CHAPTER 1 – INTRODUCTION TO INVESTMENT AND PORTFOLIO MANAGEMENT

Types of Assets commodities. It They include

1. Real assets unique feature is that investments such as
o Assets used to produce goods and services. they have intrinsic stocks and bonds. The
o Physical or tangible assets that have value, value by themselves major feature if
due to their substance and properties. and don’t rely on financial assets is that
o Real assets include precious metal, exchanges to have it has some economic
commodities, real estate, agricultural land and value. value that is easily
oil. realized. However, by
o Real assets are appropriate for inclusion in itself, it has lesser
most diversified portfolios. intrinsic value.
o Their proportion is dependent on investor’s Real assets are less More liquid and
risk tolerance and preferences. liquid since real assets location-dependent,
o Reason is real assets have a relatively low are difficult to trade, whereas financial
correlation with financial assets, such as and they don’t have a assets are more
stocks and bonds. competitive and mobile, making them
2. Financial assets efficient exchange. independent of their
o Financial assets are claims on real assets or location.
the income generated by real assets. The similarities between real financial assets
o Financial assets value is derived from a are that their valuation depends on their cash
contractual claim on an underlying asset, flow generation potential.
which may be real or intangible – meaning Table 1 – Differences and Similarities of Real Assets
that if we cannot our own auto plant (real9 and Financial Assets
asset)., we can still buy shares in Ford/Toyota
(financial assets) and thereby share in the Definition of Security
income derived from the production of An investment instrument (other than an insurance
automobiles. policy or fixed annuity) issued by a corporation,
o For example, commodities and property are government, or other organization which offers
real assets, but commodity futures and real evidence of debt or equity.
estate investment trusts constitute financial
assets whose value depend on the underlying Major Classes of Financial Assets/Security
real assets. 1. Debt
o Types of financial assets: o An amount of money borrowed by one party
- Certificate of deposit (CD) from another. Many corporations or
- Bonds individuals use debt as a method for making
- Stocks large purchases that they could not afford
- Cash or cash equivalent under normal circumstances.
- Derivatives o A debt arrangement gives the borrowing party
- Bank deposits permission to borrow money under the
- Loans and receivables condition that it is to be paid back at a later
o The success or failure of the financial assets date, usually with interest.
depends on the performance of the o Money market debt instruments - Bank
underlying real assets. certificates of deposit (CD, T-bills, commercial
3. Differences and similarities of real assets and paper
financial assets: o Capital market debt instruments – bonds and
Real Assets Financial Assets debentures
Real assets are real Financial assets 2. Common stock
estate, infrastructure include stocks, bonds o A security that represents ownership in a
and commodities. and cash. corporation.
Real assets are value- Financial assets are o On a company’s balance sheet, the amount of
driven physical assets highly liquid assets the funds contributed by the owners (the
that a company owns. that are either in cash stockholders) plus the retained earnings (or
They include buildings, or can be fast losses). Also referred to as shareholders’
land, motor cars or converted to cash. equity.
CHAPTER 1 – INTRODUCTION TO INVESTMENT AND PORTFOLIO MANAGEMENT

o Holders of common stock exercise control by 3. Financial plans should also be fluid, with
electing a board of directors and voting on occasional updates when financial changes occur.
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corporate policy.
o Common stockholders are on the bottom of Daily risk Asset
the priority ladder for ownership structure. assessment allocation
o In the event of liquidation, common
shareholders have rights to a company’s
assets only after bondholders, preferred
shareholders and other debtholders have
been paid in full.
3. Preferred Stock
o A class of ownership in a corporation that has
a higher claim on its assets and earning than
common stock.
o Preferred shares generally have a dividend
that must be paid out before dividends to
common shareholders and the shares usually
do not carry voting rights. Daily return Global macro
4. Derivative securities approach perspective
o A derivative is a security with a price that is
dependent upon or derived from one or more Figure 1 - Financial Planning Process
underlying assets. The most common Investment Portfolio
underlying assets include stocks, bonds, 1. Portfolio is a collection of investment assets
commodities, currencies, interest rates and (securities) owned by the same individual or
market indexes. organization.
o The derivative itself is a contract between two 2. A grouping of financial assets such as stocks,
or more parties based upon the asset or bonds and cash equivalents. It is also called as a
assets. basket of assets that can hold stocks, bonds, cash
o Its value is determined by fluctuations in the and more.
underlying asset. 3. Investors aim for a return by mixing these
o For example, options, futures and swap. securities in a way that reflects their risk tolerance
and financial goals.
What Is an Investment? 4. Portfolios are held directly by investors and/or
1. The current commitment or purchase of a managed by financial professionals.
financial product (or other resources0 with an
expectation of favorable future returns. Portfolio Investment Process
2. Investment means the use of money in the hope Investors make three types of decisions in
of making more money. constructing their portfolios:
3. Therefore, investors have to reduced current 1. Asset allocation
consumption and planned for later consumption. o A portfolio strategy that involves setting
4. Investors have to come up with financial plan that target allocations for various asset classes,
outline the investment goals, their risk tolerance and periodically rebalancing the portfolio back
and saving targets. to the original allocations when they deviate
significantly from the initial settings due to
Financial Planning differing returns from various assets.
1. A comprehensive evaluation of an investor’s o The allocations depend on a number of
current and future financial sate by using factors such as the investor’s risk tolerance,
currently known variables to predict future cash time horizon and investment objectives.
flows, asset values and withdrawal plans. o Example:
2. A good financial plan can alert an investor to - 55 years old En Zakaria who has a
changes that must be made to ensure a smooth conservative approach to investing and is
transition through life’s financial phases such as five years away from retirement, may
decreasing spending or changing asset allocation.
CHAPTER 1 – INTRODUCTION TO INVESTMENT AND PORTFOLIO MANAGEMENT

have an asset allocation of 40% equities, number that an investor can compare with a
40% fixed income and 20% cash. security’s current price in order to see
- Assume En Zakaria has a RM500,000 whether the security is undervalued or
portfolio and rebalances his portfolio overvalued.
annually. The dollar amounts allocated to 2. Technical analysis
the various asset classes at the time of o A method of evaluating securities by analyzing
setting the allocations would therefore be statistics generated by market activity, such as
– equities RM200,000, fixed income past prices and volume. Technical analysts do
RM200,000 and cash RM100,000. not attempt to measure a security’s intrinsic
2. Security selection value, but instead use charts or other tools to
o Process used to determine which securities identify patterns to predict future price
will be included within an asset class in a movements.
portfolio. Certain factors, such as risk and o Technical analysis can be used on a timeframe
return, are taken into consideration when of weeks, days or even minutes. Technical
selecting the security. analysis is used for a trade whereby traders
o The goal of security selection is to increase buy assets they believe they can sell to
one’s chances of making a profit on all somebody else at a greater price.
investments in the portfolio and hedge 3. Quantitative analysis
against losses. o A business or financial analysis technique that
o Example: seeks to understand behavior by using
- Equity – common stocks and preferred complex mathematical and statistical
stocks modelling, measurement and research.
- Fixed income – bonds o By assigning a numerical value to variables,
- Cash – money market funds, bank quantitative analysts try to replicate reality
accounts and certificates of deposit mathematically.
3. Security analysis o Quantitative analysis can be done for
o The analysis of various tradable financial performance evaluation or valuation of a
instruments. Security analysis helps to financial instrument. It can also be used to
determine the value of assets in a portfolio. predict real world events such as changes in a
o Security analysis is a method which helps to share price.
determine the value of various assets and also
find out the effect of various market Implications of Competitive Markets
fluctuations on the value of securities 1. Risk-return tradeoff
o Security analysis is broadly classified into o There will almost always be risk associated
three categories: with the investment. Higher risk is associated
- Fundamental analysis with greater probability of higher return and
- Technique analysis lower risk with a greater probability of smaller
- Quantitative analysis return.
o For investors, the risk-return tradeoff is one of
Three Categories of Security Analysis the essential components of each investment
1. Fundamental analysis decision as well as in the assessment of
o Fundamental analysts’ study anything that portfolios as a whole.
can affect the security’s value, from o In investments, the term ‘risk’ is often
macroeconomic factors such as the state of expressed as ‘volatility’ or variations in
the economy and industry conditions to returns. The greater the volatility the more
microeconomic factors like the effectiveness rises and falls are recorded by an individual
of the company’s management. Examples asset class the measurement of fluctuation in
include financial statements, current interest the market values of various asset classes as
rates, competitor’s products and financial they rise and fall over time.
market. o A return, also known as a financial return, in
o All stocks analysis tries to determine whether its simplest terms, is the money made or list
a security is correctly valued within the on an investment over some period of time.
broader market. The end goal is to arrive at a
CHAPTER 1 – INTRODUCTION TO INVESTMENT AND PORTFOLIO MANAGEMENT

o In investing, risk and return are highly markets, we may observe only near-efficiency
correlated. Increased potential returns on and profit opportunities may exist especially
investment usually go hand-in-hand with for diligent and creative investors.
increased risk – call as tradeoff.
o For investors, the risk-return tradeoff is one of The Players
the essential components of each investment Three major players in the financial markets:
decision as well as in the assessment of 1. Firms are net borrowers. They raise capital to pay
portfolios as a whole. for investments in plant and equipment and the
income generated by the real assets provide the
returns to investors who purchase the firm’s
securities.
2. Households typically are net savers whereby they
purchase securities issued by firms that need to
raise funds.
3. Governments can be borrowers and lenders
depending on the relationship between tax
revenue and government expenditures. Malaysian
government has run budget deficits and therefore
the government has had to borrow funds to cover
Figure 2 – Risk Return Tradeoff its budget deficit. Issuance of government debt
o At the foundation of this assessment, the securities is the major way that the government
consideration of the risk and the reward of an borrow funds from the public.
investment can be determined whether taking
action makes sense or not. Financial Intermediaries
o At the portfolio level, the risk-return trade-off 1. Financial intermediaries are institutions that bring
can include assessments on the concentration borrowers and lenders together. They include
or the diversity of holdings and whether the banks, investment companies and insurance
mix presents too much risk or a lower than companies. Financial intermediaries are
desired potential for returns. distinguished from other business because their
o Diversification means that many assets are assets and liabilities are overwhelmingly financial
held in the portfolio so that the exposure to (very small amount of real assets).
any particular asset is limited. 2. Intermediaries simply move funds from one sector
2. Efficient market hypothesis to another, for example channel household
o This hypothesis stated that financial markets savings to the business sector.
process all relevant information about 3. Institutions that connect borrowers and lenders
securities quickly and efficiently. For example, by accepting funds from lenders and loaning funds
the security price usually reflects all the to borrowers. For example, commercial banks,
information available to investors concerning investment companies, insurance companies and
the value of the security. Therefore, securities credit unions.
should be neither underpriced nor overpriced.
o The implications of this hypothesis concern
the choice between passive and active
investment management strategies.
o Passive management call for holding highly
diversified portfolios without attempting to
identify mispriced securities.
o Active management is the attempt to identify
mispriced securities or to forecast broad Figure 3 – Financial Market and The Economy
market trends. 4. Advantages of financial intermediaries:
o If markets are efficient and prices reflect all o By pooling the resources of many small
relevant information perhaps it is better to investors, they are able to lend considerable
follow passive strategies. However, even in sum to large borrowers.
environments as competitive as the financial
CHAPTER 1 – INTRODUCTION TO INVESTMENT AND PORTFOLIO MANAGEMENT

o By lending to many borrowers, intermediaries

achieve significant diversification so they can
accept loans that individually might be too
risky.
o Economies of scale. Financial intermediaries
are able to spread large amount od brokerage
fees, research cost and analytic services
among the many clients.
o Secondary securities sold by financial
intermediaries are easy to buy hold and sell.
The information cost and transaction cost
involved are very low. Banks run branches in
all urban areas and several semi-urban and
rural areas. The deposits they sell are
standardized and information about them
easily available.

Investment Bankers
1. Investment bankers are firms specializing in the
sale of new securities to the public. The
investment banking firm handles the marketing of
the security in the primary market where the new
issues of securities are offered to the public.
2. The investment bankers will suffer along with
investors if the securities it underwrites are
marketed to the public with overly optimistic or
exaggerated claims.
3. The investment banker’s effectiveness and ability
to command future business depend on the
reputation it has established over time.
4. Example – Merrill Lynch, Goldman, Sachs,
Citigroup Malaysia, CIMB Investment Bank Bhd,
Kenanga Investment Bank Bhd, Affin Hwang
Investment Bank Bhd