Page 1 of 8

BCF 412 (ASSET MANAGEMENT) – NOTES.

(I) Introduction.

Assets (Meaning).

Refers to the resources acquired or leased by a business organization or any other

economic entity for the purpose of generating income.

Assets are classified into:

(1) Real Assets. – Such as buildings, Machinery, equipment and land.

(2) Financial Assets (Also known as Securities).

These are claims to other assets and cash flow which take the form of titles to wealth.
They are simply pieces of paper with contractual provisions that entitle their owners to
specific rights and claims on specific cash flows or values. Debt instruments such as
bonds typically have specified payments and specified maturity .For example an ABC
Ltd bond might promise to pay 10% for 30 years, at which time it promises to make a shs
1,000 principal payment. If debt matures in more than a year it is called a Capital
Market Security or asset. Thus ABC Ltd. Bond in this example is a capital market
security.

If the debt matures in less than a year, it is a Money Market Instrument or asset.For
example Home Depot might expect to receive Kshs 300,000 in 75 days, but it needs cash
now. Home Depot might issue commercial paper, which is essentially an IOU.In this
example, Home Depot might agree to pay Kshs 300,000 in 75 days in exchange for say
Shs 297,000 today. Thus Commercial Paper is a money market instrument or security.

Equity Instruments.

These are a claim upon a residual value. For example ABC Ltd.’s stockholders are
entitled to the cash flows generated by ABC Ltd after its bond holders, creditors and
other claimants have been satisfied.

Because stock has no maturity date, it is a capital market security.

Note that debt and equity represent claims upon the cash flows generated by real assets
such as cash flows generated by ABC Ltd.’s factories and operations. In contrast
derivatives are securities whose values depend on or are derived from the values of some
other traded assets. For example Options and Futures are two important types of
derivatives and their values depend on the prices of other assets. An option on ABC
Stock or a futures contract to buy wheat are examples of derivatives.
 Page 2 of 8

Some financial assets or securities are a mix of debt, equity and derivatives. For example,
preferred stock has some features like debt and some like equity, while convertible debt
has both debt-like and option like features.

SECURITIES/ASSETS.

Basic Types Major Types

Interest Bearing  Money Market Instruments.
 Fixed Income Securities.
Equities  Common Stock.
 Preferred Stock
Derivatives  Options.
 Futures.

Money Market Instruments.

Refers to short term debt obligations of large corporations and governments that mature
in a year or less.

Fixed –Income Securities.

Longer-term debt obligations, often of corporations or governments that promise to make

fixed payments according to a present schedule.

Examples: Treasury Bills, Bank Certificates of deposit (CDs), Corporate and Municipal
Money Market Instruments.

Potential Gains/Losses: Fixed future payments except when the borrower default
(Fixed coupon payments and final payment at maturity).

Price quotations: Usually the Instruments are sold on a discount basis and only the
interest rates are quoted. So some calculation is necessary to convert rates to prices.

Equities.

Common Stock.

Represents ownership in a corporation. A part owner receives a pro-rated share of

whatever is left over after all obligations have been met in the event of a liquidation.

Potential gains/Losses.

 Many Companies pay cash dividends to their share holders.However,neither the

timing nor the amount of dividend is guaranteed.
 Page 3 of 8

 The Stock value may rise or fall depending on the prospects for the company and
market-wide circumstances.

Preferred Stock.

The dividend is usually fixed and must be paid before any dividend for the common
shareholders. In the event of liquidation, preferred shares have a particular face value.

Potential Gains/Losses.

 Dividends are promised. However, there is no legal requirement that the

dividends be paid as long as no common dividends are distributed.
 The Stock value may rise or fall depending on the prospects for the company and
market wide circumstances.

Derivatives.

A derivative is a financial asset that is derived from an existing traded asset rather than
issued by a business or government to raise capital.

More generally any financial asset that is not a primary asset.

Types of Derivatives.

(1) Futures Contract.

This is an agreement made today regarding the terms of trade that will take place
later.
Examples are financial futures and Commodity futures.
Potential gains/losses.
 At maturity, you gain if your contracted price is better than the market price of
the underlying asset and vice versa.
 If you sell your contract before its maturity you may gain or lose depending
on the market price for the contract.
 Note that enormous gains/losses are possible.

(2) Option contract.

An agreement that gives the owner the right but not obligation to buy or sell a specific
asset at a specified price for a set period of time.
 A Call Option gives the owner the right, but not the obligation to buy an asset
while a put option gives the owner the right but not the obligation to sell an
asset.
 The Price you pay to buy an option is called option premium.
 The specified price at which the underlying asset can be bought or sold is
called the Strike Price or Exercise Price.
 Page 4 of 8

Based on when it can be exercised, an option can either be (1) American Option or (2)
European Option.

 An American Option can be exercised anytime up to and including the

expiration date, while a European Option can be exercised only on the
expiration date.
 Options differ from futures in two main ways:
(1) There is no obligation to buy/sell the underlying asset.
(2) There is a premium associated with the contract.

Potential gains/losses.

 Buyers (In the case of Call Options) gain if the strike price is better than the
market price and if the difference is greater than the option premium. In the worst
case, buyers lose the entire premium.
 Sellers (Put Options) gain the premium if the market price is better than strike
price. Here the gain is limited but the loss is not.

Call Option: Vc = max (St – E,0),Profit = Vc – Premium.

Put Option: Vp = max (E- St,0) , Profit = Vp – Premium.

ASSET MANAGEMENT.
Asset Management broadly defined refers to any systematic system that monitors and
maintains things of value for an entity or group. It may apply to both tangible assets
such as buildings and to intangible assets such as human capital, intellectual property and
goodwill and financial assets.

The term is most commonly used in the financial world to describe people and
Companies that manage investments on behalf of others. These include for example,
investment managers that manage assets of a pension fund.

Investment Management is the sector of the financial services industry that manages
investment funds and segregated client accounts. An asset management co. is a part of a
financial company which comprises experts who manage money and handle the
investments of clients.

From studying the client’s assets to planning and looking after the investments, all things
are looked after by the asset managers and recommendations are provided based on the
financial health of each client.
 Page 5 of 8

Asset Management is therefore the direction of a client’s cash and securities by a

financial services company usually an investment Bank. The Institution offers
investment services along with a wide range of traditional and alternative product
offerings that might not be available to the average investor. The account is held by a
financial institution and includes cheque writing privileges, credit cards, debit cards,
margin loans etc.

Assets in question are such as shares, bonds and other securities (e.g. real estate) in order
to meet specified investment goals for the benefit of the investors. Investors may be
institutions (Insurance Companies, Pension Funds, Corporations, Charities, Educational
establishments) or private investors (both directly via investment contracts and more
commonly via collective investment schemes e.g. Mutual Funds of exchange Traded
Funds).

Asset Management Services.

They include elements of financial statement analysis, asset selection, stock selection,
plan implementation and ongoing monitoring of investments. Coming under the roof of
financial services, many of the world’s largest companies are at least in part investment
managers and employ millions of staff.

FUND MANAGERS OR INVESTMENT ADVISORS.

A Fund Manager or Investment Advisor (USA) refers to both a firm that provides
investment management services and an individual who directs fund management
decisions.

Asset Management is usually done for a fee (It is a professional service).

INDUSTRY SCOPE.

The business of asset management has several facets (aspects or parts):

(1) The Employment of Fund Managers.

(2) Research (of individual assets and asset classes).
(3) Dealing.
(4) Settlement.
(5) Marketing.
(6) Internal Auditing.
(7) Preparation of reports for clients.
 Page 6 of 8

The largest financial fund managers are firms that exhibit all the complexity their size
demands. A part from the people who bring in money (Marketers) and the people who
direct investment (the fund managers),there are compliance staff (to ensure accord with
legislative and regulatory constraints /requirements ),internal auditors of various kinds (to
examine internal systems and controls),financial controllers(to account for the
institution’s own money and costs),computer experts and back office employees (to track
and record transactions and fund valuations for up to thousands of clients per institution.

Key Problems/Challenges of the Industry.

(1) Revenue.
Revenue is directly linked to market valuations, so a major fall in asset prices can
cause a major decline in revenues relative to costs.
(2) Above average fund performance.
It is difficult to sustain above average fund performance and clients may not be
patient during times of poor performance.
(3) Successful fund Managers.
They are expensive and may be headhunted from competitors.
(4) Analysts/Fund managers – Who generate above-average returns often become
sufficiently wealthy that they avoid corporate employment in favour of managing
their personal portfolios.

Size of the global fund management industry.

Conventional assets under management of the global fund management industry

increased by 10% in 2010 to $ 79 trillion.
Pension Assets accounted for $ 29.9 trillion of the total, with $ 24.7 trillion invested
in Mutual Funds and $ 24.6 trillion in insurance funds.
Together with alternative assets (Sovereign wealth funds, hedge funds, private equity
funds and exchange traded funds). And funds of wealth funds, assets of the global
fund management industry totaled around 117 trillion.
The US remained by far the biggest source of funds, accounting for around a half of
conventional assets under management or some $ 36 trillion. The UK was the second
largest center in the world and by far the largest in Europe with around 8% of the
global fund.

(II) SELECTION OF SECURITIES/FINANCIAL ASSETS.

1.SELECTION OF BONDS.-(FIXED INCOME AVENUES).

 Page 7 of 8

You should carefully evaluate the following factors in selecting fixed income
avenues.
(a) Yield to Maturity.
Yield to maturity for a fixed income avenue represents the rate of return earned by
the investor if he invests in the fixed income avenue and holds it till its maturity.
(b) Risk of Default.
To assess the risk of default on a bond, you may look at the credit rating of the
bond. If no credit rating is available, examine relevant financial ratios (like debt
equity ratio etc.) of the firm and assess the general prospects of the industry to
which the firm belongs.
(c) Tax Shield.
A variety of fixed income avenues do offer tax shield.(Tax shield is a deductible
expense. The expense protects (Shields) an equivalent shilling amount of revenue
from being taxed by reducing taxable income).
(d) Liquidity.
If the fixed income avenue can be converted wholly or substantially into cash at a
fairly short notice, it possesses liquidity of a high order.

(2) SELECTION OF STOCKS.

Three broad approaches are employed for the selection of equity shares: Technical,
Analysis, Fundamental Analysis and Random selection. Technical analysis looks at
Price behavior and volume data to determine whether the share will move up or down
or remain trendless. Fundamental analysis focusses on fundamental factors like
earning level, growth prospects, and risk exposure to establish the intrinsic value of a
share.
The recommendation to buy, hold or sell is based on a comparison of the intrinsic
value and the prevailing market price.
The random selection approach is based on the premise that the market is efficient
and securities are properly priced.
Page 8 of 8