INVESTMENT ANALYSIS

WHAT IS AN INVESTMENT ?

Adam smith-WEALTH OF NATIONS

• Adam smith warned about the free market system .

• The free market system can not be left to be regulated on its own because of the greedy which is inherently in man.

• It is therefore essential that the capitalist system be regulated by government in order to check the greedy and selfishness in man

• The world financial meltdown that occurred september 2008 proves ADAM SMITH RIGHT!!!!

Definition of investment

• An investment is the current commitment of money(dollar /kwacha) for a period of time in order to derive future payments that will compensate the investor for

1.The time the funds are committed2.The expected rate of inflation3.The uncertainty of future payments

Who is an investor ?

• The investor can be :a)An individualb)Government c) Pension fund, insurance firmd)A corporation

What type of investments ?

• Investments can be all types of investments such as ;

1.Investments by corporations in plant and equipment

2.Investments by individuals in stocks ,bonds commodities, cars, real estate, cattle etc

Why people invest and what do they want from their investments?

• They invest in order to earn a return from savings due to their deferred consumption.

• They want a rate of return that compensates them for .

a. the timeb.the expected rate of inflation c. the uncertainty of the return

Measures of return and risk

• Investment analysis is about how investors select investments that will give them their required rates of return

• The investment analyst is preoccupied with the measures of return and risk

• Measures of return and risk are the core of investment selection and portfolio management

• The selection process requires the investment analyst to estimate and evaluate the expected risk-return trade off

Measures of historical rates of return

• When evaluating investment for inclusion in your portfolio of investments

• A portfolio of investments is a group of investments

• An investor can investor US $ 100,000 IN STOCKS (40,000) BONDS (50,000) REAL ESTATE (IO,OOO)

• The group of the above investments is a portfolio

Measures of historical return

• When evaluating alternative investments for inclusion in the portfolio

• The invest analyst will be comparing investments with different prices

• For example • you might want to compare a us$ 10 stock

which pays no dividends to a a stock selling at $150 that pays dividend s of $5 per year.

Measures of historical rates of return

• To properly evaluate the two stocks ofi. $10 stock that pays no dividends ii. $150 stock that pays a yearly dividend of $5• we must properly compare their historical

rates of return• When we invest we defer consumption in

order to add to our wealth so that we can consume more in future

Measures of historical rates of return

• The return in investments is essential because it is concerned with the change in wealth resulting from an investment

• This change in wealth be due to either a. To cash flows such as interest from your bonds or

certificate of deposits or dividends from the stocks or shares

b. Caused by a change in the prices of the asset which can either positive or negative , when the price of the stock either increases or reduces from the price bought .this involves the concept of capital gains

Preferences of investments

• Preferences of investments are also determined by some of the following factors

a)Age .people who are young would different preferences such a house ,car, quality funniture , ,fancy clothes etc. While ;lder people with children starting thinking of the cost of education for their children and their retirement. Younger people have a higher propensity to spend because they have a long life

Preference of investments

b. The background whether their parents are rich or not . Those who inherit large sums of money or wealth from their parents will have a different perceptions of investments

c. Culture .in some societies wealth is owned by all members of the family especially the wealth of a son, the wife is not regarded as part of their sons or brothers wealth. The wife is an intruder.

• In the jewish society its the duty of every jew to assist others accumulate wealth. If they lend each other money no interest is paid . The lender does not publicise that he has lent mr feinstein money

CONCLUSION

• An investment is the current commitment of money(dollar /kwacha) for a period of time in order to derive future payments that will compensate the investor for

1.The time the funds are committed2.The expected rate of inflation3.The uncertainty of future payments

Nature of Asset available for investments

REAL ASSETS VERSUS FINANCIAL ASSETS1.REAL ASSETS• The material wealth of any society is

determined by the productive capacity of its economy ,ie the goods and services its people create .

• The productive capacity is a function of real assets of the economy

REAL ASSETS

• Real assets are used to produce goods and services

• Real assets consist of ;1. Land2. Buildings3. Equipment4. Knowledge that can be used to produce goods

and services Real assets generate income for the economy

Financial assets • Financial assets are claims on real assets or income

generated by real assets• Financial assets are more sheets of paper or a

computer entry which consist of the following :1. Stocks(shares) - common stocks and preferred stock2. Bonds • If we cannot own our own auto plant (a real asset )

we can buy shares ( financial asset)in auto company such Toyota , Mercedes Benz etc

• By buying stock in Toyota we can be able to share in the income derived from the production of toyota cars.

Financial assets • Financial assets define the allocation of income or wealth among

investors.• Individuals can choose between consuming the wealth today • Or investing for the future • if they choose to invest they place their money in financial assets

by buying securities (equity(shares) and debt(bonds )

• The money derived from the purchase of financial assets by investors is used by firms to pay for real assets such as plant , equipment, technology .

• Investors returns on securities comes from income produced by the real assets that were financed by the issuance of those securities.

Financial assets

• Types of financial assets:i. Debt ii. Equityiii.Derivatives1.DEBT also known as fixed income securities

promise either a fixed stream of income or a stream of income Financial assets

Fixed income(debt) securities • DEBT also known as fixed income securities

promise either a) a fixed stream of income eg a corporate bond

will typically promise that a bondholder will receive a fixed amount of interest each year

a) a stream of income that is determined according to the formula . Eg floating rate bonds promise payments that depend current interest rates . In this case the income will according to the interest rate changes.

Fixed income(debt) securities

• Debt securities come a variety of maturities and payment provisions

• Money market refers to fixed income securities that are

a)short term b)Highly marketablec) Generally of very low riskd)Eg us treasury bills, certificate of deposits

Fixed income(debt) securities

• Capital market debt refers to long term securities such as treasury bonds, municipal bonds , corporate bonds which can be

a) very safe in terms of default eg treasury securities

b)Relatively risk eg high yield or junk bonds

COMMON STOCK OR EQUITY

• Equity in a firm represents an ownership share in the corporation

• Equity holders are not promised any particular payment .

• Equity holders receive any dividends the firm may pay• Equity holders have prorated ownership in the real

assets of the firm• INCOME STREAM IS DEPENDENT ON THE SUCCESS OF

THE FIRM• If the firm is successful the value of shares increases

DERIVATIVE SECURITIES

• Derivative securities such as options and futures contracts provide payoffs that are determined by the prices of other assets such as bonds and stock prices

• Derivative securities are so named because their values derive from other assets

• For example . THE VALUE OF A CALLL OPTION WILL THE PRICE OF FIRMS A’S STOCK.

THE INVESTMENT PROCESS Portfolio management • A portfolio of investments is a collection of investment

assets.• Investors make two types of decisions in constructing

their portfolio;1. Asset allocation decision is the choice among the

broad asset classes .2. Security selection decision is the choice of which

particular securities to hold within each asset class For example when you have money in the bank and wish

to set up a portfolio of investments the following happens

THE INVESTMENT PROCESS

• The investor decides what proportion of the overall portfolio will be in stocks , bonds etc

1.For example if you $1million dollars you can decide to set up the following portfolio

a)$ 200,000 in stocks b)$200,000 in treasury billsc) $600,000 in bonds

THE INVESTMENT PROCESS

• Security analysis • Involves the valuation of particular securities

that might be included in the portfolio.

Organization andFunctioning of

Securities Markets• WHAT IS A MARKET?• A market is the means through which buyers and

sellers are brought together to aid in the transfer of goods and/or services. • Characteristics of a market essential to understand

and these being 1. A market need not have a physical location. It is only necessary that the buyers and sellers can

communicate regarding the relevant aspects of the transaction

WHAT IS A MARKET?

2. The market does not necessarily own the goods or services involved

• For a good market, ownership is not involved; the important criterion is the smooth, cheap transfer of goods and services

3.A market can deal in any variety of goods and services.

For any commodity or service with a diverse clientele, a market should evolve to aid in the transfer of that commodity or service

Characteristics ofa Good Market

A good market for goods and services has the following characteristics:

1. Timely and accurate information is available on the price and volume of past transactions and the prevailing bid and ask prices.

2. It is liquid, meaning an asset can be bought or sold quickly at a price close to the prices for previous transactions (has price continuity), assuming no new information has been received. In turn, price continuity requires depth.

3. Transactions entail low costs, including the cost of reaching the market, the actual brokerage costs, and the cost of transferring the asset.

4. Prices rapidly adjust to new information; thus, the prevailing price is fair because it reflects all available information regarding the asset.

Organization ofthe Securities

Market• The principal distinction is between a)primary markets, where new securities are

sold.b)secondary markets, where outstanding

securities are bought and sold.

1 PRIMARY CAPITAL MARKETS .The primary market is ;

a) where new issues of i. bonds,ii. preferred stock or common stock b)Bonds and shares are sold by i. government units,ii. municipalitiesiii. companies _______ to acquire new capital

PRIMARY CAPITAL MARKETS

PRIMARY CAPITAL MARKETS• Government Bond Issues All U.S. government bond issues

are subdivided into three segments based on their original maturities.

1. Treasury bills are negotiable, non-interest-bearing securities with original maturities

of one year or less2. Treasury notes have original maturities of 2 to 10 years. 3.Treasury bonds have original maturities of more than 10

years• To sell bills, notes, and bonds, the Treasury relies on

Federal Reserve System auctions• In Zambia we have treasury bills and bonds which are

auctioned by BANK OF ZAQMBIA

Why capital markets • THE CAPITAL MARKET-Why does it matter ?

• The TheoryThe Theory - - Efficient and Optimal allocation of resources

• The Objective and GoalThe Objective and Goal - - Investment and Economic Growth

• The The historicalhistorical experience in Zambia / Africa experience in Zambia / Africa - - Over dependence on guaranteed loans - Over dependence on bank borrowing - Nil capital market development policy and strategy

The ResultThe Result - Low savings mobilisation - No source of long term finance - Low domestic investment - Economic reforms and policy response ineffective - Low economic growth - Weak economies

Zambian capital markets government instruments

• 91-day Treasury bill• 182-day Treasury bill• 273-day Treasury bill• 364-day Treasury bill

• 24-month Bond• 3-year Bond• 5-year Bond• 7-year Bond*• 10-year Bond*• 15-Year Bond*

Development of a bond market in zambia

• Pre 1998• GRZ securities (T-bills and Bond)• Primary Market only ( Buy and hold strategy )• Bond Discounting at BOZ / amongst banks• No formal RETAIL Market ( Secondary Market )• Short term instruments only• 1997 • LuSE visit to Bond Exchange of South Africa, Bank of South Africa,

ESKOM.• 1998 • GRZ Bonds listed on the LuSE• Formalisation of secondary market• Key for price benchmarking

PRIMARY CAPITAL MARKETS• Municipal Bond Issues. New municipal bond issues are sold by one

of three methods: 1.Competitive bid- sales typically involve sealed bids. • The bond issue is sold to the bidding syndicate of underwriters that

submits the bid with the lowest interest cost in accordance with the stipulations set forth by the issuer right to sell the issue.

2.Negotiation-involve contractual arrangements between underwriters and issuers.

• The underwriter helps the issuer prepare the bond issue and set the price and has the exclusive right to sell the issue.

3. private placement -involve the sale of a bond issue by the issuer directly to an investor or a small group of investors(usually institutions).

PRIMARY CAPITAL MARKETS• Corporate Bond Issues-are almost always sold

through a negotiated arrangement with an investment banking firm that maintains a relationship with the issuing firm

• Corporate Stock Issues In addition to the ability to issue fixed-income securities to get new capital

• corporations can also issue equity securities—generally common stock.

• For corporations, new stock issues are typically divided into two groups:

PRIMARY CAPITAL MARKETS

(1) Seasoned equity issues are new shares offered by firms that already have stock outstanding.

• An example would be General Electric, which is a large, well-regarded firm that has had public

stock trading on the NYSE for over 50 years. • If General Electric decided that it needed new

capital, it could sell additional shares of its common stock to the public at a price very close to the current price of the firm’s stock.

PRIMARY CAPITAL MARKET

• (2) initial public offerings (IPOs)- involve a firm selling its common stock to the public for the first time.

• At the time of an IPO offering, there is no existing public market for the stock, that is, the company has been closely held

• New issues (seasoned or IPOs) are typically underwritten by investment bankers,

• investment bankers acquire the total issue from the company and sell the securities to interested investors.

• The underwriter gives advice to the corporation on the general characteristics of the issue, its pricing, and the timing

of the offering.

SECONDARY FINANCIAL MARKETS

• Secondary markets -permit trading in outstanding issues;

• that is, stocks or bonds already sold to the public are traded between current and potential owners

• The proceeds from a sale in the secondary market do not go to the issuing unit (the government, municipality, or company)

• but,rather, to the current owner of the security.

Financial Futures

• In addition to the market for the bonds, a market has developed for futures contracts related to these bonds

• These contracts allow the holder to buy or sell a specified amount of a given bond issue at a stipulated price.

Secondary EquityMarkets

• The secondary equity market is usually been broken down into three major segments:

(1) the major national stock exchanges, including the New York, the Tokyo, and the London stock , Lusaka stock Exchanges

(2) regional stock exchanges in such cities as Chicago, San Francisco, Boston, Osaka

and Nagoya in Japan, and Dublin in Ireland (3) the over-the-counter (OTC) market, which

involves trading in stocks not listed on an organized exchange.