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1、Francis & IbbotsonChapter 1: The Investment Setting1Chapter 1The Investment SettingFrancis & IbbotsonChapter 1: The Investment Setting2What is Investing?Criteria used to determine whether an investment of money is investing or something else, including:Is it short-term or long-term?Is it productive

2、or unproductive?Is it legal or illegal?Is it rational or irrational?Francis & IbbotsonChapter 1: The Investment Setting3Gambling vs. SpeculatingGambling occurs whenOutcome is determined very quickly (a roll of the dice, for instance)A source of entertainmentOutcome is not based on an economic endeav

3、or, but, rather, random outcomesCreates risk without expectation of economic benefitSpeculation occurs whenAn asset is purchased with hope that price will rise rapidly, leading to quick profitNot based on random outcomesExample: Buying an IPO of a stock on the first day hoping to sell it in several

4、days at a higher priceFrancis & IbbotsonChapter 1: The Investment Setting4Assets of ChoiceMajor asset classes includePrimary securities such as common and preferred stock, government bonds, corporate bonds, Treasury bills, commercial paperDerived instruments such as mutual funds, put and call option

5、s, forward and futures contractsPhysical assets such as houses, land, buildings, diamonds, goldFrancis & IbbotsonChapter 1: The Investment Setting5Other IssuesLarge international corporations have their securities traded somewhere in the world 24 hours a dayWhile other areassuch as China and Africa

6、have a larger population than the U.S., the U.S. has the highest Gross National Product (GNP) a measure of a nations incomeHowever, when allocating a countrys GNP across the countrys population, the U.S. ranks 6thBut after adjusting for each countrys cost of living, the U.S. ranks 2nd behind Luxembo

7、urgFrancis & IbbotsonChapter 1: The Investment Setting6The Worlds Equity CapitalWorlds equity capital is concentrated in North America, western and central Europe and the Pacific Rim (mostly Japan)Because market prices are rather volatile, this situation can change rapidly. For instance, from 1989-1

8、990 Japans stock market was worth more than the U.S. stock market.Francis & IbbotsonChapter 1: The Investment Setting7The Worlds Bond MarketFrancis & IbbotsonChapter 1: The Investment Setting8The Worlds Bond MarketFrancis & IbbotsonChapter 1: The Investment Setting9Worlds Real & Human CapitalValue o

9、f worlds real assets financial assetsWorlds human capital greatly exceeds combined worlds real and financial capitalIncome from human capital is 80% of the worlds incomeHuman capital represents the stock of ideas and information possessed by humansFor instance, the capital contained within a tool do

10、esnt come from the tool itself, but from the knowledge of how to build and use the toolFrancis & IbbotsonChapter 1: The Investment Setting10The U.S. Financial MarketsResidential real estate is one of the larger investments made by U.S. citizens. However, this may change in the future.Francis & Ibbot

11、sonChapter 1: The Investment Setting11U.S. Equity InvestorsIndividual investorsOver 50 million in the U.S.Typically own only a few stocks with aggregate value of $15,000Have a small impact on U.S. equities marketMostly amateurs who play the marketInstitutional investorsInclude pension funds, mutual

12、funds, life insurance companies, commercial bank trust departments, etc.In 2019 controlled 60% of market value of U.S. equities with individual investors controlling remainderHouseholds own much of the money managed by institutional investorsFrequently buy shares in blocks of 10,000 or moreBlock tra

13、des account for 51% of volume on NYSEFrancis & IbbotsonChapter 1: The Investment Setting12U.S. Market for BondsFrancis & IbbotsonChapter 1: The Investment Setting13The Bottom LineIn determining whether a gamble, a speculation or an investment has occurred, it is useful to examine the length of the h

14、olding periodEven though there are millions of individual investors, their impact on the U.S. equities market is smallInstitutional investors (such as pension funds, insurance companies, mutual funds) have a much greater impact on the U.S. marketsFrancis & IbbotsonChapter 1: The Investment Setting14

15、Appendix: Opportunities and Salaries in InvestmentsInvestment Counsel. FirmBankSecurity Broker/DealerInsurance CompanyMutual Fund Mgmt. Co.Plan Sponsor/Endow./Foundat.Pension Consult. Firm2019 Median Salary$113,150$90,000$90,000$107,000$110,000$92,750$80,0002019 Median Bonus$50,000$30,000$85,000$35,

16、000$70,000$11,000$12,5002019 Median Non-Cash Compensation$9,000$10,000$8,000$5,000$20,000$200$2,000Median Total Compensation$185,000$128,000$185,000$150,000$196,000$104,200$95,00090th Percentile$682,265$365,111$757,108$430,769$814,603$294,412$256,250Francis & IbbotsonChapter 2: Rates of Return15Chap

17、ter 2Rates of ReturnFrancis & IbbotsonChapter 2: Rates of Return16BackgroundInvestors want to maximize their returns (or wealth)Chapter discussesThe calculation of a returnHistorical returns offered by different types of investmentsFrancis & IbbotsonChapter 2: Rates of Return17The Investors GoalGoal

18、 is to maximize what is earned relative to the amount put into an investmentMaximize either theRate of returnInvestments terminal valueEquivalentFrancis & IbbotsonChapter 2: Rates of Return18The Investors GoalSome claim wealth-maximizing investors are performing harmful greedy activitiesLaw abiding

19、wealth maximization is beneficial to both investor and general populationSeek out securities issued by firms producing high quality goods and servicesCapital is used to benefit general populationInvestors can request management actions at stockholder meetingsHelps nation compete internationallyCreat

20、es new job opportunitiesFrancis & IbbotsonChapter 2: Rates of Return19Ethics Box: The Need for Ethics in InvestmentSome level of ethics is necessaryEthics concerned with standards of right and wrongConcepts of trust and fairness are relevant to investmentsInvestors trust investment firms to act in t

21、heir best interest and to safeguard their assetsFairness means a level playing field and the absence of fraudDecreasing information asymmetry increases efficiency and fairnessAn investment professional shouldBe loyalAct with due careKeep information confidentialAvoid conflicts of interestFrancis & I

22、bbotsonChapter 2: Rates of Return20The One-Period Rate of ReturnRate of return measures change in an investors wealth over timeMeasures the success or failure of the investmentMeasures holding period returnDefined asFrancis & IbbotsonChapter 2: Rates of Return21Examples: One Period ReturnYou purchas

23、ed one share of Coca-Cola one year ago for $54. You sold it today for $64, and you received dividends of $0.80 during the yearYour income from dividends = 80Your capital gain is $10 ($64 - $54)Your return is $10.80 $54 = 20%Francis & IbbotsonChapter 2: Rates of Return22Examples: One Period ReturnYou

24、 purchased a U.S. T-bond for $900. One year later you sold the bond for $910. You received $35 in interest during the year. Your rate of return isYou bought a six-month T-bill for $9,800 with a maturity value of $10,000. After the bond matures your six-month return isSince there are two six-month pe

25、riods in one year, your annual return is1.02042 1 = 1.0412 1 = 4.12%Francis & IbbotsonChapter 2: Rates of Return23Figure 2-1:Wealth Indices for Average U.S. Investments in Different Asset Classes Compared to Inflation, 1926-99If you had invested $1 on December 31, 1925 in each of the following, you

26、would haveIn some years inflation exceeds T-bill returnsleading to a drop in purchasing power for T-bill investors.Small company stocks are the most risky, but offer the highest return.T-bills are the least riskysmoothest growth path, but lowest return.Francis & IbbotsonChapter 2: Rates of Return24T

27、able 2-1:Average Annual Rate of Return and Risk Statistics for Asset Classes and Inflation in the U.S., 1926-99Noticeable tendency for higher risk assets to offer the higher return.Francis & IbbotsonChapter 2: Rates of Return25Realized One-Period Rates of ReturnWe can calculate one period rates of c

28、hange for the indexes Includes dividends, coupon interest on bondsFrancis & IbbotsonChapter 2: Rates of Return26Average Rates of ReturnArithmetic mean return (AMR) measures average historical one-period rates of returnCompound average rate of return, or geometric mean return (GMR) isAMR GMR because

29、compound interest grows more rapidly than simple interestFrancis & IbbotsonChapter 2: Rates of Return27Example: Average Rates of ReturnA three-year investment earned the following annual returns:YearRt120%2-10%35%If you placed $100 in this investment at the beginning of year 1, at the end of the thi

30、rd year it would be worth $100 (1.0428)3 = $113.40Francis & IbbotsonChapter 2: Rates of Return28Assessing RiskAn asset is riskier ifIts one-period rates of return fluctuate over a wide rangeSuch as small company stocksMeasures of risk includeVariancethe average of squared deviations from AMRStandard

31、 deviationsquare root of varianceBoth measure total riskFrancis & IbbotsonChapter 2: Rates of Return29Example: Variance & SDCalculate the variance and standard deviation of the previous exampleFrancis & IbbotsonChapter 2: Rates of Return30Risk RankingsBoth standard deviation and variance result in t

32、he same risk rankingsAdvantages of standard deviationConsiders every outcomeUnlike range which only considers high and low valuesWell known by statisticiansProgrammed into calculators and softwareMeasures the wideness of probability distributionsMeasure of dispersion around arithmetic meanAlso widel

33、y used in mathematics, econometrics, etc.Francis & IbbotsonChapter 2: Rates of Return31Interpreting Historical Return and RiskExamining the historical returns and risk leads to the following observations:Large company common stocksEarn higher returns than bondsIf a firm is declared bankrupt, all cre

34、ditors are paid in full before common stockholders receive any proceedsCommon stockholders usually receive nothing which makes it more risky than debtStockholders demand a higher average rate of returnFrancis & IbbotsonChapter 2: Rates of Return32Interpreting Historical Return and RiskSmall company

35、stocksEarned highest returns of all other investmentsBut, riskier than any of the other investmentsThe percentage of small firms declared bankrupt is greater than the percentage of large firmsInvestors require a higher rate of return for investing in a small firmLong-term corporate bondsBonds issued

36、 by the U.S. Treasury are unlikely to be defaultedHowever, bonds issued by corporations are more likely to be defaultedFrancis & IbbotsonChapter 2: Rates of Return33Interpreting Historical Return and RiskLong-term U.S. Treasury bondsMature about 20 years from initial offering dateInvolve no default

37、riskIntermediate-term U.S. Treasury BondsMature about 5 years after issue dateExperience smaller price fluctuations than long-term U.S. Treasury bondsU.S. Treasury billsMature in less than one yearNo horizon premium necessaryU.S. Treasury is unlikely to defaultNo default premium neededAKA risk-free

38、assetsProbably no other security in world with less riskFrancis & IbbotsonChapter 2: Rates of Return34Interpreting Historical Return and RiskOpportunity costWhat it could earn in its highest paying alternative useExample: The opportunity cost of attending college includes foregone wagesLess obvious

39、expenses than out-of-pocket expensesExample: The opportunity cost of holding cash rather than investing in large company stocks was 13.3% a yearFrancis & IbbotsonChapter 2: Rates of Return35Required Rate of ReturnShould only invest if you expect to earn a return greater than your cost of capitalInte

40、rest expense paid for borrowed fundsCash dividend payment paid to stockholdersOpportunity costsAKA required rate of returnMinimum rate of return an investment must earn to increase investors wealthRRR r leads to a wealth decreaseFrancis & IbbotsonChapter 2: Rates of Return36Combining Risk Premiums T

41、o Compute Required Rate of ReturnRequired Rate of Return (k)Sum ofappropriate risk premiumsFor T-bills, k=4.5%4.5% =Risk-free rate (RFR)For T-notes, k = 5.5%4.5% =+1.0% =5.5%=Risk-free rate (RFR)+ Intermediate Horizon PremiumTotal = Required rate of returnFor T-bonds, k = 5.9%4.5% =+ 1.4% =5.9% =Ris

42、k-free rate (RFR)+ Long Horizon premiumTotal = Required rate of returnFor Corporate bonds, k = 6.3%4.5% =+ 1.4% =+0.4% =6.3% =Risk-free rate (RFR)+ Long Horizon Premium+ Default PremiumTotal = Required rate of returnFrancis & IbbotsonChapter 2: Rates of Return37Combining Risk Premiums To Compute Req

43、uired Rate of ReturnRequired Rate of Return (k)Sum ofappropriate risk premiumsFor Large Cap Stocks, k = 13.0%4.5% =+1.4% =+7.1% =13.0% =Risk-free rate (RFR)+ Long Horizon Premium+Equity Risk PremiumTotal = Required rate of returnFor Small Cap Stocks, k = 14.5%4.5% =+1.4% =+7.1% =+ 1.5% =14.5% =Risk-

44、free rate (RFR)+ Long Horizon Premium+Equity Risk Premium+ Size PremiumTotal = Required rate of returnFrancis & IbbotsonChapter 2: Rates of Return38The Largest Investors in the WorldU.S. pension funds are the largest investors in the worldHire professional money managersOwners/sponsors of largest pe

45、nsionsU.S. Pension Fund SponsorAssets (in billions)California Public Employees Retirement System$155.82New York Common111.40California State Teachers98.40Florida State Board93.20General Motors91.00Francis & IbbotsonChapter 2: Rates of Return39The Largest Investors in the WorldFirms hired to manage p

46、ension assets includeInvestment Management FirmTax-exempt assets managed (in billions)State Street Global103Capital Guardian85Barclays Global Investors62.6Morgan Stanley Dean Witter56.4Putnam Investments33.5Janus31.6J.P. Morgan28.8UBS Asset Management25.4Francis & IbbotsonChapter 2: Rates of Return4

47、0Ethics and Pension FundsManagers of defined benefit plans (guarantee fixed income in retirement)Have duty to maintain sufficient funds for future obligationsSome funds become overfundedShould these funds be allowed to divest excess funds?Managers of defined contribution plans (employee and employer

48、 contributions accumulate in individual accounts)Must offer at least three different fundsMust seek to maximize risk-adjusted returnHave a fiduciary duty to vote funds stock solely in beneficiaries interestsFrancis & IbbotsonChapter 2: Rates of Return41The Bottom LineInvestors wish to maximize their

49、 wealth (return) over the long-runArithmetic mean is not a compounded return like the geometric meanAMR GMRRealized returns represent historical dataInvestors desire investments with an expected return greater than their required rate of return or hurdle rateFrancis & IbbotsonChapter 3: Introduction

50、 to Valuation42Introduction to ValuationChapter 3Francis & IbbotsonChapter 3: Introduction to Valuation43BackgroundDetermining current price of a security is easyAsk the sellerLook in newspaper, television, InternetMuch more difficult to determine the value of an investmentHow much is an investment

51、worth?Need to know so you can determine if the investment is over- or under-valuedChapter presents the discounted present value model to estimate value of an investmentDemonstrates examples of valuing stock, bond and rental propertyFrancis & IbbotsonChapter 3: Introduction to Valuation44BackgroundSe

52、curity price fluctuations may appear chaoticResponses to markets reaction to random arrival of new informationWhen you buy or sell a security you are part of marketHedging is a technique that reduces riskOne form of hedging is arbitrageAligns prices with respect to law of one priceInformed buying, s

53、elling, hedging and arbitrage tends to make a securitys price move closer to its valueFrancis & IbbotsonChapter 3: Introduction to Valuation45Time Value of MoneyOne-period rate of returnRearranging this equation gives us the time value modelThe two models are equivalent becauseThe interest rate on t

54、he investment equals lenders one-period rate of returnThe present value of an investment is Francis & IbbotsonChapter 3: Introduction to Valuation46Time Value of MoneyIf the rate of return differs from the discount rate, we can rewrite the equation asSituations in which the discount rate (k) differs

55、 from the rate of return (r) are commonDifferent people have different opinions, different resources, etc.If k E(r) asset is over-pricedPresent value of asset its priceIf k its priceFrancis & IbbotsonChapter 3: Introduction to Valuation47An ExchangeFrancois deposits 100 euros in a French bankHe rece

56、ives a negotiable CD with a maturity value of 105 eurosExpects to earn 5% a year for one yearAn American has a required rate of return of 3%Economic conditions are not the same in U.S. as they are in FranceYou and Francois are not concerned with exchange rate riskBelieve that exchange rate will rema

57、in constant over the next yearFrancis & IbbotsonChapter 3: Introduction to Valuation48An ExchangeFrancois values the CD atYou decide to offer to buy Francois CD todayWhat price are you willing to pay?Will Francois be willing to sell?Yes, because it is worth only 100 to himHe would get more than he t

58、hinks it is worthAre both parties pleased with the transaction?Yes!Francis & IbbotsonChapter 3: Introduction to Valuation49Valuing Coca-Cola at Different Discount RatesCoca-Cola (ticker symbol: KO) is currently selling for $54You expect the selling price in one year to be $64 and that KO will pay $0

59、.80 in dividends during the yearBased on that information, your expected rate of return would beFrancis & IbbotsonChapter 3: Introduction to Valuation50Valuing Coca-Cola at Different Discount RatesIf your required rate of return were 19%, you would think that KO was underpriced at $54The most you ar

60、e willing to pay, which is greater than the current price of $54.If your required rate of return were 20%, you would think that KO was correctly priced at $54Francis & IbbotsonChapter 3: Introduction to Valuation51Valuing Coca-Cola at Different Discount RatesIf your required rate of return were 21%,