F303 Intermediate Investments Fall 2003

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F303 Intermediate InvestmentsFall 2003

• Andrey Ukhov
• Kelley School of Business
• Indiana University

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F303 Intermediate InvestmentsFall 2003

• Andrey Ukhov
• Room BU356B
• E-mail aukhov_at_indiana.edu
• Office Hours Monday 200-400
• and Thursday 400-600.
• Alternatively, by appointment only

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What is This Course About?

• Risk and returns of different financial
  instruments
• Diversification and how it reduces portfolio risk
• Asset pricing models and implications to
  investors
• Examining the performance of fund managers
• Bonds yield-to-maturity and meaning to the
  investing community
• Derivative instruments and payoffs associated
  with various option positions

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Investment Environment and Investment Process

• Investment Environment refers to the different
  types of marketable securities available for
  investors
• Investment Process is about the way investors
  should decide on the marketable instruments they
  will invest in, when to invest, etc.

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Marketable Financial Securities

• Financial Instruments
• Direct Investments Indirect Investments
• Money Market Instruments Capital Market
  Instruments Derivative Instruments
• Fixed Income Instruments Equity Instruments

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Markets Founding Dates For World Equity Markets
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How Can We Define Investments?

• Investment can be defined as the sacrifice of
  present consumption for some future value. This
  future value is possibly uncertain
• Three main sectors to consider households,
  business, and government.
• The first sector has to decide on investing
  funds the last two need to raise funds.

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Risk and Return

• Understanding the tradeoff between risk and
  return.
• What does this mean?
• When investments are compared, risk and expected
  return go with each other.
• Why is the trade-off important?
• Because we believe that investors are
  risk-aversehence they have to be compensated for
  the risks they take.

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Historical Analysis of Risk and Returns

• So how can we go about making investment
  decisions?
• One avenue is looking at historical analysis.
• Such an analysis gives support to the view that
  there is a positive relation between risk and
  reward.

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Dow Jones 1900 - 2002
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Dow Jones 1980 - 2002
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The UK Market 1900-2002
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Dow Jones Annual Returns(1945-2002)
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US, Japan and UK Markets Annual Returns
(1976-2002)
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U.S. Treasury Bills Annual Returns (1945-2002)
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Risk-Return Relationship for Different
Instruments (1928-2000)
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Risk-Return and Diversification

• Common Stock
• Return 13.5 Risk 22
• Corporate Bonds
• Return 5.5 Risk 7
• Common Stock (50) and Bond (50) Blend Portfolio
• Return 9.5 Risk 11.60

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Risk-Return and Diversification

• Building a portfolio with 50 Common Stock and
  50 Corporate Bonds produces an interesting
  result
• portfolio returns are the weighted average of
  both Common Stock and Corporate Bonds
• but portfolio risk is LESS than the weighted
  average of the risk of individual asset classes!!

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Historical Variability and Prospective Risk

• Historical variability is not necessarily an
  indication of prospective risk.
• The former deals with the record over some past
  period the latter has to do with uncertainty
  about the future.
• However, historical variability can be one very
  useful tool to analyze returns on common stock.

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Can We Obtain the Best Investment?

• Very difficult to make general conclusions
• Why?
• The optimal investment depends on the investors
  preferences
• ...his/her distates for risk are crucial and have
  to be analysed very carefully!

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For Next Session

• We shall discuss risk and return in more detail
• Review the basic statistics that we will use in
  order to measure and understand risk and return
• Introduce the mean-variance framework.

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Key Points to Remember

• Investment Environment and Investment Process
• Investment is the sacrifice of current for future
  dollars
• We have to consider return and risk
• Historical analysis shows that equity produces
  high but variable returns while fixed income
  securities generate lower but less variable
  returns.