03 Iapm9e Ppt_ch03

8/20/2019 03 Iapm9e Ppt_ch03

1/56

Investment Analysis andPortfolio Management

by Frank K. Reilly & Keith C. Brown

Ch

apte

r3

Ch

apte

r3

Selecting Investments

in a Global Market !he Case for "lobal Investments

"lobal Investment Choi#es

$istori#al Risk%Retrns on Alternative

Investments

8/20/2019 03 Iapm9e Ppt_ch03

2/56

3-2

Growing Investment Opportunities

' More investment instrments available in thefinan#ial markets as a reslts of te#hnologi#aladvan#es and new reglations

' Ability to invest from a global (ers(e#tivethanks to the globali)ation or integration ofdomesti# and foreign finan#ial markets

' Investment vehi#les with a variety of matrities*

risk%retrn #hara#teristi#s* and #ash flow(atterns being s(awned de to #om(etitionand dereglations in the finan#ial se#tor

8/20/2019 03 Iapm9e Ppt_ch03

3/56

3-3

The Case for Global Investments

' !hree reasons +.,. investors shold think of#onstr#ting global investment (ortfolios Ignoring foreign markets #an sbstantially red#e

the investment #hoi#es for +.,. investors

!he rates of retrn on non%+.,. se#rities oftenhave sbstantially e-#eeded those for +.,.%onlyse#rities

!he low #orrelation between +.,. sto#k markets

and many foreign markets #an hel( to sbstantiallyred#e (ortfolio risk

8/20/2019 03 Iapm9e Ppt_ch03

4/56

3-4


' Relative ,i)e of +.,. Finan#ial Markets verall vale of the se#rities available in world

#a(ital market has in#reased from /0.1 !rillion in2343 to /251 !rillion in 0554 and the +.,. (ortion

has de#lined to less than half. !he share of the +.,. in world sto#k and bond

markets has dro((ed from abot 46 (er#ent of thetotal in 2343 to abot 74 (er#ent in 0554.

!he growing im(ortan#e of foreign se#rities inworld #a(ital markets is likely to #ontine.

8-hibit 1.2 shows the breakdown of se#rities in theglobal #a(ital market.

8/20/2019 03 Iapm9e Ppt_ch03

5/56

3-5

Exhibit 3!

8/20/2019 03 Iapm9e Ppt_ch03

6/56

3-6


' Rates of Retrn on +.,. and Foreign ,e#rities "lobal Bond%Market Retrn9

' From 2333055:* the retrn (erforman#e of the +.,.bond market ranked fifth ot of the si- #ontries when

the retrns are measred in +.,. dollar.' !he better (erforman#e of the non%+.,. markets is

(artly de to the weakened dollar in this time frame

' ,ee 8-hibit 1.0

"lobal 8;ity%Market Retrn' From 0551 throgh 0554* the +nited ,tates< average

rank in annal retrn measred in +.,. dollar was03.6 ot of 17 #ontries.

8/20/2019 03 Iapm9e Ppt_ch03

7/56 3-7

Exhibit 3"

8/20/2019 03 Iapm9e Ppt_ch03

8/56 3-8


' Risk of Combined Contry Investments =iversifi#ation with foreign se#rities #an hel( red#e

(ortfolio risk be#ase foreign markets have low#orrelation with +.,. #a(ital markets.

!he #orrelation of retrns between a single (air of#ontries #hanges over time be#ase the fa#torsinflen#ing the #orrelation #hange over time.

=iversified (ortfolios red#e variability of retrns over

time. Correlation #oeffi#ients measre diversifi#ation

#ontribtion.

8/20/2019 03 Iapm9e Ppt_ch03

9/56 3-9


' "lobal Bond Portfolio Risk >ow (ositive #orrelation ?8-hibit 1.7@

' For a +.,. investor* the average #orrelation betweenforeign bond retrn and +.,. bond retrn in +.,. dollars isabot 5.41 from 23 to 0554.

' !he +.,.Canada #orrelation is 5.:7* whereas the +.,.a(an #orrelation is only 5.1.

((ortnities for +.,. investors to red#e risk

Correlation #hanges over time

Adding non%#orrelated foreign bonds to a (ortfolio of

+.,. bonds in#reases the rate of retrn and red#es the

risk of the (ortfolio. ?8-hibit 1.6@

8/20/2019 03 Iapm9e Ppt_ch03

10/56 3-

Exhibit 3#

8/20/2019 03 Iapm9e Ppt_ch03

11/56 3-

Exhibit 3$

8/20/2019 03 Iapm9e Ppt_ch03

12/56 3-


' "lobal 8;ity Portfolio Risk >ow (ositive #orrelation ?8-hibit 1.4@

' !he #orrelation of world e;ity markets resembles thatfor bonds however* the average #orrelation between+.,. and foreign markets is abot 5.64* lower thanthat for bonds from 23 to 0554.

' Again* the +.,.Canada #orrelation is 5.:1* whereasthe +.,.a(an #orrelation is only 5.17.

((ortnities to red#e risk of a sto#k (ortfolio by

in#lding foreign sto#ks* as illstrated in 8-hibit 1.:.

8/20/2019 03 Iapm9e Ppt_ch03

13/56 3-

Exhibit 3%

8/20/2019 03 Iapm9e Ppt_ch03

14/56 3-

Exhibit 3&

8/20/2019 03 Iapm9e Ppt_ch03

15/56 3-

Global Investment Choices

' Fi-ed%In#ome Investments Bonds and (referred sto#ks

' 8;ity Investments

' ,(e#ial 8;ity Instrments Darrants and o(tions

' Ftres Contra#ts

' Investment Com(anies

' Real Assets

' >ow >i;idity Investments

8/20/2019 03 Iapm9e Ppt_ch03

16/56 3-

'ixe()Income Investments

' Basi# #on#e(ts of fi-ed%in#ome investments Contra#tal (ayment s#hedle Re#orse varies by instrment

Bonds

' Investors are lenders' 8-(e#t interest (ayment and retrn of (rin#i(al

Preferred sto#ks

' =ividends re;ire board of dire#tors a((roval

8/20/2019 03 Iapm9e Ppt_ch03

17/56 3-

'ixe()Income Investments

' ,avings A##onts Fi-ed earnings

Convenient

>i;id and low risk

>ow rates Certifi#ates of =e(osit ?C=s@

Money Market Certifi#ates' Com(ete against !reasry bills ?!%bills@

' Minimm /25*555' Minimm matrity of si- months

' Redeemable only at bank of isse

' Penalty if withdrawn before matrity

8/20/2019 03 Iapm9e Ppt_ch03

18/56 3-

Capital Market Instruments

' Fi-ed in#ome obligations that trade inse#ondary market

' +.,. !reasry se#rities

' +.,. "overnment agen#y se#rities

' Mni#i(al bonds

' Cor(orate bonds ,e#red bonds

=ebentres ,bordinated bonds

In#ome bonds

Convertible bonds

8/20/2019 03 Iapm9e Ppt_ch03

19/56 3-

*S Treasur+ Securities

' Issed by the +.,. !reasry' =e(ending on the matrity* they are9

Bills with a matrity less than 2 year

Eotes with a matrity in 2 % 25 years

Bonds with a matrity over 25 years

' $ighly li;id

' 8ssentially free of #redit risk9 !hey are

ba#ked by the fll faith and #redit of the +.,."overnment

8/20/2019 03 Iapm9e Ppt_ch03

20/56

3-

*S Government ,genc+ Securities

' ,old by government agen#ies Federal Eational Mortgage Asso#iation ?FEMA or

Fannie Mae@

Federal $ome >oan Bank ?F$>B@

"overnment Eational Mortgage Asso#iation?"EMA or "innie Mae@

Federal $osing Administration ?F$A@

' Eot dire#t obligations of the !reasry ,till #onsidered almost defalt%free and fairly

li;id

8/20/2019 03 Iapm9e Ppt_ch03

21/56

3-

Municipal -on(s

' Issed by state and lo#al governmentssally to finan#e infrastr#tral (roe#ts.

' 8-em(t from ta-ation by the federal

government and by the state that issed the

bond* (rovided the investor is a resident of

that state.

' !wo ty(es9

"eneral obligation bonds ?"s@

Revene bonds

8/20/2019 03 Iapm9e Ppt_ch03

22/56

3-

Corporate -on(s

' Basi# Con#e(ts Issed by a #or(oration Fi-ed in#ome

Credit ;ality measred by ratings

Matrity Featres

' Indentre

' Call (rovision

' ,inking fnd

,eniority #ategories

8/20/2019 03 Iapm9e Ppt_ch03

23/56

3-

Corporate -on(s

' ,e#red bonds ,enior se#red bonds

' Most senior bonds in #a(ital str#tre and have the

lowest risk of defalt

Mortgage bonds

' ,e#red by liens on s(e#ifi# assets

Collateral trst bonds

' ,e#red by finan#ial assets 8;i(ment trst #ertifi#ates

' ,e#red by trans(ortation e;i(ment

8/20/2019 03 Iapm9e Ppt_ch03

24/56

3-

Corporate -on(s

' =ebentres +nse#red (romises to (ay interest and (rin#i(al

In #ase of defalt* debentre owner #an for#ebankr(t#y and #laim any n(ledged assets to

(ay off the bonds' ,bordinated bonds

+nse#red like debentres* bt holders of thesebonds may #laim assets after senior se#red and

debentre holders #laims have been satisfied

8/20/2019 03 Iapm9e Ppt_ch03

25/56

3-

Corporate -on(s

' In#ome bonds Interest (ayment #ontingent (on earningsffi#ient in#ome

If sbse;ently earned* it mst be (aid off

Riskier than debentre bonds' Convertible bonds

ffer the (side (otential of #ommon sto#k andthe downside (rote#tion of a bond

+sally have lower interest rates

8/20/2019 03 Iapm9e Ppt_ch03

26/56

3-

Corporate -on(s

' Darrants Allows bondholder to (r#hase the firm

8/20/2019 03 Iapm9e Ppt_ch03

27/56

3-

.referre( Stock

' $ybrid se#rity' Fi-ed dividends

' =ividend obligations are not legally binding*bt mst be voted on by the board ofdire#tors to be (aid

' Most (referred sto#k is #mlative

' Credit im(li#ations of missing dividends

' Cor(orations may e-#lde 5H of dividendin#ome from ta-able in#ome

8/20/2019 03 Iapm9e Ppt_ch03

28/56

3-

International -on( Investing

' Investors shold be aware that there is a verysbstantial fi-ed in#ome market otside the+nited ,tates that offers additional o((ortnityfor diversifi#ation and retrns.

' Bond identifi#ation #hara#teristi#s

Contry of origin

>o#ation of (rimary trading market

$ome #ontry of the maor byers Crren#y of the se#rity denomination

8/20/2019 03 Iapm9e Ppt_ch03

29/56

8/20/2019 03 Iapm9e Ppt_ch03

30/56

3-

E/uit+ Investments

' Common ,to#k Re(resents ownershi( of a firm Investor

8/20/2019 03 Iapm9e Ppt_ch03

31/56

3-

,c/uiring 'oreign E/uities

' Ameri#an =e(ository Re#ei(ts ?A=Rs@ 8asiest way to dire#tly a#;ire foreign shares Certifi#ates of ownershi( issed by a +.,. bank

that re(resents indire#t ownershi( of a #ertain

nmber of shares of a s(e#ifi# foreign firm onde(osit in a +.,. bank in the firmisted on +.,. e-#hanges

Jery (o(lar* 164 ot of 740 on E,8 in 0554

8/20/2019 03 Iapm9e Ppt_ch03

32/56

3-


' Pr#hase of Ameri#an ,hares Issed in the +nited ,tates by transfer agent on

behalf of a foreign firm

$igher e-(enses

>imited availability

' =ire#t Pr#hase of Foreign ,hares In the foreign firms< own #ontry

>isted on a foreign sto#k e-#hange otside thehome #ontry ?e.g.* Fren#h firms on >,8@

>isted on a +.,. sto#k e-#hange

8/20/2019 03 Iapm9e Ppt_ch03

33/56

3-


' "lobal Mtal Fnds or 8!Fs "lobal fnds9 Invest in both +.,. and foreignsto#ks

International fnds9 Invest mostly otside the +.,.

Fnds #an s(e#iali)e' =iversifi#ation a#ross many #ontries

' Con#entrate in a segment of the world

' Con#entrate in a s(e#ifi# #ontry

' Con#entrate in ty(es of markets

8-#hange%traded fnds or 8!Fs are a re#ent

innovation in the world of inde- (rod#ts

8/20/2019 03 Iapm9e Ppt_ch03

34/56

3-

Special E/uit+ Instruments0 Options

' !hese are e;ity%derivative se#rities whi#hhave a #laim on the #ommon sto#k of a firm.

' (tions are rights to by or sell #ommon sto#kor other nderlying assets at a stated (ri#e for

a (eriod of time. Pts are o(tions to sell

Calls are o(tions to by

' Darrants An o(tions issed by a #om(any giving the holders

the right to by its #ommon sto#k

Eormally issed with bonds

8/20/2019 03 Iapm9e Ppt_ch03

35/56

3-

'utures Contracts

' 8-#hange of a (arti#lar asset at a s(e#ifieddelivery date for a stated (ri#e (aid at thetime of delivery

' =e(osit ?25H margin@ is made by byer at

#ontra#t to (rote#t the seller ' Commodities trading is largely in ftres

#ontra#ts

' Crrent (ri#e de(ends on e-(e#tations

8/20/2019 03 Iapm9e Ppt_ch03

36/56

3-

'utures Contracts

' Finan#ial Ftres Re#ent develo(ment of #ontra#ts on finan#ial

instrments s#h as !%bills* !reasry bonds* and8robonds

!raded mostly on Chi#ago Mer#antile 8-#hange?CM8@ and Chi#ago Board of !rade ?CB!@

Allow investors and (ortfolio managers to (rote#tagainst volatile interest rates

Crren#y ftres allow (rote#tion against #hangesin e-#hange rates

Jarios sto#k ftres on market inde-es s#h asthe ,&P 655 and Jale >ine Inde-

8/20/2019 03 Iapm9e Ppt_ch03

37/56

3-

Investment Companies

' Rather than by individal se#rities dire#tlyfrom the isser they #an be a#;iredindire#tly throgh shares in an investment#om(any

' Investment #om(anies sell shares in itselfand ses (ro#eeds to by se#rities

' Investors own (art of the (ortfolio of

investments

8/20/2019 03 Iapm9e Ppt_ch03

38/56

3-


' Money Market Fnds A#;ire high%;ality* short%term investments

ields are higher than normal bank C=s

!y(i#al minimm investment is /2*555

Eo sales #ommission #harges

Dithdrawal is by #he#k with no (enalty

Investments sally are not insred

!he total vale of these fnds rea#hed more than/0.6 trillion in 055:

8/20/2019 03 Iapm9e Ppt_ch03

39/56

3-


' Bond Fnds Invest in long%term government* #or(orate* or

mni#i(al bonds

Bond fnds vary in bond ;ality from the risk%free

government bonds to the high%yield or nk bonds

8-(e#ted retrns also differ refle#ting the risk

level of bonds in the fnd

8/20/2019 03 Iapm9e Ppt_ch03

40/56

3-


' Common ,to#k Fnds

Many different fnds with varying statedinvestment obe#tives

' Aggressive growth* in#ome* (re#ios metals*

international sto#ks

ffer diversifi#ation to smaller investors

,e#tor fnds #on#entrate in an indstry

International fnds invest otside the +nited

,tates "lobal fnds invest in the +.,. and other

#ontries

8/20/2019 03 Iapm9e Ppt_ch03

41/56

3-


' Balan#ed Fnds Invest in a #ombination of sto#ks and bonds

de(ending on their stated obe#tives

' Inde- Fnds

!hese are mtal fnds #reated to tra#k the(erforman#e of a market inde- like the ,&P 655

A((eal to (assive investors who want to sim(lye-(erien#e retrns e;al to some market inde-

Emeros non%sto#k inde-es in#lding variosbond inde-es have been #reated

8/20/2019 03 Iapm9e Ppt_ch03

42/56

3-


' 8-#hange%!raded Fnds ?8!Fs@ !hese are de(ository re#ei(ts for a (ortfolio of

se#rities de(osited at a finan#ial instittion in a

nit trst that isses a #ertifi#ate of ownershi( for

the (ortfolio of sto#ks !he sto#ks in a (ortfolio are those in an inde- like

the ,&P 655 and do)ens of #ontry or indstry

inde-es

8!Fs #an be boght and sold #ontinosly on an

e-#hange like #ommon sto#k

8/20/2019 03 Iapm9e Ppt_ch03

43/56

3-

1eal Estate

' Real 8state Investment !rsts ?R8I!s@ Investment fnd that invests in a variety of real

estate (ro(erties* similar to a sto#k or bondmtal fnd

Constr#tion and develo(ment trsts (rovidebilders with #onstr#tion finan#ing

Mortgage trsts (rovide long%term finan#ing for(ro(erties

8;ity trsts own varios in#ome%(rod#ing(ro(erties

8/20/2019 03 Iapm9e Ppt_ch03

44/56

3-

1eal Estate

' =ire#t Real 8state Investment Pr#hase of a home

Pr#hase of raw land

' Intention of selling in ftre for a (rofit

' wnershi( (rovides a negative #ash flow de to

mortgage (ayments* ta-es* and (ro(erty

maintenan#e

>and =evelo(ment

' =ivide the land into individal lots

' Bild hoses or a sho((ing mall on it

' Re;ires #a(ital* time* and e-(ertise

8/20/2019 03 Iapm9e Ppt_ch03

45/56

3-

1eal Estate

' Rental Pro(erty A#;ire a(artment bildings or hoses with low

down (ayments

=erive enogh in#ome from the rents to (ay the

e-(enses of the str#tre* in#lding the mortgage

(ayments* and generate a good retrn

Rental (ro(erty (rovides a #ash flow and an

o((ortnity to (rofit from the sale of the (ro(erty

8/20/2019 03 Iapm9e Ppt_ch03

46/56

3-

2ow)2i/ui(it+ Investments

' Basi# Con#e(ts ,ome investments dona#k of li;idity kee(s many investors away

A#tion sales #reate wide fl#tations in (ri#es

Dithot notional markets* dealers in#r high

transa#tion #osts

,ome may #onsider them more as hobbies thaninvestments

8/20/2019 03 Iapm9e Ppt_ch03

47/56

3-


' Anti;es =ealers by at estate sales* refrbish* and sell

at a (rofit

,erios #olle#tors may enoy good retrns

Individals bying a few (ie#es to de#orate a

home may have diffi#lty over#oming

transa#tion #osts to ever enoy a (rofit them

more as hobbies than investments

8/20/2019 03 Iapm9e Ppt_ch03

48/56

3-


' Art Investment re;ires sbstantial knowledge of art

and the art world

A#;isition of work from a well%known artist

re;ires large #a(ital #ommitments and(atien#e

$igh transa#tion #osts

+n#ertainty and illi;idity

8/20/2019 03 Iapm9e Ppt_ch03

49/56

3-


' Coins and ,tam(s 8noyed by many as hobby and as an

investment

Market is more fragmented than sto#k market*

bt more li;id than art and anti;es markets

Pri#e lists are (blished weekly and monthly

"rading s(e#ifi#ations aid sales

Dide s(read between bid and ask (ri#es

8/20/2019 03 Iapm9e Ppt_ch03

50/56

3-


' =iamonds Can be illi;id

"rading determines vale* bt is sbe#tive

Investment%grade gems re;ire sbstantialinvestments

Eo (ositive #ash flow ntil sold

Costs of insran#e* storage* and a((raisal

8/20/2019 03 Iapm9e Ppt_ch03

51/56

3-

istorical 1isk)1eturns on Investments

' Dorld Portfolio Performan#e Reilly and Dright ?0557@ e-amined the

(erforman#e of varios investment alternativesfrom the +nited ,tates* Canada* 8ro(e* a(an*

and the emerging markets for the (eriod 235%0552* as shown in 8-hibit 1.

Asset Retrns and !otal Risk

' !he e-(e#ted relationshi( between annal rates of

retrn and total risk ?standard deviation@ of thesese#rities was #onfirmed

8/20/2019 03 Iapm9e Ppt_ch03

52/56

3-


Retrn and ,ystemati# Risk

' !he systemati# risk measre ?beta@ did a better ob ofe-(laining the retrns dring the (eriod than did thetotal risk measre

' !he beta risk measre that sed the Brinson inde- as

a market (ro-y was somewhat better than the betathat sed the ,&P 655 Inde-

' ,ee 8-hibit 1.3

Correlations between Asset Retrns

' +.,. e;ities have a reasonably high #orrelation withCanadian and +.K. sto#ks bt low #orrelation withemerging market sto#ks and a(anese sto#ks

' +.,. e;ities show almost )ero #orrelation with worldgovernment bonds* e-#e(t +.,. bonds

8/20/2019 03 Iapm9e Ppt_ch03

53/56

3-

Exhibit 34

8/20/2019 03 Iapm9e Ppt_ch03

54/56

3-


' Art and Anti;es

Market data is limited

Reslts vary widely* and #hange over time* making

generali)ation im(ossible* bt showing a

reasonably #onsistent relationshi( between riskand retrn

Correlation #oeffi#ients vary widely* allowing for

great diversifi#ation (otential

>i;idity is still a #on#ern

8/20/2019 03 Iapm9e Ppt_ch03

55/56

3-


' Real 8state Retrns are diffi#lt to derive de to la#k of data

Residential shows lower risk and retrn than#ommer#ial real estate

R8I!s have shown higher retrns with lower riskthan sto#k in short%term bt lower retrn with lowerrisk than sto#k in long%term

Eegative #orrelation between residential and farm

real estate and sto#ks >ow (ositive #orrelation between #ommer#ial realestate and sto#ks

Potential for diversifi#ation

8/20/2019 03 Iapm9e Ppt_ch03

56/56

!he Internet Investments nline

' htt(9www.site%by%site.#om' htt(9www.money#afe.#om

' htt(9www.emgmkts.#om

' htt(9www.law.dke.edglobalmark' htt(9www.lebenthal.#om

' htt(9www.sothebys.#om
http://www.site-by-site.com/http://www.moneycafe.com/http://www.emgmkts.com/http://www.law.duke.edu/globalmarkhttp://www.lebenthal.com/http://www.sothebys.com/http://www.sothebys.com/http://www.sothebys.com/http://www.lebenthal.com/http://www.law.duke.edu/globalmarkhttp://www.emgmkts.com/http://www.moneycafe.com/http://www.site-by-site.com/

Documents

03 Iapm9e Ppt_ch03