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Flashcards in The investment setting Deck (52)
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Goal of investment management

To find investments that satisfy the investor's required rate of return



- Can be seen as an individual's total assets minus their liabilities (Net Worth)

- Or as the present value of their future income minus the present value of their expenses



- Defined as the current commitment of an individual's money, based on fundamental research, to real and/or financial assets for a given period in order to accumulate wealth over the long term

- Can be seen as an individual's actual portfolio



- Investments that involve high risks and high returns

- Usually associated with a certain view taken on the market in order to make a profit



- Taking an almost certain small loss for the probability of making a large profit


Most important decision in creating wealth

Asset allocation


Most important decision in creating wealth

Asset allocation


Required rate of return

The minimum return an investor should accept from an investment to compensate him for deferring consumption


Three components/categories of required rate of return

- The time value of money during the period of the investment (excluding inflation)

- The expected rate of inflation during the period

- The risks involved


Real Risk Free Rate

- Price charged for the exchange between current consumption and future consumption

- Starting point in determining the investor's required rate of return


Risk Free Investment

An investment which provides the investor with certainty regarding the amount and timing of the expected returns


Capital markets

Bring together investors (who want to invest their savings) and demanders of funds

Monetary and fiscal policy determine the conditions in the capital market


Monetary policy

Refers to the policy of the central bank (SARB in SA) on the control of interest rates based on its expectations about growth in the economy, the inflation rate and the exchange rate of the local currency

If the economy grows / inflation increases, the the interest rates increase (FACT CHECK!!!)


Fiscal Policy

- Fiscal policy is determined by the extent to which a government finances its expenditure by mean of taxes and debt

- The greater the deficit (the part of the budget that cannot be financed by taxes), the more money the government has to borrow in the capital market


Different types of risk premiums

- Political Risks
- Business Risks
- Financial Risks
- Liquidity Risks
- Currency Risk
- Market Risk
- Callability Risk
- Convertibility Risk


Political Risks

Broadly refers to the risks associated with a certain country's political system


Business Risk

Refers to the extent of certainty about a firm's cash flows as a result of the nature of its business

Eg monopolies and products with an inelastic demand have greater certainty about their income and cashflows


Financial Risk

Relates to the financial leverage (gearing) employed by a firm

Credit Rating and how firms is financed


Liquidity Risk

Relates to obtaining the right price in the right time for a certain investment

Liquidity Risk thus refers to the effort and certainty of trading a specific investment instrument in the secondary financial markets


Currency Risk

Relates to the fluctuation of the exchange rate


Market Risk

Refers to adverse movements in the value of equities, currencies, interest rates and commodities


Callability Risk

Refers to the variability of return that derives from the possibility that bonds or preference shares may be called by the issuing firm


Convertibility Risk

Refers to the possibility that the investment may be converted into the issuer's ordinary shares at times or under terms which prevent the investor from achieving his required rate of return


Total Risk

Non-Systematic Risk + Systematic Risk


Non-Systematic Risk

- Risk that can be diversified away

- Relates to events that affect individual companies


Systematic Risk

- Risk that cannot be diversifies away

- Relates to general economic conditions and monetary and fiscal policy that affect all firms


Time value of money

Refers to the phenomenon that an amount of money can increase in value because of interest earned from an investment over time



- The uncertainty about whether an investment will earn its expected rate of return

- Uncertainty about future outcomes or the probability of an adverse outcome


Non-financial / Pure Risk

- Exposure to uncertainty that has a non-monetary outcome or implication

- No financial benefit from an increases exposure to the risk

- Best outcome is no loss


Financial Risk

-Associated with a distribution of possible outcomes, including both positive and negative scenarios