IPM L1

Economics: Investment

utilization of resources in order to increase income or production output in the future

Finance: Investment

buying of a financial product or any valued item with anticipation that positive returns will be received in the future

Benjamin Graham

• father of value investing

Louis Bachelier

• forefather of Mathematical Finance

• field of applied math in finance

Irving Fisher

• greatest economist in US

• father of quantity theory money

• best remembered today in neoclassical economics for his Theory of Capital, Investment, & Interest Rates, first exposited in his The Nature of Capital & Income (1906) & elaborated on in The Rate of Interest (1907)

Paul Samuelson

• father of modern economics

• first

Harry Markowitz

• introduced modern portfolio theory (MPT) in 1952

World History of Investment

1. Mesopotamian Investment

2. Greek Investment

3. Roman Investment

4. Medieval Period

5. European Renaissance

6. Joint-Stock Companies

7. Advent of Public Markets

8. Industrial Revolution

9. Great Depression

10. 21st Century

Mesopotamian Investment

• 3000-5000 BC

• investment was a privilege of the power elite

• only a small portion of the population could take part, & these investors had high economic, social, & political standing

• Code of Hammurabi - first law to state collateral and foundation of insurance

Greek Investment

• 800-300 BCA

• greek civilization witnessed the development of partnership for long distance trade in the Mediterranean world, as well as the development of banking partnerships for loan making activity & for investment management

• dito na nauso ang interest

• Investment Owner -

Roman Investment

• 500 BC - AD 400

• with the expansion of Roman territory, it became more common for wealthy people to own estates in multiple locations, with local managers overseeing estates in the owners’ absence

• notable for the 1st known Pension where Roman soldiers were sometimes granted estates far from the city of Rome

• first life insurance in the America

Medieval Period

• Rise of Cities & Economic Rebirth

• 1000-1200

• period of economic & technological stagnation

• rise of cities established in urban areas as centers if trade, culture, & prosperity, & city dwellers gained increasing power through municipal government, guilds, & merchant groups

European Renaissance

• 1200-1500

• rise of merchant banks, double-entry bookkeeping, commercial fairs of the kind that would later develop into stock markets, & other financial innovations that allowed for unprecedented economic growth

Join-Stock Companies

• 1550-1600

• 1st join-stock companies were established including the ff:

• 1555 - Muscovy Company

• 1600 - British East India Company

• 1602 - Dutch East India Company

• 1606 - London Company

Advent of Public Markets

• 1600-1787

• first public markets were developed, connecting potential investors with investment opportunities

• offered liquidity, publicized value, broadcast availability, & lowered transaction costs, & they permitted investors to gain diversification with relative ease

Industrial Revolution

• 1760-1910s

• witnessed numerous technological innovations, such as steam power & improved iron manufacturing

• key innovation included the combustion engine, radio, & electric power

Great Depression

• 1929-1939

• brought a decade of economic contraction around the world

21st Century

• 2000s

• innovation & opportunism combined with spectacular asset growth have given birth to billionaire hedge fund & private equity managers: a new elite

• Great Recession was a period of worldwide economic contraction, with the global financial crisis peaking in 2008

Philippines Economy Transformation

1. Mid-19th Century

2. 1950s-1960s

3. PH Economy under Marcos Sr

4. PH Economy under Cory Aquino

5. PH Economy under Ramos

6. PH Economy under Estrada

7. PH Economy under Arroyo

Mid-19th Century

• Filipino landowning elite developed on the basis of the export of abaca (Manila hemp), sugar, & other agricultural products

• at the onset of the US power in PH in 1898-1899, this planter group was cultivated as part of the US military & political pacification program

• democratic process imposed on the PH during the American colonial period remained under the control of this elite

1950s-1960s

• economic development in the PH during these years

• import restrictions stimulated the manufacturing sector

• manufacturing net domestic product (NDP) at first grew rapidly, averaging 12% growth per annum in real terms during the first half of the 1950s, contributing to an average 7.7% growth in the GNP, a higher rate than in any subsequent 5-year period

Marcos Sr

• PH economy grew at a relatively high average annual rate of 6.4% during the 1970s, financed in large part by foreign-currency borrowing

• external indebtedness grew from $2.3 billion in 1970 to $24.4 billion in 1983

• in 1980s, the PH economy was hurt by political instability, authoritarianism, increasing foreign debt, failing commodity prices, corporate mismanagement & vast

Cory Aquino

• PH economy floundered under Corazon Aquino

• power shortages & brownouts were common

• American bases were closed down

• economic growth revived in 1986 under Aquino, reaching 6.7% in 1988

• but in 1988, the economy once again began to encounter difficulties as the trade deficit & the government budget deficit were of particular concern

• in 1990, the economy continued to experience difficulties, a situation exacerbated by several natural disasters & growth declined to 3%

Ramos

• 1992-1998

• President Fidel Ramos was given high marks for handling the economy

• by breaking apart monopolies, liberalizing foreign investment laws, & privatizing business & industries by controlled powerful families

• Ramos was crediting with transforming the PH from a country with a history of poverty, corruption, rebellion, foreign ineptness, & tax evasion into an economic powerhouse that was not yet an Asian Tiger but was sometimes referred to as Asian Tiger Cub

Estrada

• investors shared this sense of hope & initially poured money into the PH but it didn’t take long for this optimism to evaporate

• foreign investors were turned off by cronyism, scandals, & favoritism towards PH companies

• Estrada moved to tighten securities regulations, liberalize the trade of grains & privatize the electricity industry

• his effort to change laws limiting foreign ownership of businesses to 40% was halted by his impeachment trial

Arroyo

• the day she was sworn in, the stock market surged 30% & businessmen praised her skills & abilities

• Arroyo launched free market & anti-corruption policies that were welcomed by both the local & international business communities

• there was a sense of hope but the sense of optimism didn’t last long

• investment dried up as a result of global slowdowns & security concerns

• direct foreign investment was only $319 million in 2001 compared to $1.8 billion in 1992

Nature of Investments

features of economic & financial investment (return, risk, safety, liquidity)

Features of economic & financial investments can be summarized as

1. Return

2. Risk

3. Safety

4. Liquidity

Return

• money made or lost on an investment over some period of time

• actual income from a project as well as appreciation in the value of capital

• there are 2 components in return

  • Interest or Dividends

  • Capital Gain or Loss

Risk

loss of principal amount of an investment, & one of the major characteristics of an investment

1. Systematic Risk

2. Unsystematic Risk - strategic risk, operational risk, financial risk

Safety

protection of investor principal amount & expected rate of return

Liquidity

investment ready to convert into cash position, & available immediately in cash form

Objectives of Invesmet

1. Capital Appreciation

2. Capital Preservation

3. Current Income

Investor

• an individual that puts money into an entity such as business for financial return

• main goal of any investor is to minimize risk & maximize return

• Institutional Investor

• Retail Investor

Investing

act of putting money into a business or organization to earn a profit

Institutional Investor

• Capital & Resources: large capital base, extensive trading resources

• Strategies: complex, algorithmic trading

• Market Access: direct market access, lower transaction cost

• Regulation: strict regulatory oversight

Retail Investor

• Capital & Resources: limited capital, personal resources

• Strategies: manual trading

• Market Access: brokerage platform, higher fees

• Regulation: less oversight, fewer restrictions

In investing, risk & return are highly correlated as

increased potential returns on investment usually go hand-in-hand with increased risk

As future is uncertain,

the future expected return too are uncertain

The expected return is the

uncertain future return that a firm expects to get from its project

The realized return is the

certain return that a firm has actually earned

Systematic Risk

• risk that affects the entire market, not just a particular stock or industry

• reflects the impact of economic, geopolitical, & financial factors

• largely unpredictable & is generally viewed as being difficult to avoid

• investors can mitigate the impact of systematic risk by building a diversified portfolio

Unsystematic Risk

• can affect a single company such as a threat from a new competitor, a corporate scandal, or a major lawsuit

• uncertainty inherent in a company or industry investment

  • Strategic Risk

  • Operational Risk

  • Financial Risk

Strategic Risk

• uncertainty regarding the firm’s objectives

  • if a firm enters a new line of business, the line may be unprofitable

Operational Risk

• prospect of loss resulting from inadequate or failed procedures, systems, or policies

  • a bank that offers online banking services may incur losses if hackers break into the bank’s computer

  • employee errors

Financial Risk

• uncertainty of loss because of adverse changes in commodity prices, interest rates, foreign exchange rates, & the value of money

  • a bank with a large portfolio of Treasury bonds may incur losses if interest rates rise

  • food company that agrees to deliver cereal at a fixed price to a supermarket chain in 6 months may lose money if grain prices rise

Interest/Dividends

basic component of return or the periodic cash flows from the investment

Capital Gain/Loss

change in the prices of the asset

Formula of Total Return

Total Return = (Cash payments received + Priced change in assets over the period) divided by Purchase price of the asset

Total Return

• measures the overall gain or loss from an investment over a specific period, expressed as a percentage of the original investment

• has 2 main components:

  • periodic income earned from the asset (dividends for stocks, interest for bonds, rental income for real estate)

  • price change in the asset (capital gain or loss: Price Change = Ending Price - Beginning Price)

Steps for Total Return Formula

1. Compute price change (price change = ending price - beginning price)

2. Add cash payments

3. Compute total return

Example for Total Return Formula

Stock Investment:

• Purchase price of stock = 1,000

• Dividends received during the year = 80

• Ending price after 1 year = 1,150

  • 1,150-1,000 = 150

  • 150 + 80 = 230

  • 230/1,000 = Total Return is 23% or 0.23