INVESTMENTS

An Introduction
 Starting Early & Compounding
• The earlier you start saving for retirement, the easier it will be
to afford, given the number of financial obligations that tend
to be incurred later in life
• Understanding the effects of compounding will illustrate how,
in the retirement game, the early bird really does get the
worm
• The sooner you invest, the more time your money has to grow

• COMPOUNDING
– The ability of an asset to generate earnings which are then reinvested
in order to generate their own earnings. In other words, compounding
refers to generating earnings from previous earnings. Also known as
“compound interest”
 Inflation
• What is inflation?
– Sustained increase in the general level of prices for goods and services
– Measured as an annual percentage increase
– As inflation rises, every dollar you own buys a smaller percentage of a good
or service

• Causes of Inflation
– Demand Pull Inflation
• “too much money chasing too few goods”
• If demand is growing faster than supply, then prices will increase
– Cost Push Inflation
• When companies costs go up, they need to increase prices to maintain profit
margins
• Increased costs can include things such as wages, taxes, or increased costs of
imports
 Variations on Inflation
• Deflation
– General decline in prices, often caused by a reduction in
the supply of money or credit
– Deflation has the side effect of increased unemployment
since there is a lower level of demand in the economy,
which can lead to an economic depression

• Hyperinflation
– Extremely rapid or out of control inflation

• Stagflation
– A condition of slow economic growth and relatively high
unemployment – a time of stagnation – accompanied by a
rise in prices, or inflation
 Inflation
• What is money illusion?
– Difference between nominal changes and real
changes in money

• Return on risk free cash investments may look

good, but when you factor in inflation, it is not
as impressive
 Risk Appetite
• What is risk appetite?

• Is it important to know one’s risk taking capability?

• What happens typically when one of your “well

chosen” investments decline for a year or two? What
do you do?
– Do you exit?
– Do you buy more?
 Risk return trade-off
• The “ability to sleep at night” test
– Deciding what amount of risk you can take on while still being able to
feel comfortable about your investments is a very important decision
• What is risk?
– The chance that an investment’s actual return will be different than
expected
– Risk is the possibility of loosing some, or even all, of our original
investment
• Technically, this is measured in statistics by standard deviation
– Standard deviation is applied to the annual rate of return of an
investment to measure the investment’s risk (volatility)
 Risk return trade-off
• Low levels of uncertainty (low risk) are associated with low
potential returns

• High levels or uncertainty (high risk) are associated with high

potential returns

• The risk/return tradeoff is the balance between the desire

for the lowest possible risk and the highest possible return

• A higher standard deviation means a higher risk and a higher

possible return
 Diversification
• Outline goals and risk-orientation
• Don’t put all your eggs in one basket!
• Diversification would depend on what the investor’s
circumstances, needs, and objectives are
• Ensure that the investor is not reliant or dependent on the
performance of one asset class or particular investment
vehicle
• Diversification is a risk-management technique that mixes a
wide variety of investments within a portfolio in order to
minimize the impact that any one security will have on the
overall performance of the portfolio
• Diversification lowers the risk of your portfolio
 Diversification
Three practices to ensure best diversification –

1. Spread your portfolio among multiple investment vehicles –

cash, stocks, bonds, mutual funds and perhaps even some
real estate
2. Vary the risk in your securities. You are not restricted to
choosing only blue chip stocks. In fact, it would be wise to
pick investments with varied risk levels, this will ensure that
large losses are offset by other areas
3. Vary your securities by industry. This will minimize the impact
of industry-specific risks
 Time Horizon
• How long are you planning to invest for?

• Difference between short term and long term financial needs

• Are you a short term player (less than one year)

• Are you going to need the money invested in the stock market
over the next 2-3 years

• Invest in the stock markets only if there is a long term plan

 Market Timing
MF’s vs. MF holders – Activity

• Fact#1: From 1984 through 1995, the average stock mutual

fund in the USA posted a yearly return of 12.3%, while the
average bond mutual fund returned 9.7% a year

• Fact#2: From 1984 through 1995, the average investor in a

stock mutual fund earned 6.3%, while the average investor in
a bond mutual fund earned 8%

• What’s wrong with this picture?

 Market Timing
• Time is the key to successful investing

• It’s time in the market, not Timing the market that’s

important

• Types of Investment Strategies

– Buy and Hold Strategy: Invest in a few well researched
funds and hold onto them for a long time through thick
and thin
– Flit in and out of a variety of funds, in an effort to
maximize results
 SIP’s
• What is market volatility?
– How does it affect investments?
– Is volatility good or bad?
– How does one use volatility to one’s advantage?

Activity –
• David invests $6000 as a lump sum investment
• Peter invests the same amount, but in multiples of $1000
each month for 6 months.

• Given a simulated market volatility environment, who has a

higher probability of having earned more return on
investment – David or Peter?
 Dollar Cost Averaging
• Ask any professional investor – “What is the hardest investment task?”
– Picking the bottoms and tops in the market
– Trying to time the market is a very tricky strategy
– Solution – Dollar Cost Averaging (DCA)

• What is Dollar Cost Averaging?

– The process of buying, regardless of the share price, a fixed dollar amount of a
particular investment on a regular schedule

• Benefits of DCA?
– You gain whether the share prices go up or down
– When they go up, the value of the investment you have already goes up
– When they go down, you get more units for the same price
– Your entire capital is not at risk because it is being drip-fed into the market
 The inherent volatility of equity prices
is used to enhance returns while
reducing the time your entire capital is
exposed to the market
 Asset Allocation
• Asset allocation is an investment portfolio technique that aims
to balance risk and create diversification by dividing assets
among major categories such as bonds, stocks, real estate,
and cash
• Each asset has different levels of return and risk, so each will
behave differently over time
• The underlying principle or asset allocation is that the older a
person gets, the less risk he or she should take on
• After you retire, you may have to depend on your savings as
your only source of income. Hence you should invest more
conservatively because asset preservation is crucial at this
time in life
 Random Walk Theory
• Random Walk Theory gained popularity in 1973 when Burton
Malkiel wrote “A Random Walk Down Wall Street” a book that
is now regarded as an investment classic

• Random walk is a stock market theory that states that the

past movement or direction of the price of a stock or overall
market cannot be used to predict its future movement

• Stock price fluctuations are independent of each other and

have the same probability distribution, but that over a period
of time, prices maintain an upward trend

• In short – random walk says that stocks take a random and

unpredictable path
 Random Walk Theory
• The chance of a stock’s future price going up is the same as it
going down

• A follower of random walk believes it is impossible to

outperform the market without assuming additional risk

• Malkiel constantly states that a long term buy and hold

strategy is the best and that individuals should not attempt
to time the markets. Attempts based on technical,
fundamental, or any other analysis are futile

• Random walk has never been a popular concept with those

on Wall Street, probably because it condemns the concepts
on which it is based such as analysis and stock picking
 Efficient Market Hypothesis
• Efficient market hypothesis is an idea developed in
the 1960s by Eugene Fama
– It is impossible to beat the market because prices already
incorporate and reflect all relevant information

• Supporters of this model believe it is pointless to

search for undervalued stocks or try to predict trends
in the market through fundamental analysis or
technical analysis
– Any time you buy and sell securities, you are engaging in a
game of chance, not skill.
– If markets are efficient and current, it means that prices
always reflect all information, so there is no way you will
ever be able to buy a stock at a bargain price
 Efficient Market Hypothesis
• Highly controversial and often disputed theory

• The theory has been met with a lot of opposition, especially

from the technical analysts

• Their argument against the efficient market theory is that

many investors base their expectations on past prices, past
earnings, track records and other indicators. Because stock
prices are largely based on investor expectations, many
believe it only makes sense to believe that past prices
influence future prices
 The Optimal Portfolio
• This theory assumes that investors try as much as possible to
avoid risk while obtaining the highest return possible

• Investors will act rationally in making decisions based on

maximizing their return for the level of risk that is acceptable
for them

• The Optimal Portfolio shows us that it is possible to have a

different number of portfolios that have varying levels of risk
and return
– Each investor must decide how much risk they can handle and allocate
(or diversify) their portfolio accordingly to this decision
The Optimal Portfolio
 Capital Asset Pricing Model
• CAPM – describes the relationship between risk and
expected return, and serves as a model for the
pricing of risky securities

– CAPM says that the expected return of a security or a

portfolio equals the rate on a risk-free security plus a risk
premium
– If this expected return does not meet or beat our required
return then the investment should not be undertaken
– Formula to describe the CAPM relationship
• Required (or expected) Return = RF Rate + (Market Return – RF
Rate) * Beta
 Capital Asset Pricing Model
Lets take an example -
• Current risk rate = 5%
• S&P 500 is expected to return 12% next year
• You are interested in determining the return that Joe’s Oyster
Bar Inc (JOB) will have next year
• JAB has a beta value of 1.9
– Overall stock market has a beta of 1
– JOB’s beta of 1.9 means it is more risky than the overall market
– This extra risk means we should expect a higher potential return than
the 12% for the S&P 500

Required (or expected) Return = 5% + (12% - 5%) * 1.9

Required (or expected) Return = 18.3%
 Conclusion
• Your investments gain most from compounded interest when
you have time on your side
• Investing late means you need to invest that much more to
derive a similar return on investment
• Return on risk free cash investments may look good, but when
you factor in inflation, it is not as impressive
• The risk/return tradeoff is the balance between the desire for
the lowest possible risk against the highest possible return
• More risk equals greater possible return
• Diversification lowers the risk of your portfolio
• Dollar cost averaging is a technique where a fixed dollar
amount is invested on a regular schedule, regardless of the
share price
 Conclusion
• Asset allocation divides assets among major categories in
order to create diversification and balance the risk
• Random Walk Theory says that stocks take a random and
unpredictable path
• Efficient Market Hypothesis (EMH) says it is impossible to beat
the market because prices already incorporate and reflect all
relevant information
• Optimal portfolio is a model that attempts to show how
rational investors will maximize their return for the level or
risk that is acceptable to them
• CAPM describes the relationship between risk and expected
return, and serves as a model for he pricing or risky securities
FINANCIAL MARKETS [AN
INTRODUCTION]
 FINACIAL MARKETS – AN INTRODUCTION

• Purpose
– An introduction to financial markets
– Covers the role of the financial markets and their key
functions including borrowing & lending, price
determination, information aggregation and coordination,
risk sharing, liquidity and efficiency
– Covers the major players in the market like brokers,
dealers, Investment banks, financial intermediaries etc as
well as financial market structures like auction markets,
OTC markets, organized exchanges, intermediation
financial markets, security markets
 Basic terms
• An asset
– Anything of durable value
– Anything that acts as a means of storing value over a period of time
• Real assets
– Assets in physical form (house, land, equipment etc)
– Including human capital assets embodied in people (skills, natural
abilities, knowledge etc)
• Financial assets
– Claims against real assets either directly (stock share equity claims) or
indirectly (money holdings or claims to future income streams that
originate ultimately from real assets)
 Basic terms
• Securities
– Financial assets exchanged in auction and over-the-counter markets
whose distribution is subject to legal requirements and restrictions
(e.g., information disclosure requirements)
• Lenders
– People who have available funds in excess of their desired
expenditures that they are attempting to loan out
• Borrowers
– People who have a shortage of funds relative to their desired
expenditures who are seeking to obtain loans. Borrowers attempt to
obtain funds from lenders by selling to lenders newly issued claims
against the borrowers' real assets, i.e., by selling the lenders newly
issued financial assets
 Basic terms
• Financial markets
– A market in which financial assets are traded
• Enable exchange of previously issued financial assets
• Facilitate borrowing and lending by facilitating the sale by newly issued financial
assets
• Examples of financial markets include
– The New York Stock Exchange (resale of previously issued stock shares)
– The U.S. government bond market (resale of previously issued bonds)
– U.S. Treasury bills auction (sales of newly issued T-bills)
– An institution whose primary source of profits is through financial asset
transactions
• Examples of such financial institutions include
– Discount brokers (e.g., Charles Schwab and Associates)
– Banks
– Insurance companies
– Complex multi-function financial institutions such as Merrill Lynch.
 Functions of Financial Markets
• Six basic functions
– Borrowing & Lending
• Financial markets permit the transfer of funds (purchasing power)
from one agent to another for either investment or consumption
purposes
– Price determination
• Financial markets provide vehicles by which prices are set both for
newly issued financial assets and for the existing stock of financial
assets
– Information aggregation & coordination
• Financial markets act as collectors and aggregators of information
about financial asset values and the flow of funds from lenders to
borrowers
 Functions of Financial Markets
• Six basic functions…
– Risk sharing
• Financial markets allow a transfer of risk from those
who undertake investments to those who provide
funds for those investments
– Liquidity
• Financial markets provide the holders of financial
assets with a chance to resell or liquidate these assets
– Efficiency
• Financial markets reduce transaction costs and
information costs
In attempting to characterize the way financial
markets operate, one must consider both the
various types of financial institutions that
participate in such markets and the various
ways in which these markets are structured
 Major players in financial markets
• By definition, financial institutions are institutions
that participate in financial markets, i.e., in the
creation and/or exchange of financial assets.
• At present in the United States, financial institutions
can be roughly classified into the following four
categories
– Brokers
– Dealers
– Investment banks
– Financial intermediaries
 Brokers
• A commissioned agent of a buyer (or seller)
who facilitates trade by locating a seller (or
buyer) to complete the desired transaction
• A broker does not take a position in the
assets he or she trades -- that is, the broker
does not maintain inventories in these
assets
• Profits of brokers are determined by the
commissions they charge to the users of
their services (either the buyers, the sellers,
or both)
• Brokers could mean the inclusion of real
Illustration of a stock broker
 
Payment ---------------- Payment
------------>| |------------->
Stock | | Stock
Buyer | Stock Broker | Seller
<-------------|<----------------|<-------------
Stock | (Passed Thru) | Stock
Shares ----------------- Shares
 Dealers
• Like brokers
– Dealers facilitate trade by matching buyers with sellers of assets
– They do not engage in asset transformation
• Unlike brokers
– A dealer can and does "take positions" (i.e., maintain inventories) in
the assets he or she trades that permit the dealer to sell out of
inventory rather than always having to locate sellers to match every
offer to buy
– Dealers do not receive sales commissions. They make profits by buying
assets at relatively low prices and reselling them at relatively high
prices (buy low - sell high)
• The price at which a dealer offers to sell an asset (the "asked price") minus
the price at which a dealer offers to buy an asset (the "bid price") is called
the bid-ask spread and represents the dealer's profit margin on the asset
exchange

Real-world examples of dealers include car dealers, dealers in U.S.

Illustration of a bond dealer
Payment ----------------- Payment
------------>| |------------->
Bond | Dealer | Bond
Buyer | | Seller
<-------------| Bond Inventory |<-------------
Bonds | | Bonds
-----------------
 Investment banks
• An investment bank assists in the initial sale of newly
issued securities (i.e., in IPOs = Initial Public
Offerings) by engaging in a number of different
activities:
– Advice: Advising corporations on whether they should
issue bonds or stock, and, for bond issues, on the
particular types of payment schedules these securities
should offer;
– Underwriting: Guaranteeing corporations a price on the
securities they offer, either individually or by having
several different investment banks form a syndicate to
underwrite the issue jointly;
– Sales Assistance: Assisting in the sale of these securities to
the public.
 Financial intermediaries
• These are financial institutions that engage in financial asset
transformation
– i.e. they purchase one kind of financial asset from borrowers (generally some
kind of long-term loan contract whose terms are adapted to the specific
circumstances of the borrower - e.g., a mortgage) and sell a different kind of
financial asset to savers (generally some kind of relatively liquid claim against
the financial intermediary - e.g., a deposit account
– They also typically hold financial assets as part of an investment portfolio
rather than as an inventory for resale. In addition to making profits on their
investment portfolios, financial intermediaries make profits by charging
relatively high interest rates to borrowers and paying relatively low interest
rates to savers
 Financial intermediaries
• Types of financial intermediaries include
– Depository Institutions
• Commercial banks, savings and loan associations, mutual savings banks,
credit unions
– Contractual Savings Institutions
• Life insurance companies, fire and casualty insurance companies, pension
funds, government retirement funds
– Investment Intermediaries
• Finance companies, stock and bond mutual funds, money market mutual
funds
Illustration of a Financial Intermediary: A Commercial Bank

Lending by B Borrowing by B
 
deposited
------- funds ------- funds -------
| |<............. | |<............. | |
| F |.............> | B |..............> | H |
------- loan ------- deposit -------
contracts accounts
 
Loan contracts Deposit accounts
issued by F to B issued by B to H
are liabilities of F are liabilities of B
and assets of B and assets of H
 
NOTE: F=Firms, B=Commercial Bank, and H=Households
Caution: These four types of financial institutions are simplified
idealized classifications, and many actual financial institutions
in the fast-changing financial landscape today engage in
activities that overlap two or more of these classifications, or
even to some extent fall outside these classifications.

A prime example is Merrill Lynch, which simultaneously acts as a

broker, a dealer (taking positions in certain stocks and bonds it
sells), a financial intermediary (e.g., through its provision of
mutual funds and CMA checkable deposit accounts), and an
investment banker
 Types of financial market structures
• What determines the types of financial market structures that
may emerge?
– The costs of collecting and aggregating information
• These financial market structures take four basic forms
– Auction markets conducted through brokers
– OTC (over the counter) markets conducted through dealers
– Organized exchanges
• E.g. the NYSE, which combines auction and OTC market features.
Specifically, organized exchanges permit buyers and sellers to trade with
each other in a centralized location, like an auction. However, securities
are traded on the floor of the exchange with the help of specialist traders
who combine broker and dealer functions. The specialists broker trades
but also stands ready to buy and sell stocks from personal inventories if
buy and sell orders do not match up
– Intermediation financial markets conducted through financial
intermediaries

Note: Financial markets taking the first three forms are generally referred
 Auction markets
• It is some form of centralized facility (or clearing house) by which buyers
and sellers, through their commissioned agents (brokers), execute trades
in an open and competitive bidding process
• The "centralized facility" is not necessarily a place where buyers and
sellers physically meet. Rather, it is any institution that provides buyers
and sellers with a centralized access to the bidding process
• All of the needed information about offers to buy (bid prices) and offers to
sell (asked prices) is centralized in one location which is readily accessible
to all would-be buyers and sellers, e.g., through a computer network
• No private exchanges between individual buyers and sellers are made
outside of the centralized facility
 Auction markets
• This is typically a public market in the sense that it open to all
agents who wish to participate
• Auction markets can either be
– call markets
• such as art auctions, for which bid and asked prices are all posted at one
time
– or continuous markets
• such as stock exchanges and real estate markets, for which bid and asked
prices can be posted at any time the market is open and exchanges take
place on a continual basis
 Auction markets
• Many auction markets trade in relatively homogeneous assets (e.g.
Treasury bills, notes & bonds) to cut down on information costs
• Alternatively, some auction markets (e.g., in second-hand jewelry,
furniture, paintings etc.) allow would-be buyers to inspect the goods to be
sold prior to the opening of the actual bidding process. This inspection
tour can take the form of a
– Warehouse tour
– A catalog issued with pictures and descriptions of items to be sold
– Or (in televised auctions) a time during which assets are simply displayed one
by one to viewers prior to bidding.
 Auction markets
• Auction markets depend on participation for any one
type of asset not being too "thin"
• The costs of collecting information about any one
type of asset are sunk costs independent of the
volume of trading in that asset
– Consequently, auction markets depend on volume to
spread these costs over a wide number of participants
 OTC (Over the counter) markets
• This has no centralized mechanism or facility for trading
• Instead, the market is a public market consisting of a number
of dealers spread across a region, a country, or indeed the
world, who make the market in some type of asset.
– That is, the dealers themselves post bid and asked prices for this asset
and then stand ready to buy or sell units of this asset with anyone who
chooses to trade at these posted prices.
– The dealers provide customers more flexibility in trading than brokers,
because dealers can offset imbalances in the demand and supply of
assets by trading out of their own accounts. Many well-known
common stocks are traded over-the-counter in the United States
through NASDAQ (National Association of Securities Dealers’
Automated Quotation System)
 Intermediation Financial Markets
• This is a financial market in which financial intermediaries
help transfer funds from savers to borrowers by issuing
certain types of financial assets to savers and receiving other
types of financial assets from borrowers
• The financial assets issued to savers are claims against the
financial intermediaries, hence liabilities of the financial
intermediaries, whereas the financial assets received from
borrowers are claims against the borrowers, hence assets of
the financial intermediaries
 EQUITIES
[AN INTRODUCTION]
 Basics
• What are Equities?
– An equity is a security that confers on the holder an
ownership interest in the issuer
• So, what are the key types of securities?
• To understand this, let’s examine two categories of
securities markets
– Primary market & Secondary market
– Debt market & Equity market
 Primary and Secondary markets
• Primary market
– These are securities markets in which newly issued
securities are offered for sale to buyers
• Secondary markets
– These are securities markets in which existing
securities that have previously been issued are
resold.

• The initial issuer raises funds only through the

primary market
 Debt and Equity markets
• Debt
– Debt instruments are particular types of securities that require the
issuer (the borrower) to pay the holder (the lender) certain fixed dollar
amounts at regularly scheduled intervals until a specified time (the
maturity date) is reached, regardless of the success or failure of any
investment projects for which the borrowed funds are used
– A debt instrument holder only participates in the management of the
debt instrument issuer if the issuer goes bankrupt
– An example of a debt instrument is a 30-year mortgage.
 Debt and Equity markets
• Equity
– An equity is a security that confers on the holder
an ownership interest in the issuer
– There are two general categories of equities
• Preferred stock and
• Common stock
 Common stock
• Common stock shares issued by a corporation are
claims to a share of the assets of a corporation as
well as to a share of the corporation's net income
– i.e., the corporation's income after subtraction of taxes
and other expenses, including the payment of any debt
obligations
– This implies that the return that holders of common stock
receive depends on the economic performance of the
issuing corporation.
 Common stock
• Holders of a corporation's common stock typically participate
in any upside performance of the corporation in two ways
– By receiving a share of net income in the form of dividends, and
– By enjoying an appreciation in the price of their stock shares
• However, the payment of dividends is not a contractual or
legal requirement
– Even if net earnings are positive, a corporation is not obliged to
distribute dividends to shareholders
• For example, a corporation might instead choose to keep its profits as
retained earnings to be used for new capital investment (self-financing of
investment rather than debt or equity financing).
 Preferred stock
• Preferred stock shares are usually issued
– With a par value (e.g., $100), and
– Pay a fixed dividend expressed as a percentage of par value
• Preferred stock is a claim against a corporation's cash flow that is prior to
the claims of its common stock holders but is generally subordinate to the
claims of its debt holders
• In addition, like debt holders but unlike common stock holders, preferred
stock holders generally do not participate in the management of issuers
through voting or other means unless the issuer is in extreme financial
distress (e.g., insolvency)
• Consequently, preferred stock combines some of the basic attributes of
both debt and common stock and is often referred to as a hybrid security
 Debt vs. Equity - basics
• Why does a company issue stock when it can keep all the
profits to themselves?
– Because, at some point, all companies need to raise money
• A company has two avenues to raise money
– Debt financing
• When the company takes a loan from the bank or issues bonds, and
– Equity financing
• When the company issues stock of the company
• Issuing stock is advantageous for a company because
– It does not require them to pay back the money or
– To make interest payments along the way
 Debt vs. Equity - basics
• When you buy a debt investment like a bond, it guarantees
– The principal payment, and
– Promised interest payments
• An equity investment does not guarantee either
– If the company goes bankrupt, as an equity investor you get paid only
after the banks (creditors) and the bond holders have been paid
• However, if the company is successful, as an equity investor
you stand to earn more than the bond holders
 Market Capitalization
• One of the main ways to categorize stocks is by their
market capitalization, sometimes known as market
value
• Market cap is calculated by multiplying a company’s
current stock price by the number of its existing
shares
• For eg –
– A stock with a current market value of $30 a share and a
hundred million shares of existing stock would have a
market cap of $3 billion
 Market Capitalization ……contd
• Stocks are usually designated large-cap,
medium or mid-cap, and small-cap.
• Some experts also add a special category of
micro-caps, or stocks with even smaller
market capitalization
• In general large cap stocks are less volatile
than small-cap stocks
Market Capitalization
 Ways to purchase Stock
• Using a Brokerage
• DRIPs or DIPs
 Using a Brokerage
• Full Service Brokerage
– Offer expert advice
– Manage your account
– Expensive
• Discount Brokerage
– Less personal attention
– Much cheaper
 DRIPs or DIPs
• Dividend Reinvestment Plans (DRIPs) or Direct
Investment Plans (DIPs)
– Plans with which individual companies, for a
minimal cost, allow shareholders to purchase
stock directly from the company
– DRIPs are great ways to invest small amounts of
money at regular intervals
 Animals in the Farm
• Bulls
• Bears
• Chickens
• Pigs
 Animals in the Farm ……contd
BULLS
• When everything in the economy is great – people
are finding jobs, GDP is growing, and stocks are rising
• Picking stocks during a bull market is easier because
everything is going up
• If a person is optimistic, believing that stocks will go
up, he or she is called a “bull” and is said to have a
“bullish outlook”
 Animals in the Farm ……contd
BEARS
• When the economy is bad, recession is looming,
and stock prices are falling
• Bear markets make it tough for investors to pick
profitable stocks
• One solution to make money when stocks are
falling is using a technique called short selling
• If a person is pessimistic, believing that stocks are
going to drop, he or she is called a “bear” and is
said to have a “bearish outlook”
 Animals in the Farm ……contd
CHICKENS
• Afraid to lose anything
• Their fear overrides their need to make profits
and so they turn only to money market
securities or get out of the markets altogether
 Animals in the Farm……contd
PIGS
• High risk investors looking for that one big
score in a short period of time
• Pigs buy on hot tips and invest in companies
without doing their due diligence
• Professional traders love the pigs, as its often
from their losses that the bulls and bears reap
their profits
 Common Investor Behavior

• There are various types of investment styles

and strategies
• Even though the bulls and the bears are
constantly at odds, they can both make
money with the changing cycles in the
market
• Even the chickens see some returns, though
not a lot
• The only loser is the pig!
 Common Investor Behavior ……
contd
• Make sure you don’t get into the market
before you are ready
• Be conservative and never invest in anything
you do not understand
• Before you jump in without the right
knowledge, think about the old market saying
– “Bulls make money, bears make money, but
pigs just get slaughtered!!”
 BONDS
Primary & Secondary Markets
 Introduction
• Newly issued bonds are sold in the primary markets,
where bonds are available directly to investors
without any intermediary – or any commission
• Brokers and banks may buy large amount of bonds in
the primary market, and then sell them to investors
in the secondary market, where bonds are bought
and sold after they are issued
• It is common for a bond to change hands a number
of times in the secondary market before it matures
 The Primary Market
• If you buy a bond when its issued, or sold for the
first time, you typically pay par value, or the face
value of the bond
• If you hold the bond until it matures, you earn the
coupon rate for as long as you own the bond, and
the yield is the same as the coupon rate
• At maturity you get par value back
• Example –
– If you buy $10,000 worth of 10 year fixed-rate bonds
paying 4.5% at issue and hold your investment to
maturity, the rate and the yield are both 4.5%. You
would earn $4,500 in interest ($450 a year for ten
years) and get $10,000 back at the end of the term
 The Secondary Market
• When you buy or sell bonds after the date they
are issued, they trade on what’s known as the
secondary market.
• This is where most bond trading occurs
• The corporation, government, or agency that
issued the bond gets no income from these
secondary trades as it does when it first issues the
bonds in the primary market
• When the bond matures, the issuer repays the par
value to the current owner
• If you buy in a secondary market, you may buy at
par value, at a premium, or at a discount
 The Secondary Market ……contd
• Buying at a premium
– You pay more than the par value
– Usually bonds sell at a premium when their coupon
rate is higher than the prevailing rate on similar bonds
– Although you’ll earn a higher rate, your yield will be
lower than the bond’s coupon rate since you paid more
for the bond
• Buying at a discount
– You pay less than par
– Bond is likely to be paying an interest rate that is lower
than the current rate
– Yield will be higher than the coupon rate since you paid
less for the bond
US BOND
MARKET
 Introduction – Bond Market
Bond market - 3 main groups
– ISSUERS – Sell bonds or other debt instruments
• Governments, Banks & Corporations
– UNDERWRITERS – helps the issuers to sell the
bonds
• Investment Banks & Other Financial institutions
– PURCHASERS – those who buy the debt
• All players mentioned above, other investors &
individuals
 Various Types of Bonds
• US Government Bonds
• Municipal Bonds
• Corporate Bonds
• Zero Coupon Bonds
• Agency Bonds
• Inflation Index Bonds
• Junk Bonds
• Brady Bonds
• Savings Bonds
 US Government Bonds
• Fixed Income securities
• Classified according to the length of time before maturity.
– US Treasury Bills – maturities from 90 days to one year
– US Treasury Notes – maturities from two to 10 years
– US Treasury Bonds – maturities from 10 to 30 years
• Marketable securities from the US Government and are
collectively called Treasuries.
• They are widely regarded as the safest bond investments, as
they are backed by the US Government
• Income earned is exempt from state and local taxes
 US Government Bonds ……contd
How US Treasury Bonds work?
• US Government – the most reliable borrower in the
world, never defaulted on a loan
• Since they are the safest in the world – lower yields
than other bonds of the same maturity
• Only risk – you can’t predict what price you will get
for your bond if you have to sell before maturity
 US Government Bonds ……contd
How US Treasury Bonds work?....contd
• Interest payments are exempt from local and state
taxes (not from Federal income tax)
• You can buy Treasuries through a broker, or you can
buy them directly from the federal government,
which holds regular auctions that individual investors
can participate in
• If you buy from the government, you can’t redeem
the security prior to maturity. You have to use the
services of a broker to sell your bonds in the
secondary market
 US Government Bonds ……contd
Treasury Bonds, Bills and Notes
• All issued in face values of $1000, though there
are different purchase minimums for each type of
security
• Investors shorten the word Treasury to the letter
“T”. Hence they are called T-Bonds, T-Notes and T-
Bills
• No matter what you buy, you can often get a
better deal when you buy direct.
– This program is called Treasury Direct, and it allows you
to set up an account to make purchases of Treasury
securities at auctions
 Municipal Bonds
• Also knows as “munis”
• Major advantage to munis is that the returns are
free from city, state and federal taxes
• Good investment on an after-tax basis
• Step up on the risk scale from Treasuries
• Munis are what help local or state government
pay for public projects
– Construction or improvement of schools, streets,
highways, hospitals, bridges, low income housing,
water and sewer projects, ports, airports and other
public works
 Municipal Bonds……contd
• Munis are usually high quality issues, since
the governments that stands behind the
bonds are generally not in danger of going
bankrupt
• Some municipal bond issuers purchase
insurance to guarantee that their bonds will
be repaid
– Who pays for this insurance?
• Bond holders in the form of a lower return
 Municipal Bonds……contd
• Tax savings with munis
– Minis are called tax-free as they are exempt from
federal tax
– If you buy a munis issued by your state, you don’t
pay state income tax on the interest – double tax
free munis
– And if you buy a muni issued by the city or locality
where you live, you don’t have to pay local income
taxes – so triple tax free!
 Municipal Bonds……contd
RISK FACTORS –
• Credit risk – If the issuer is unable to meet its financial
obligations
• Interest Rate Risk – If the interest rates in the market
place rise, the bond you own will be paying a lower yield
relative to the yield offered by a newly issued bond
• Call Risk – Many bonds allow the issuer to repay all or a
portion of the bond prior to the maturity date
• Market Risk – Price of bonds change in response to market
conditions. If interest rates rise, newly issued bonds will
pay a higher yield than existing issues
 Corporate Bonds
• Companies have three choices when they want to
raise cash
– Issue shares of stock
– Borrow from the bank
– Borrow from investors by issuing bonds
• Most corporate bonds are fixed-rate bonds
– Interest rate fixed until maturity
• Some corporates use floating rates to determine the
exact interest rate paid to bond holders
 Corporate Bonds ……contd
• Characterized by higher yields because there is a higher risk of
a company defaulting than a government
• They can also be the most rewarding fixed-income investment
because of the risk the investor must take on
• Corporate bonds – Several maturities
– Short term : One to five years
– Intermediate term – five to 15 years
– Long term – longer than 15 years
• Convertible Bonds – holder can convert into stock
• Callable Bonds – allows a company to redeem an issue prior
to maturity
 Corporate Bonds ……contd
• The credit quality of companies and governments is
closely monitored by debt-rating agencies. These
agencies evaluate corporations and other bond
issuers and their fiscal strength.
– Standard & Poor's
– Moody's
– Fitch IBCA
• They assign credit ratings based on the entity's
perceived ability to pay its debts over time
• Those ratings -- expressed as letters
– Aaa, Aa, A, Baa, Ba, B, Caa, Ca, C
 Corporate Bonds ……contd
RISKS OF INVESTING IN BONDS
• Interest Rate Risk
– Risk that the bond prices will fall as interest
rates rise
– Should the market interest rate rise from the
date of the bond’s purchase, the bond price
will fall accordingly
– The bond will then be trading at a discount to
reflect the lower return than an investor will
make on the bond
 Corporate Bonds ……contd
RISKS OF INVESTING IN BONDS....contd
• Reinvestment Risk
– The risk that the proceeds from a bond will be
reinvested at a lower rate than the bond originally
provided
– Eg – If an investor bought a $1000 bond that had an
annual coupon of 12%. Each year the investor receives
$120, which can be reinvested back into another bond.
But if over time the market rate falls to 1%. Suddenly,
that $120 received from the bond can only be
reinvested at 1%, instead of the 12% rate of the
original bond
 Corporate Bonds ……contd
RISKS OF INVESTING IN BONDS....contd
• Call Risk
– The risk that the bond will be called by its issuer
– Callable bonds have call provisions, which allow
the bond issuer to purchase the bond back from
the bondholders and retire the issue
– This is usually done when interest rates have fallen
substantially since the issue date
 Corporate Bonds ……contd
RISKS OF INVESTING IN BONDS…contd
• Default Risk
– The risk that the bond’s issuer will be unable to pay the
contractual interest or principal on the bond in a timely
manner, or at all.
– Credit ratings services such as Moody’s, Standard and
Poor’s and Fitch give credit ratings to bond issues, which
help to give investors an idea of how likely it is that a
payment default will occur
 Corporate Bonds ……contd
RISKS OF INVESTING IN BONDS….contd
• Inflation Risk
– The risk that the rate of price increase in the economy
deteriorates the returns associated with the bond
– This has the greatest effect on fixed bonds, which have
a set interest rate from inception.
– For eg. – if an investor purchases a 5% bond and then
inflation rises to 10% a year, the bondholder will lose
money on the investment because the purchasing
power of the proceeds has been greatly diminished.
– Interest rates of floating rate bonds (floaters) are
adjusted periodically to match inflation rates, limiting
investors exposure to inflation risk
 Zero Coupon Bonds
• Fixed-income securities that don't make interest
payments each year like regular bonds
• The bond is sold at a deep discount to its face value
and at maturity, the bondholder collects all of the
compounded interest, plus the principal
• Zeros do have a tax drawback, however, unless you
hold them in a tax-deferred retirement account or an
education IRA (Individual Retirement Account)
 Zero Coupon Bonds……contd
Advantages
• Zeros are usually priced aggressively and are useful for
investors who are looking for a set payout on a given date
• People saving for college tuition and retirement are the prime
targets
• The SmartMoney college portfolios make use of zero-coupon
Treasuries -- known as Treasury strips -- for two reasons
– you can buy them in a maturity that matches the date your child will
enter college
– generally have a slightly higher yield than a regular bond
Zero Coupon Bonds……contd

Zero Coupon Vanilla or

Bonds Straight Bonds
 Agency Bonds
• Issued by other Government agencies (usually at the
federal level) to finance their activities
• These bonds help support projects relevant to public
policy
– Farming, small business, loans to first time home buyers
• These bonds do not carry the full faith and credit
guarantee of Government issued bonds, but
investors are likely to hold them in high regard as
they are issued by a government agency
 Agency Bonds……contd
Federal Agencies that issue Bonds
• Federal National Mortgage Association (Fannie Mae)
• Federal Home Loan Mortgage Corporation (Freddie
Mac)
• Farm Credit System Financial Assistance Corporation
• Federal Agricultural Mortgage Corporation (Farmer
Mac)
 Agency Bonds……contd
Federal Agencies that issue Bonds….contd
• Federal Home Loan Banks
• Student Loan Marketing Association (Sallie Mae)
• College Construction Loan Insurance Association
(Connie Lee)
• Small Business Administration (SBA)
• Tennessee Valley Authority (TVA)
Most investors are institutional, however individuals
can also invest in this segment of debt securities
 Inflation Index Bonds
• Gives both individual and institutional investors a
chance to buy a security that keeps pace with
inflation
• US Treasury pays you interest on the inflation
adjusted principal amount
• Competitive bidding before the security’s issue
determines the fixed interest or coupon rate
• At maturity, the Treasury redeems your securities
at their inflation adjusted principal or par amount,
whichever is greater
 Inflation Index Bonds ……contd
• The securities values are periodically adjusted for
inflation, and the principal you receive when they
mature won’t drop below the par amount at which
they were originally issued.
• Like other Treasury securities, they are safe – backed
by the full faith and credit of the US Government
• Exempt from state and local taxes, although federal
income taxes apply
 Junk Bonds
All bonds are characterized according to their credit
quality and therefore fall into two broad categories
– Investment Grade : bonds issued by low to medium risk lenders
– Junk Bonds : issued by high risk lenders

JUNK BONDS
• High yields, high risk!
• Very low credit ratings
• They pay high yields to bondholders, as it is difficult for
them to acquire capital at an inexpensive cost
 Junk Bonds ……contd
• Can be broken into 2 categories
– Fallen Angels : Bond that was once investment
grade but has since been reduced to junk bond
status because of the issuing company’s poor
credit quality
– Rising Stars – Bond whose rating has been
increased because of the issuing company’s
improving credit quality. A rising star may still
be a junk bond but on its way to being
investment quality
 Brady Bonds
• Named after the former US Treasury Secretary –
Nicholas Brady
• Nicholas Brady, along with the IMF (International
Monetary Fund) and the World Bank, led the debt
reduction plan for LDCs (Less Developed
Countries)
• Idea was to restructure the debts of an LDC,
allowing that country to achieve economic growth
and make interest payments, by converting the
defaulted loans into a bond to ensure payment of
capital
 Brady Bonds ……contd
• Most Brady Bonds are denominated in US dollars,
but there are also bonds denominated in the
currencies of several other countries
• Coupon bearing bonds with fixed, step or floating
rate (or a combination of each)
• Maturities between 10 to 30 years
• Bonds issued at either par or discount
• Most issuers are Latin American countries
 Savings Bonds
• Vehicle of choice for millions of Americans to reach
their savings goals
• Knows by their series names eg Series EE or Series
HH
• Can be bought at most banks, with as little as $25
• Many companies offer a payroll savings plan to allow
their employees to automatically withhold money
from each paycheck that goes to purchase savings
bonds
 Savings Bonds ……contd
• Purchase price is always half of the face value
– $50 bond costs $25, $10000 bond costs $5000
• Bonds available in 8 different denominations
– $50, $75, $100, $200, $500,. $1000, $5000 & $10000
• Liquid investments – easy to cash in on your
savings bonds if you need money
• No penalty if you cash in your savings bonds
anytime after the first six months that you’ve
owned them, and you can cash them in at any
bank
 Savings Bonds ……contd
• The principal and interest of savings bonds are
guaranteed by the full faith and credit of the US
Government
• If you ever lose a savings bond it can be replaced
• Interest on savings bonds is exempt from state and
local income taxes
• Federal income taxes are postponed until you cash
your bond, or until it stops earning interest
 Savings Bonds ……contd
• When a savings bond reaches maturity, it doesn’t
stop accumulating interest like most other bonds
• After maturity it is automatically extended for 10
years, and can be extended for additional periods
following that.
• Interest continues to accrue on the bonds during
these extensions
• If bonds are used for college expenses then interest
can be exempt from tax
 Savings Bonds ……contd
INFLATION LINKED SAVINGS BONDS
• Offer investors inflationary protection, as their yields
are tied to the inflation rate
• Usually exempt from income tax – hence provide a
more attractive after tax return
• Available directly from the US Treasury, these debt
securities are an exceptionally low risk investment
suitable for the most risk averse investor, they have
virtually zero default risk and inflationary risk
 Bond Strategies
• Whether you are just starting your investing
career or have already amassed some
wealth, your portfolio needs some steady
and reliable income
• For younger people, that income will
balance out the periodic dips in a stock
dominated asset mix
• For those in retirement, it will provide
money to live on
 Bond Laddering
• One popular way that investors can help to balance
the risk and return in a bond portfolio is to use a
technique called laddering
• Building a laddered portfolio means that you buy a
collection of bonds with different maturities spread
out over your investment time frame
• For eg – in a 10 year laddered portfolio, you might
purchase bonds that mature in 1,2,3,4,5,6,7,8,9 & 10
years
 Bond Laddering……contd
• When the first bond matures in a year,
you’d reinvest in a bond that matures in ten
years, thereby preserving the ladder (and
so on for each year)
• Rationale behind laddering is quite simple –
– When you buy bonds with short term
maturities, you have a high degree of stability,
but because these bonds are not very sensitive
to changing interest rates, you have to accept
lower yields
 Bond Laddering……contd
• Rationale behind laddering….contd
– When you buy bonds with long term
maturities, you can receive a higher yield, but
you must also accept the risk that the prices of
the bonds may change
– With a laddered portfolio you would realize
greater returns than from holding only short
term bonds
– By spreading out the maturities of your
portfolio, you get protection from interest
changes
 Bond vs Bond Funds
• Bonds are complex, if you are a novice
investor. Which is why a lot of people opt
for bond funds
• Like an equity mutual fund, a bond fund is
managed by a professional investor who
buys a portfolio of securities and makes all
the decisions
• Most funds buy bonds of a specific type,
maturity and risk profile
 Bond vs Bond Funds……contd
• Bond funds pay out a coupon to investors – often
monthly, rather than annually or semiannually like a
regular bond
• If you lack time and interest to manage a bond
portfolio on your own – or you want a mixed
portfolio or corporates or municipals – buy a bond
fund
• However if you want a tailored portfolio that matures
at a certain age, and want to avoid fees etc go ahead
with direct bonds
 Bond vs Bond Funds……contd
Advantages of Bond Funds -
• Convenient
• For corporate and municipal bonds – a professional
manager backed by a strong research organization can
make better decisions than an average individual investor
Disadvantages of Bond Funds -
• It is not a bond
• Fees and expenses that can cut into returns
• They have neither a fixed yield nor a contractual obligation
to give investors back their principal at some later
maturity date
INVESTMENT
COMPANIES
An Introduction
 What are Investment Companies?
• An “Investment Company” is a company that issues
securities, and is primarily engaged in the business of
investing in securities
• An investment company invests the money it
receives from investors on a collective basis, and
each investor shares in the profits and losses in
proportion to the investor’s interest in the
investment company
• The performance of the investment company will be
based on (but not identical to) the performance of
the securities and other assets that the investment
company owns
Types of Investment Companies
• Mutual Funds
– Legally knows as open-end companies
– Redeemable – when investors want to sell their shares,
they sell them back to the fund, or to a broker acting for
the fund, at their NAV
• Closed-end Funds
– Legally known as closed-end companies
– Not redeemable – when closed-end fund investors want to
sell their shares, they sell them to other investors on the
secondary market, at a price determined by the market
• UITs
– Legally known as unit investment trusts
– Redeemable
 Types of Investment Companies
• In addition, there are variations within each type of
investment company, such as stock funds, bond
funds, money market funds, index funds, interval
funds and exchange-traded funds (ETFs)
• Some companies that might initially appear to be
investment companies may actually be excluded
under the federal securities laws
– Eg. Private investment funds with less than 100 investors
 Classification
1. Face-amount Certification Company
• Engaged or proposes to engage in the business of issuing face-
amount certificates of the installment type, or which has engaged in
such business and has any such certificate outstanding
2. Unit Investment Trust
• Organized under a trust indenture, contract or custodianship or
agency, or similar instrument
• Does not have board or directors
• Issues only redeemable securities, each of which represents an
undivided interest in a unit or specified securities, but does not
include a voting trust
3. Management Company
• Company other than a face-amount certificate company or a unit
investment trust
 Advantages of Mutual Funds
• Professional Management
– The primary advantage of MF’s at least in theory is the
professional management of your money
– Investors purchase funds because they do not have the
time or the expertise to manage their own portfolio
– A MF is a relatively inexpensive way for a small investor to
get a full-time manager to make and monitor investments
 Advantages of Mutual Funds
……contd

• Diversification
– By owning shares in a MF instead of owning individual
stocks or bonds, your risk is spread out
– The idea behind diversification is to invest in a large
number of assets so that a loss in any particular
investment is minimized by the gains in others
– Large MF’s typically own hundreds of different stocks in
many different industries
• Economies of Scale
– Because a MF buys and sells large amounts of
securities at a time, its transaction costs are lower than
you as an individual would pay
 Advantages of Mutual Funds
……contd
• Liquidity
– Just like an individual stock, a MF allows you to request
that your shares be converted into cash at any time
• Simplicity
– Buying a MF is easy! Most banks have their own line of
MFs and the minimum investment is small
– Most companies have automatic purchase plans whereby
as little as $100 can be invested on a monthly basis
 Disadvantages of Mutual Funds
• Professional Management
– Many investors debate over whether or not the so-called
professionals are any better than you or I at picking
stocks
– Management is by no means infallible, and, even if the
fund loses money, the manager still takes his/her cut
• Costs
– The MF industry is masterful at burying costs under
layers of jargon
 Disadvantages of Mutual Funds
……contd
• Dilution
– Because funds have small holdings in so many different companies,
high returns from a few investments often don’t make much
difference on the overall return.
– Dilution is often the result of a successful fund getting too big
• Taxes
– When making decisions about your money, fund managers don’t
consider your personal tax situation.
– For eg – when a fund manager sells a security, a capital-gain tax is
triggered, which affects how profitable the individual is from the
sale. It might have been more advantageous for the individual to
defer the capital gains liability
 Different types of Mutual Funds

• According to the last count there are over 10,000 Mutual

Funds in North America! That means there are more
mutual funds than stocks!!
• It is important to understand that each mutual fund has
different risks and rewards
• In general, the higher the potential return, the higher the
risk of loss
• Although some funds are less risky than others, all funds
have some level of risk – its never possible to diversify
away all risk
• Each fund has a predetermined investment objective that
tailors the fund’s assets, regions of investment, and
investment strategies
 Different types of Mutual Funds
……contd

• At a fundamental level there are three types

of Mutual Funds
– Equity Funds (Stocks)
– Fixed Income Funds (Bonds)
– Money Market Funds
 Equity Funds (Stocks)
• Fund that invest in stocks represent the largest category
of Mutual funds.
• Investment objective – long term capital growth with
some income
• There are many different types of equity funds because
there are many different types of equities
• A great way to understand the universe of equity funds
is to use a style box
• A style box is a graphical representation of Mutual Fund’s
characteristics
Understanding the Style Box
 Understanding the Style Box
……contd

• The idea is to classify funds based on both the size of the

companies invested in and the investment style of the
manager
• This categorization is useful in determining how an
investment fits into a particular investment portfolio from
an asset allocation perspective
• An aggressive investor might focus primarily on small
capitalization funds or growth funds
• The term “value” refers to a style of investing that looks
for high quality companies that are out of favor with the
market. These companies are characterized by low P/E
ratios, price to book ratios, and high dividend yields etc
 Understanding the Style Box
……contd

• The opposite of value is growth, which refers to

companies that have had (and are expected to continue to
have) strong growth in earnings, sales, and cash flow, etc
• A compromise between value and growth is “blend”,
which simply refers to companies that are neither value
nor growth stocks and so are classified as being
somewhere in middle
• For eg – a MF that invests in large cap companies where in
strong financial shape but have recently seen their share
price fall would be places in the upper left quadrant of the
style box (large and value)
• The opposite of this would be a fund that invests in
startup technology companies with excellent growth
prospects. Such a MF would reside in the bottom right
quadrant (small and growth)
Fixed Income Funds (Bonds)
• Their purpose is to provide current income on a steady basis
• When referring to MF’s the terms – “fixed-income”, “bond” and
“income” are synonymous. These terms denote funds that
invest primarily in government and corporate debt.
• The target for these funds are conservative investors and
retirees.
• Bond funds are likely to pay higher returns than certificates of
deposit and money market investments, but bond funds are
without risk.
• Because there are many different types of bonds, bond funds
can vary dramatically depending on where they invest
• For eg – a fund specializing in high yield junk bonds is much
more risky than a fund that invests in government securities.
• Nearly all bond funds are subject to interest rate risk, which
means if the rates go up the value of the fund goes down
 Money Market Funds
• Consist of short term debt instruments, mostly
T-bills
• Safe place to park your money
• Low returns but you wont have to worry about
losing your principle
• A typical return is twice the amount you would
earn in a regular checking/savings account and a
little less than the average CD (Certificate of
Deposit)
 Other types of Mutual Funds
• Balanced Funds
– the objective of these funds is to provide a
“balanced” mixture of safety, income, and capital
appreciation.
– The strategy of balanced funds is to invest in a
combination of fixed-income and equities.
– A typical balanced fund might have a weighting of
60% equity and 40% fixed income
 Other types of Mutual Funds
……contd

• Asset Allocation Fund

– Objectives are similar to those of a balanced fund,
but these kinds of funds typically do not have to
hold a specified percentage of any asset class
– The portfolio manager is therefore given freedom
to switch the ratio of asset classes as the economy
moves through the business cycle
 Other types of Mutual Funds
……contd

• Global/International Funds
– International funds (or foreign funds) invest only outside your home
country
– Global funds invest anywhere around the world, including your home
country
– It is tough to classify these funds as either more risky or safer. On the
one hand they tend to be more volatile and have unique country
and/or political risks. But, on the flip side, they can, as part of a well-
balanced portfolio, actually reduce risk by increasing diversification.
– Although the world’s economies are becoming more inter-related, it is
likely that another economy somewhere is outperforming the
economy of our home country.
 Other types of Mutual Funds
……contd

• Specialty Funds
– These are funds that have proven to be popular but
don’t necessarily belong to the categories described so
far.
– This type of MF forgoes broad diversification to
concentrate on a certain segment of the economy
• SECTOR FUND
– targeted at specific sectors of the economy such as financial,
technology, health, etc.
– These are extremely volatile.
– There is a greater possibility of gains, but you have to accept that
your sector may tank
 Other types of Mutual Funds
……contd

• Specialty Funds
• REGIONAL FUND
– Focus on a specific area of the world. Eg – region (Latin America) or
an individual country (Brazil).
– Just like sector funs, you have to accept the high risk of loss, which
occurs if the region goes into a bad recession.

• SOCIALLY RESPONSIBLE FUNDS (or ETHICAL FUNDS) –

– Invest only in companies that meet the criteria of certain guidelines
or beliefs.
– Most socially responsible funds do not invest in industries such as
tobacco, alcoholic beverages, weapons, or nuclear power.
– The idea is to get a competitive performance while still maintaining
a healthy conscience.
 Passively Managed Funds
• Also called Index Funds
• Rage of the second half of the 1990s
• Investment objective of nothing more than strictly
mirroring a specific benchmark
• The portfolio of investments that are weighted the same
as a stock exchange index in order to mirror its
performance. This process is also referred to as indexing
• Attempts to replicate the index by holding the same stocks
in the same proportion
• Investment decisions usually involve little research and
intervention
• They hold stocks not necessarily because they are worth
investing in, but because they are in the index
 Passively Managed Funds
……contd

ADVANTAGES
• You know exactly what you will be getting
• Lower management expense ratios on index funds
• Exposure to a wide swath of the stock market
• Strongly diversified equity portfolio
• No need to worry how a portfolio manager is moving your
money among stocks
• Nearly impossible for an individual investor to replicate an
index on his own, due to the millions of dollars it would
take
• Most actively managed funds fail to beat broad indexes
such as the S&P 500