Investments PDF

# Risk Management ## Types of financial Risk: - Market: From changes in market conditions - Credit: From counterparty not fulfilling obligations - Operational: From internal processing ## RISK Mitigation Techniques: - Hedging: Using financial instruments (eg derivatives) to offset potential losse...

# Risk Management ## Types of financial Risk: - Market: From changes in market conditions - Credit: From counterparty not fulfilling obligations - Operational: From internal processing ## RISK Mitigation Techniques: - Hedging: Using financial instruments (eg derivatives) to offset potential losses - Diversification: Investing in various assets to spread risk - Insurance: Transferring risk to insurance providers for events like property damage/liability # Corporate Governance ## Definition: System of rules/practices ensuring accountability/fairness/transparency in companies' relationship with stakeholders. ## Key Components: - **Board of Directors:** Elected group overseeing corp management & decision making - **Shareholder Rights:** Ensure shareholder interests are represented and protected - **Transparency:** Accurate and timely disclosure of financial & operational information # Investments ## Overview ## Definition: The allocation of capital with an expectation of generating a return/ profit. ## Types of Investments: - **Equity:** Ownership in a company, usually the shares - **Debt:** Lending money to an entity such as bonds - **Alternative Investments:** \- Real estate \- Commodities \- Hedge funds/private equity # Investment Risk & return ## RISK: The uncertainty in investment returns that can be measured by **volatility**. ## Types of Risk: - **Systematic:** Market-wide risk (can't be diversified). Ex: Interest rates/inflation. - **Unsystematic:** Specific to a company/industry (can be reduced through diversification). ## Return: - The gain or cost of an investment, including income/capital gains. ## Expected Return: - The weighted average of possible returns based on probabilities. ## Risk Return Trade-Off: - Increased Risk → Increased Returns # Portfolio Theory ## Modern Portfolio Theory (MPT): - A framework for constructing a portfolio - Maximizes returns for a given risk level ## Diversification: - Reduces unsystematic risk - Spreads investments across assets ## Efficient Frontier: - Set of portfolios - Offer max return for each level of risk ## Capital Asset Pricing Model (CAPM): - Formula: _E_ = _R__f + β(_R__m - _R__f) - _E_: Expected Return - _R__f: Risk-free rate - β: Measures assets volatility relative to market \- β>1: Indicates higher volatility than the market # Asset Classes ## Equities/Stocks: - **Common Stocks:** Equity ownership + voting rights - **Preferred Stocks:** Limited/no voting + fixed dividends + higher priority over common stocks in event claims ## Fixed Income (Bonds): - **Types:** - Government bonds - Corporate bonds - Municipal bonds - **Key Metrics:** - Coupon Rates: Interest paid. - Yield to Maturity (YTM): Total return if held to maturity - Duration: Sensitivity to interest rate changes ## Cash & Cash Equivalents: - Low risk assets: - Treasury Bills - Money Market Funds ## Alternative Investments: - **Real Estate:** Tangible asset; Offer potential income through rent/value appreciation - **Commodities:** Physical assets (eg gold/oil/agriculture); Often used as inflation hedges - **Hedge Funds/Private Equity:** Pooled funds; Various strategies to maximize returns # Valuation Methods ## Equity Val - **Discounted Cash Flow (DCF):** Present-value of projected cashflow discounted at a required rate. - **Dividend Discount Model (DDM):** Values stocks based on expected dividends. ## Price Multiples: - Compare valuation metrics (eg: P/E, P/B, P/S). ## Bond Valuation: - **Present Value of Future Cash Flows:** Discount coupon payments + principle repayment by YTM. - **Yield Spread:** The difference between bond yields and benchmark yields, capturing credit quality. # Investment Strategies ## Active vs Passive: - **Active:** Attempting to outperform the market. Using stock picking, timing, and analysis. - **Passive:** Matching the performance of a market index through index funds or ETFs (exchange-traded funds). ## Growth vs Value: - **Growth:** Focus on companies with high potential growth (high P/E ratios). - **Value:** Focus on undervalued companies with strong fundamentals (low P/E ratios). ## Income Investing: - Promise investments that provide regular income (dividends/stocks/bonds). ## Contrarian Investing: - Investing against prevailing market sentiment. Buying undervalued assets during downturns. # Behavioral Finance ## Key Concepts: - **Overconfidence:** Individuals overestimate their knowledge/ability, leading to risky decisions. - **Herd Behavior:** Following other investors or experts, often blindly. - **Anchoring:** Relying heavily on initial info (like asset's purchase price). - **Loss Aversion:** People are more averse to losing their gains than getting a new gain, leading to higher risk tolerance. # Efficient Market Hypothesis (EMH) ## Theory: - Asset prices fully reflect all information. - It's impossible to consistently achieve higher returns without higher risk. ## Forms of EMH: - **Weak:** Prices reflect past market data (historical prices). - **Semi-Strong:** Prices reflect all publicly available data. - **Strong:** Prices reflect all public and private information. # Financial Instruments ## Types: - **Stocks:** Equity ownership + periodic interest and principal repayment. - **Bonds:** Debt instruments + periodic interest & principal repayment. # Performance Measurements ## Absolute vs Relative Returns: - **Absolute:** Total return without any comparison to a benchmark. - **Relative:** Performance of an investment compared to a market index or similar asset class. ## Common Metrics: - **Sharpe Ratio:** Adjusted return based on risk (risk-adjusted return). - **Alpha:** Excess return achieved relative to a benchmark. - **Beta:** Volatility related to market. It helps detect sensitivity to market movements.