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1、Lecture Presentation Software to accompanyInvestment Analysis and Portfolio ManagementSeventh Editionby Frank K.Reilly&Keith C.BrownChapter 2Chapter 2The Asset Allocation DecisionQuestions to be answered:What is asset allocation?What are the four steps in the portfolio management process?What is the
2、 role of asset allocation in investment planning?Why is a policy statement important to the planning process?Chapter 2The Asset Allocation Decision What objectives and constraints should be detailed in a policy statement?How and why do investment goals change over a persons lifetime and circumstance
3、s?Why do asset allocation strategies differ across national boundaries?Financial Plan PreliminariesInsuranceLife insurance Term life insurance-Provides death benefit only.Premium could change every renewal period Universal and variable life insurance provide cash value plus death benefit Financial P
4、lan PreliminariesInsuranceHealth insuranceDisability insuranceAutomobile insuranceHome/rental insuranceLiability insuranceFinancial Plan PreliminariesCash reserveTo meet emergency needsIncludes cash equivalents(liquid investments)Equal to six months living expenses recommended by expertsIndividual I
5、nvestorLife Cycle Accumulation phase early to middle years of working career Consolidation phase past midpoint of careers.Earnings greater than expenses Spending/Gifting phase begins after retirementIndividual Investor Life CycleNet WorthAgeAccumulation PhaseLong-term:Retirement Childrens college Sh
6、ort-term:House CarConsolidation PhaseLong-term:RetirementShort-term:VacationsChildrens CollegeSpending Phase Gifting PhaseLong-term:Estate PlanningShort-term:Lifestyle Needs Gifts Exhibit 2.1Life Cycle Investment Goals Near-term,high-priority goals Long-term,high-priority goals Lower-priority goalsT
7、he Portfolio Management Process1.Policy statement-Focus:Investors short-term and long-term needs,familiarity with capital market history,and expectations2.Examine current and project financial,economic,political,and social conditions-Focus:Short-term and intermediate-term expected conditions to use
8、in constructing a specific portfolio3.Implement the plan by constructing the portfolio-Focus:Meet the investors needs at the minimum risk levels4.Feedback loop:Monitor and update investor needs,environmental conditions,portfolio performanceExhibit 2.2The Portfolio Management Process 1.Policy stateme
9、ntspecifies investment goals and acceptable risk levelsshould be reviewed periodicallyguides all investment decisionsThe Portfolio Management Process 2.Study current financial and economic conditions and forecast future trendsdetermine strategies to meet goalsrequires monitoring and updatingThe Port
10、folio Management Process 3.Construct the portfolioallocate available funds to minimize investors risks and meet investment goals The Portfolio Management Process 4.Monitor and updateevaluate portfolio performanceMonitor investors needs and market conditionsrevise policy statement as neededmodify inv
11、estment strategy accordinglyThe Need For A Policy Statement Helps investors understand their own needs,objectives,and investment constraints Sets standards for evaluating portfolio performance Reduces the possibility of inappropriate behavior on the part of the portfolio manager Constructing A Polic
12、y StatementQuestions to be answered:What are the real risks of an adverse financial outcome,especially in the short run?What probable emotional reactions will I have to an adverse financial outcome?How knowledgeable am I about investments and the financial markets?Constructing A Policy Statement Wha
13、t other capital or income sources do I have?How important is this particular portfolio to my overall financial position?What,if any,legal restrictions may affect my investment needs?What,if any,unanticipated consequences of interim fluctuations in portfolio value might affect my investment policy?In
14、vestment Objectives Risk Tolerance Absolute or relative percentage return General goalsInvestment ObjectivesGeneral Goals Capital preservation minimize risk of real loss Capital appreciation Growth of the portfolio in real terms to meet future need Current income Focus is in generating income rather
15、 than capital gainsInvestment ObjectivesGeneral Goals Total return Increase portfolio value by capital gains and by reinvesting current income Maintain moderate risk exposureInvestment Constraints Liquidity needs Vary between investors depending upon age,employment,tax status,etc.Time horizon Influe
16、nces liquidity needs and risk toleranceInvestment Constraints Tax concerns Capital gains or losses taxed differently from income Unrealized capital gain reflect price appreciation of currently held assets that have not yet been sold Realized capital gain when the asset has been sold at a profit Trad
17、e-off between taxes and diversification tax consequences of selling company stock for diversification purposesInvestment Constraints Tax concerns(continued)interest on municipal bonds exempt from federal income tax and from state of issue interest on federal securities exempt from state income tax c
18、ontributions to an IRA may qualify as deductible from taxable income tax deferral considerations-compoundingEquivalent Taxable YieldEffect of Tax Deferral on Investor Wealth over Time$1,000Investment ValueTime$10,062.66$5,365.91Exhibit 2.6Methods of Tax Deferral Regular IRA-tax deductible Tax on ret
19、urns deferred until withdrawal Roth IRA-not tax deductible tax-free withdrawals possible Cash value life insurance funds accumulate tax-free until they are withdrawn Tax Sheltered Annuities Employers 401(k)and 403(b)plans tax-deferred investmentsLegal and Regulatory Factors Limitations or penalties
20、on withdrawals Fiduciary responsibilities-“prudent man”rule Investment laws prohibit insider tradingUnique Needs and Preferences Personal preferences such as socially conscious investments could influence investment choice Time constraints or lack of expertise for managing the portfolio may require
21、professional management Large investment in employers stock may require consideration of diversification needs Institutional investors needsConstructing the Policy Statement Objectives-risk and return Constraints-liquidity,time horizon,tax factors,legal and regulatory constraints,and unique needs an
22、d preferences Developing a plan depends on understanding the relationship between risk and return and the the importance of diversificationThe Importance of Asset Allocation An investment strategy is based on four decisions What asset classes to consider for investment What normal or policy weights
23、to assign to each eligible class Determining the allowable allocation ranges based on policy weights What specific securities to purchase for the portfolioThe Importance of Asset Allocation According to research studies,most(85%to 95%)of the overall investment return is due to the first two decision
24、s,not the selection of individual investmentsReturns and Risk of Different Asset Classes Historically,small company stocks have generated the highest returns.But the volatility of returns have been the highest too Inflation and taxes have a major impact on returns Returns on Treasury Bills have bare
25、ly kept pace with inflationReturns and Risk of Different Asset Classes Measuring risk by probability of not meeting your investment return objective indicates risk of equities is small and that of T-bills is large because of their differences in expected returns Focusing only on return variability a
26、s a measure of risk ignores reinvestment riskAsset Allocation Summary Policy statement determines types of assets to include in portfolio Asset allocation determines portfolio return more than stock selection Over long time periods,sizable allocation to equity will improve results Risk of a strategy
27、 depends on the investors goals and time horizonAsset Allocation and Cultural Differences Social,political,and tax environments influence the asset allocation decision Equity allocations of U.S.pension funds average 58%In the United Kingdom,equities make up 78%of assets In Germany,equity allocation
28、averages 8%In Japan,equities are 37%of assetsSummary1.Identify investment needs,risk tolerance,and familiarity with capital markets2.Identify objectives and constraints3.Enhance investment plans by accurate formulation of a policy statement4.Focus on asset allocation as it determines long-term retur
29、ns and riskThe InternetInvestments Onlinewww.amercoll.eduwww.idfp.orgwww.napfa.orgAppendix Objectives and Constraints of Institutional Investors Mutual Funds pool investors funds and invests them in financial assets as per its investment objectivePension Funds Receive contributions from the firm,its
30、 employees,or both and invests those funds Defined Benefit promise to pay retirees a specific income stream after retirement Defined Contribution do not promise a set of benefits.Employees retirement income is not an obligation of the firm Endowment FundsThey represent contributions made to charitab
31、le or educational institutions Insurance Companies Life Insurance Companiesearn rate in excess of actuarial rategrowing surplus if the spread is positivefiduciary principles limit the risk toleranceliquidity needs have increased tax rule changesInsurance Companies Nonlife Insurance Companiescash flo
32、ws less predictablefiduciary responsibility to claimantsRisk exposure low to moderateliquidity concerns due to uncertain claim patternsregulation more permissiveBanks Must attract funds in a competitive interest rate environment Try to maintain a positive difference between their cost of funds and their return on assets Need substantial liquidity to meet withdrawals and loan demands Face regulatory constraintsFuture topicsChapter 3 Investment choices Including global assets in asset allocation decisions