ch 03 indirect investing

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Chap 3


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Chapter 3

Indirect Investing

Learning Objectives

What is Indirect Investing?

Direct Investing

Indirect Investing

What is an Investment Company?

What are Types of Investment Companies?

What are Types of Mutual Funds?

What are the mechanics of Investing Indirectly?

What is Investment Company Performance?

What are Exchange Traded Funds?


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DIRECT INVESTING

Non-Marketablesecurities

Money Markets

Capital Markets

Derivatives Markets

INDIRECT INVESTING

Investment Companies Mutual Funds

Stock, Bond Funds

Exchange Traded Funds


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What are major types of Financial Assets?

In-direct Investing

Buying & Selling of shares of investment

companies, which then hold portfolios ofsecurities.

Funds are given to professional money managersto make decisions on an investors behalf (forbetter or worst)

Fees are charged for this service


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What are major types of Financial Assets?

In-direct Investing

Investment Company?


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Exchange Traded Funds


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Exchange Traded Funds An exchange traded fund is a basket of stocks that tracks a

particular index, sector, investment style, geographical areaor the market as a whole.

ETFs unlike mutual funds can be bought on margin & sold

short.

Tax Efficient

Very small premiums & discounts from NAV

Unlike mutual Funds, can be traded anytime during the day.

Lower Expenses


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Unit Investment Trusts


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Unit Investment Trusts Unit Investment Trust is an unmanaged portfolio of tax

exempt securities put together by a sponsor & handled by anindependent trustee.

Redeemable trust certificates representing claims against the

assets of the trust are sold to investors at Net Asset Valueplus commission.


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Closed-End Investment Companies


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Closed-End Investment Companies Closed Investment Company offers investors an actively

managed portfolio of securities. Its capitalization is fixedunless a new public offering is made.

Shares of closed-end Funds trade on Stock exchanges &

hence their prices are determined by forces of supply &demand.


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Closed-End Investment Companies-

Mechanics of Investing Indirectly Net Asset Value- NAV is per share value of portfolio of

securities held by the investment company on a given

day.

If NAV > Market price Discount

If NAV < Market price Premium

NAV = (Market Value of Funds Securities Liabilities)

Total Number of shares outstanding


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Open-End Investment Companies

(Mutual Funds)


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Open-End Investment Companies

(Mutual Funds) Mutual Funds are either corporations or Business trusts

formed by an investment advisory firm that selects the boardof trustees (Directors) for the company.

The trustees, in turn, hire a separate management company,

normally, the investment advisory firm to manage the fund. The number of shares outstanding of an open end investment

company is continually changing.


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Mutual Funds - TypesThere are four basic types of Mutual Funds:1. Money Market Mutual Funds

2. Equity Funds

3. Bond Funds4. Hybrid Funds


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Mutual Funds - Types1. Money Market Mutual Funds No Load Funds

Taxable Vs Tax Exempt Funds

2.Equity Funds Capital Appreciation Fund

Total Return fund

World Equity Fund

3. Bond Funds

4. Hybrid Funds


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Mutual Funds Value Funds Vs Growth Funds

Index Funds


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Mutual Funds- Trading MechanicsMutual Fund Share prices Owners of shares can sell them back to the company anytime

they choose; the mutual fund is legally obligated to redeemthem.


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Mutual Funds- Trading MechanicsFees Vs Expenses Front-End Load

Back-end Load

Management Fee

Distribution Fee (12b-1)

Load & No load Funds


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Hedge Funds


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Hedge Funds Hedge Funds are unregulated companies that seek to exploit

various market opportunities & thereby earn larger returnsthan are ordinarily available.

As hedge funds are unregulated, they may invest in assets

not typically available to mutual Funds. A high water mark provision


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Hedge Funds - Classifications Long/Short Funds: These funds take long & short common

stock positions, use leverage & are invested in markets worldwide.

Market-neutral Funds: These funds take long & shortpositions, but the positions will offset each other so that theeffect is a net zero exposure to the market.

Global Macro Funds: These funds are typically highlyleveraged & rely heavily upon derivatives.


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Fund of Funds Fund of Funds investing involves creating a fund open to

both individual & institutional investors, which in turn investsin hedge funds.

Benefits for investors with limited capital?

Benefits for investors with more capital?

Drawbacks?


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Hedge fund performance

measurementThere are numerous hedge fund indices designed to measurehistorical performance. Some general conclusions regardinghedge funds can be derived:

Hedge Funds have demonstrated a lower risk profile than

traditional equity investments as measured by a standarddeviation.

In recent years, the Sharpe Ratio has been consistentlyhigher for hedge funds than for most equity investments.

There is a low correlation between the performance of hedgefunds & conventional investments.


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Hedge fund performance

measurement - Biases Self selection Bias

Backfilling Bias

Survivorship Bias

Smoothed pricing of infrequently traded assets


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Alternative Investments Closely held companies

Distressed Securities

Venture Capital Investing


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Alternative InvestmentsClosely

held companies The equity shares of closely held companies are not publicly

traded & are not subject to the same SEC regulations aspublic companies regarding reporting & disclosure.

The Cost approach

The comparables approach The income approach


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Alternative InvestmentsDistressed

Securities When companies are on the brink of bankruptcy or have

already filed for bankruptcy protection, their securities areconsidered Distressed.


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Alternative InvestmentsVenture

Capital Investing Venture Capital Investments are private, non exchange traded

equity investments in business venture.

Investments may be made at any point of the business cycleof the company, from the initial planning stage of a new

venture to an established firm ready to go public. Long term investment horizon

Difficulty in valuation

Requirement for extensive operation analysis


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Valuing a Venture Capital

Investment - ExampleA venture capital fundmanager is consideringinvesting 2.5 million in anew project that he believes

will pay $12 million at theend of five years. The costof equity for the investor is15% & the estimatedprobability of failure is

presented in the figurebelow.

Year Failure Probability

1 0.20

2 0.20

3 0.17

4 0.15

5 0.15


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Assignment # 3Q1: A venture capital fund

manager is consideringinvesting 3.5 million in anew project that he believes

will pay $30 million at theend of five years. The costof equity for the investor is13% & the estimatedprobability of failure is


Year Failure Probability

1 0.10

2 0.20

3 0.07

4 0.25

5 0.05


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Assignment # 3Q2: A venture capital fund

manager is consideringinvesting 1.75 million in anew project that he believes

will pay $25 million at theend of six years. The cost ofequity for the investor is12% & the estimatedprobability of survival is


Year survival Probability

1 0.75

2 0.80

3 0.80

4 0.85

5 0.90

6 0.95


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Chapter 3

Indirect Investing

Summary

What is Indirect Investing?

Direct Investing

Indirect Investing

What is an Investment Company?

What are Types of Investment Companies?

What are Types of Mutual Funds?

What are the mechanics of Investing Indirectly?

What is Investment Company Performance?

What are Exchange Traded Funds?


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Thank you for your time

& patience

ch 03 indirect investing

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