they take is giving good returns or not.
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Risk Return Trade-off
 Probability that actual return will be different from the expected return (high or low).
 The tradeoff is the proportional increase/decrease of returns to an increase/decrease in
risk (high risk = high return, low risk = low return).
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Market Efficiency
 Refers to the degree to which market prices reflect all available, relevant information.
Forms of Market Efficiency
 Strong form all information, public and private
 Semi strong form all publicly available information
 Weak form market data