Lecture 6-Investments Flashcards
(33 cards)
What is a saving?
-Means the act of setting aside money today to use at some time in future.
What are savings?
-often means the stock of cash products
that you have built up.
-However, sometimes
people refer to a stock of investments as ‘savings’
too.
What are investments?
-refer to those assets whose value can go up and down and which are usually bought in the hope of a rise in their value.
-It is a good advice to choose savings for short term
goals and investment for long term goals
What is risk?
-refers to the probability of occurrence of an (mostly unfavourable) event.
What are the 3 types of risk?
- Capital risk
- Inflation risk
- Shortfall risk
What is capital risk?
- the risk that investor may lose some of the invested money
- At the value of the investments can go up and down.
What is inflation risk?
Losing buying power because of rising prices.
What is shortfall risk?
-the risk you might fail to reach your
goal because the return you are getting on
investment is too low
How to reduce inflation and shortfall risk?
- The investor needs a higher return
- Taking on a higher return increase capital risk
-A higher return reduces inflation risk but
increases capital risk
Low risk and high risk returns
- Low risk, low rewards
- High risk, high reward
- Capital risk
How are attitudes towards risk assessed?
Psychometric risk profiling assessments are a useful tool.
• The aim of these tests is to assess how much risk they
might be willing to take given their goals and how
comfortable they feel about capital risk.
• Risk profiling tests produce a report which includes a
risk score.
• The higher the score, the more risk the investor is
comfortable to take.
• Purpose is to match investors risk profile with their goal
Capacity for loss
-The need for income or financial goals
determine capacity for loss
• A person who needs a regular income every
month to sustain monthly living expenses will
prefer a low risk low return savings account
rather than a high risk investment.
• A person with no immediate need for cash
may invest in a highly risky venture.
4 asset classes
– Cash
– Fixed-interest / Bonds
– Property
– Equities
Cash as an asset class
-Cash includes various cash products used for
savings. It also includes money market
products.
• Money market: Banks lend cash to each other
in money market.
• Examples include saving accounts, notice
accounts, Individual Saving Accounts.
What are fixed-interest/bonds?
Fixed-interest investments actually represent loans from investors to either the government or companies.
-Government bonds: issued by government and also
called gilts. UK Government bonds are considered to
have low risk because they are issued by UK
government which is very unlikely to default. This may
not be true for all countries’ governments.
-Corporate bonds: Issued by companies. They carry
relatively higher risk as they are not as safe as
government bond.
-The lender (investor) will eventually get the money back and in the mean time receives interest.
The problems with fixed-interest/bonds?
Fixed-interest securities also involve capital
risk due to fluctuations in their stock-market
price. However, they have low risk compared
to shares/stock.
• Their value fluctuates considerably especially
during periods of interest-rate volatility and
inflation
What are bonds?
-When you buy a bond, you are lending money to the government or company that issued the bond, and in return, the government or company that issued the bond is agreeing to pay your money back, with interest, at some point in the future.
Property as an asset class
-commercial property, for example an office, retail including shops and retail parks, and industrial property such as factories and warehouses
-An advantage of commercial property in the UK is that it
gives a relatively stable return from rental income.
• There is also a possibility of profit/loss when property is sold.
• Private investors do not normally invest directly in a
commercial property. They normally buy shares of a
property company.
What is the drawback of property company?
-The main drawback of property company is that, if it needs to be sold, it can be illiquid. So investors will have to wait a long time before they can get their money back
Equities/shares as an asset class
-Equities are shares in companies
• By buying a share investor becomes a part-owner
of the company along with all other shareholders.
• You can invest either by buying new shares when
they are first issued or existing shares through
the stock market.
• Unlike corporate bonds, this is not a loan. You are
rather buying a portion of the company’s assets
-Shares can be sold on stock market.
• You can make a profit or loss by sale of shares.
• The company may pay a profit to shareholders
if it makes a profit. However, there is no
guarantee that dividends will be paid. The
amount of dividends can go up or down
Risks with equities
-Equities fluctuate in relation to supply and demand.
The purpose of building a portfolio
All money could simply be put in one asset class.
• However, it will expose to a lot of risk in case of a
down in the market for that particular asset class.
• Asset Allocation: Risk can be managed effectively
by building a portfolio that combines different asset
classes.
• Cash and fixed-interest securities provide a hedge
through their low risk, while equities and property
brings excessive returns.
-Thus diversify.
What is dynamic diversification?
-A shift in the asset allocation in response to changing economic and financial conditions.
Behavioural finance
-Research suggests that people do not always
make rational decisions, but are driven by their
emotions and frequently rely on short-cuts and
rules of thumb.
-This characteristic of investors influences financial markets.
