Chapter 3 Investment Analysis andPortfolio Management

1、Investment Analysis and Portfolio Management by Frank K. Reilly & Keith C. Brown Selecting Investments in a Global Market The Case for Global Investments Global Investment Choices Historical Risk-Returns on Alternative Investments3-2Growing Investment Opportunities More investment instruments availa

2、ble in the financial markets as a results of technological advances and new regulations Ability to invest from a global perspective thanks to the globalization or integration of domestic and foreign financial markets Investment vehicles with a variety of maturities, risk-return characteristics, and

3、cash flow patterns being spawned due to competition and deregulations in the financial sector3-3The Case for Global Investments Three reasons U.S. investors should think of constructing global investment portfolios Ignoring foreign markets can substantially reduce the investment choices for U.S. inv

4、estors The rates of return on non-U.S. securities often have substantially exceeded those for U.S.-only securities The low correlation between U.S. stock markets and many foreign markets can help to substantially reduce portfolio risk3-4The Case for Global Investments Relative Size of U.S. Financial

5、 Markets Overall value of the securities available in world capital market has increased from $2.3 Trillion in 1969 to $103 Trillion in 2006 and the U.S. portion has declined to less than half. The share of the U.S. in world stock and bond markets has dropped from about 65 percent of the total in 19

6、69 to about 46 percent in 2006. The growing importance of foreign securities in world capital markets is likely to continue. Exhibit 3.1 shows the breakdown of securities in the global capital market. 3-5Exhibit 3.13-6The Case for Global Investments Rates of Return on U.S. and Foreign Securities Glo

7、bal Bond-Market Return: From 19992007, the return performance of the U.S. bond market ranked fifth out of the six countries when the returns are measured in U.S. dollar.The better performance of the non-U.S. markets is partly due to the weakened dollar in this time frameSee Exhibit 3.2 Global Equity

8、-Market ReturnFrom 2003 through 2006, the United States average rank in annual return measured in U.S. dollar was 29.5 out of 34 countries.3-7Exhibit 3.23-8The Case for Global Investments Risk of Combined Country InvestmentsDiversification with foreign securities can help reduce portfolio risk becau

9、se foreign markets have low correlation with U.S. capital markets.The correlation of returns between a single pair of countries changes over time because the factors influencing the correlation change over time.Diversified portfolios reduce variability of returns over time.Correlation coefficients m

10、easure diversification contribution.3-9The Case for Global Investments Global Bond Portfolio Risk Low positive correlation (Exhibit 3.4) For a U.S. investor, the average correlation between foreign bond return and U.S. bond return in U.S. dollars is about 0.63 from 1988 to 2006. The U.S.Canada corre

11、lation is 0.74, whereas the U.S.Japan correlation is only 0.38.Opportunities for U.S. investors to reduce riskCorrelation changes over timeAdding non-correlated foreign bonds to a portfolio of U.S. bonds increases the rate of return and reduces the risk of the portfolio. (Exhibit 3.5)3-10Exhibit 3.4

12、3-11Exhibit 3.53-12The Case for Global Investments Global Equity Portfolio Risk Low positive correlation (Exhibit 3.6) The correlation of world equity markets resembles that for bonds; however, the average correlation between U.S. and foreign markets is about 0.56, lower than that for bonds from 198

13、8 to 2006. Again, the U.S.Canada correlation is 0.73, whereas the U.S.Japan correlation is only 0.34. Opportunities to reduce risk of a stock portfolio by including foreign stocks, as illustrated in Exhibit 3.7.3-13Exhibit 3.63-14Exhibit 3.73-15Global Investment Choices Fixed-Income Investments Bond

14、s and preferred stocks Equity Investments Special Equity Instruments Warrants and options Futures Contracts Investment Companies Real Assets Low Liquidity Investments3-16Fixed-Income Investments Basic concepts of fixed-income investments Contractual payment schedule Recourse varies by instrument Bon

15、ds Investors are lenders Expect interest payment and return of principal Preferred stocks Dividends require board of directors approval3-17Fixed-Income Investments Savings Accounts Fixed earnings Convenient Liquid and low risk Low rates Certificates of Deposit (CDs) Money Market Certificates Compete

16、 against Treasury bills (T-bills) Minimum $10,000 Minimum maturity of six months Redeemable only at bank of issue Penalty if withdrawn before maturity3-18Capital Market Instruments Fixed income obligations that trade in secondary market U.S. Treasury securities U.S. Government agency securities Muni

17、cipal bonds Corporate bonds Secured bonds Debentures Subordinated bonds Income bonds Convertible bonds3-19U.S. Treasury Securities Issued by the U.S. Treasury Depending on the maturity, they are: Bills with a maturity less than 1 year Notes with a maturity in 1 - 10 years Bonds with a maturity over

18、10 years Highly liquid Essentially free of credit risk: They are backed by the full faith and credit of the U.S. Government3-20U.S. Government Agency Securities Sold by government agencies Federal National Mortgage Association (FNMA or Fannie Mae) Federal Home Loan Bank (FHLB) Government National Mo

19、rtgage Association (GNMA or Ginnie Mae) Federal Housing Administration (FHA) Not direct obligations of the Treasury Still considered almost default-free and fairly liquid3-21Municipal Bonds Issued by state and local governments usually to finance infrastructural projects. Exempt from taxation by the

20、 federal government and by the state that issued the bond, provided the investor is a resident of that state. Two types: General obligation bonds (GOs) Revenue bonds3-22Corporate Bonds Basic Concepts Issued by a corporation Fixed income Credit quality measured by ratings Maturity Features Indenture

21、Call provision Sinking fund Seniority categories 3-23Corporate Bonds Secured bonds Senior secured bonds Most senior bonds in capital structure and have the lowest risk of default Mortgage bonds Secured by liens on specific assets Collateral trust bonds Secured by financial assets Equipment trust cer

22、tificates Secured by transportation equipment3-24Corporate Bonds Debentures Unsecured promises to pay interest and principal In case of default, debenture owner can force bankruptcy and claim any unpledged assets to pay off the bonds Subordinated bonds Unsecured like debentures, but holders of these

23、 bonds may claim assets after senior secured and debenture holders claims have been satisfied3-25Corporate Bonds Income bonds Interest payment contingent upon earning sufficient income If subsequently earned, it must be paid off Riskier than debenture bonds Convertible bonds Offer the upside potenti

24、al of common stock and the downside protection of a bond Usually have lower interest rates3-26Corporate Bonds Warrants Allows bondholder to purchase the firms common stock at a fixed price for a given time period Interest rates usually lower on bonds with warrants attached Zero coupon bond Offered a

25、t a deep discount from the face value No interest during the life of the bond, only the principal payment at maturity3-27Preferred Stock Hybrid security Fixed dividends Dividend obligations are not legally binding, but must be voted on by the board of directors to be paid Most preferred stock is cum

26、ulative Credit implications of missing dividends Corporations may exclude 80% of dividend income from taxable income 3-28International Bond Investing Investors should be aware that there is a very substantial fixed income market outside the United States that offers additional opportunity for divers

27、ification and returns. Bond identification characteristics Country of origin Location of primary trading market Home country of the major buyers Currency of the security denomination3-29International Bond Investing Eurobond An international bond denominated in a currency other than the country where

28、 it is issued Yankee bonds Sold in the United States and denominated is U.S. dollars, but issued by foreign corporations or governments Eliminates exchange risk to U.S. investors International domestic bonds Sold by issuer within its own country in that countrys currency3-30Equity Investments Common

29、 Stock Represents ownership of a firm Investors return tied to the performance of the company and may result in loss or gain Common Stock Classifications Industrial: manufacturers of automobiles, machinery, chemicals, beverages Utilities: electrical power companies, gas suppliers, water industry Tra

30、nsportation: airlines, truck lines, railroads Financial: banks, savings and loans, credit unions3-31Acquiring Foreign Equities American Depository Receipts (ADRs) Easiest way to directly acquire foreign shares Certificates of ownership issued by a U.S. bank that represents indirect ownership of a ce

31、rtain number of shares of a specific foreign firm on deposit in a U.S. bank in the firms home country Buy and sell in U.S. dollars Dividends in U.S. dollars May represent multiple shares Listed on U.S. exchanges Very popular, 356 out of 462 on NYSE in 20063-32Acquiring Foreign Equities Purchase of A

32、merican Shares Issued in the United States by transfer agent on behalf of a foreign firm Higher expenses Limited availability Direct Purchase of Foreign Shares In the foreign firms own country Listed on a foreign stock exchange outside the home country (e.g., French firms on LSE) Listed on a U.S. st

33、ock exchange3-33Acquiring Foreign Equities Global Mutual Funds or ETFs Global funds: Invest in both U.S. and foreign stocks International funds: Invest mostly outside the U.S. Funds can specialize Diversification across many countries Concentrate in a segment of the world Concentrate in a specific c

34、ountry Concentrate in types of markets Exchange-traded funds or ETFs are a recent innovation in the world of index products3-34Special Equity Instruments: Options These are equity-derivative securities which have a claim on the common stock of a firm. Options are rights to buy or sell common stock o

35、r other underlying assets at a stated price for a period of time. Puts are options to sell Calls are options to buy Warrants An options issued by a company giving the holders the right to buy its common stock Normally issued with bonds3-35Futures Contracts Exchange of a particular asset at a specifi

36、ed delivery date for a stated price paid at the time of delivery Deposit (10% margin) is made by buyer at contract to protect the seller Commodities trading is largely in futures contracts Current price depends on expectations3-36Futures Contracts Financial Futures Recent development of contracts on

37、 financial instruments such as T-bills, Treasury bonds, and Eurobonds Traded mostly on Chicago Mercantile Exchange (CME) and Chicago Board of Trade (CBOT) Allow investors and portfolio managers to protect against volatile interest rates Currency futures allow protection against changes in exchange r

38、ates Various stock futures on market indexes such as the S&P 500 and Value Line Index3-37Investment Companies Rather than buy individual securities directly from the issuer they can be acquired indirectly through shares in an investment company Investment companies sell shares in itself and uses pro

39、ceeds to buy securities Investors own part of the portfolio of investments3-38Investment Companies Money Market Funds Acquire high-quality, short-term investments Yields are higher than normal bank CDs Typical minimum investment is $1,000 No sales commission charges Withdrawal is by check with no pe

40、nalty Investments usually are not insured The total value of these funds reached more than $2.5 trillion in 20073-39Investment Companies Bond Funds Invest in long-term government, corporate, or municipal bonds Bond funds vary in bond quality from the risk-free government bonds to the high-yield or j

41、unk bonds Expected returns also differ reflecting the risk level of bonds in the fund3-40Investment Companies Common Stock Funds Many different funds with varying stated investment objectives Aggressive growth, income, precious metals, international stocks Offer diversification to smaller investors

42、Sector funds concentrate in an industry International funds invest outside the United States Global funds invest in the U.S. and other countries3-41Investment Companies Balanced Funds Invest in a combination of stocks and bonds depending on their stated objectives Index Funds These are mutual funds

43、created to track the performance of a market index like the S&P 500 Appeal to passive investors who want to simply experience returns equal to some market index Numerous non-stock indexes including various bond indexes have been created3-42Investment Companies Exchange-Traded Funds (ETFs) These are

44、depository receipts for a portfolio of securities deposited at a financial institution in a unit trust that issues a certificate of ownership for the portfolio of stocks The stocks in a portfolio are those in an index like the S&P 500 and dozens of country or industry indexes ETFs can be bought and

45、sold continuously on an exchange like common stock3-43Real Estate Real Estate Investment Trusts (REITs) Investment fund that invests in a variety of real estate properties, similar to a stock or bond mutual fund Construction and development trusts provide builders with construction financing Mortgag

46、e trusts provide long-term financing for properties Equity trusts own various income-producing properties3-44Real Estate Direct Real Estate Investment Purchase of a home Purchase of raw land Intention of selling in future for a profit Ownership provides a negative cash flow due to mortgage payments,

47、 taxes, and property maintenance Land Development Divide the land into individual lots Build houses or a shopping mall on it Requires capital, time, and expertise3-45Real Estate Rental Property Acquire apartment buildings or houses with low down payments Derive enough income from the rents to pay th

48、e expenses of the structure, including the mortgage payments, and generate a good return Rental property provides a cash flow and an opportunity to profit from the sale of the property3-46Low-Liquidity Investments Basic Concepts Some investments dont trade on securities markets Lack of liquidity kee

49、ps many investors away Auction sales create wide fluctuations in prices Without notional markets, dealers incur high transaction costs Some may consider them more as hobbies than investments3-47Low-Liquidity Investments Antiques Dealers buy at estate sales, refurbish, and sell at a profit Serious co

50、llectors may enjoy good returns Individuals buying a few pieces to decorate a home may have difficulty overcoming transaction costs to ever enjoy a profit them more as hobbies than investments3-48Low-Liquidity Investments Art Investment requires substantial knowledge of art and the art world Acquisi

51、tion of work from a well-known artist requires large capital commitments and patience High transaction costs Uncertainty and illiquidity3-49Low-Liquidity Investments Coins and Stamps Enjoyed by many as hobby and as an investment Market is more fragmented than stock market, but more liquid than art a

52、nd antiques markets Price lists are published weekly and monthly Grading specifications aid sales Wide spread between bid and ask prices3-50Low-Liquidity Investments Diamonds Can be illiquid Grading determines value, but is subjective Investment-grade gems require substantial investments No positive cash flow until sold Costs of insurance, storage, and appraisal3-51Historical Risk-Returns on Investments World Portfolio Performance Reilly and Wright (2004) examined the performance of various investment alternatives from the United States, Canada, Europe, Japan, and the emerging markets for