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Transcript
Investment Basics
Clench Fraud Trust
Investment Workshop
October 24, 2011
Jeff Frketich, CFA
Topics

Risk and Return

Fixed income (bonds)

Equities (stocks)

Asset Mix (how you combine stocks and bonds)

Diversification
2
Risk and Return
3
Risk And Return


In financial markets you get paid a Return for taking a Risk, and every
investment contains some risk
The two most common definitions or risk are

the potential of permanent loss
 risk of borrower not paying back interest or principal
 risk of company not paying dividends or the value of company’s
shares declining


the volatility of day to day changes in the market value of
investments
 how much and how often does the value of our investment
change, for better or worse
Fixed income (bonds and short-term money market investments) are
typically less risky than equities
4
As An Investor, You Have 2 Options

Make a loan to someone


Cash deposit, GICs,
bankers acceptances,
commercial paper, money
market, bonds
Buy ownership in a
company

Purchase stocks
All investments have Risk, it is only a matter of how much
5
Risk And Return
Always a Tradeoff!!
Higher Risk
High Potential Return
Alternative Investments
i.e. Private Equity, Hedge Funds
Equities
Canadian, U.S. & International
Return
Low Risk
Low Return
Corporate Bonds
Government Bonds
Money Market
Cash
Risk
6
Fixed Income Securities (Bonds)
7
What Are Fixed Income Securities?

They pay a fixed amount of income to the owner


Fixed income securities have a limited life


produce a steady income stream that you can use to budget
at some point the security matures and the borrower pays back
your principal
Stocks do not ‘mature’

they exist as long as the company exists
8
Short Term Fixed Income Securities

Examples of short-term (usually less than one
year) fixed income include:
 GICs


Treasury Bills


short-term borrowing by banks
short-term borrowing by Federal and Provincial
Governments
Bankers Acceptances and Commercial Paper

short-term borrowing by corporations
9
Short Term Fixed Income Securities

Examples of short-term (usually less than one
year) fixed income include:
 Money Market

a pool of treasury bills, bankers acceptances,
commercial paper, short term bonds, all with a very
short term to maturity
10
Long-Term Fixed Income Securities

Examples of long-term fixed income include:

Bonds


long-term borrowing by governments (federal, provincial and
municipal) and corporations
Mortgage and Asset Backed Securities

pools of mortgages that are packaged together and sold just
like bonds
11
Bonds



When talking about fixed income securities, we are
usually talking about bonds
Bonds are a contract that entitle the owner to regular
interest payments and the return of their principal
(original amount of the loan) when the bond matures
Bonds are bought and sold in the open market, like
stocks
12
Bond Example
Suppose you buy a new 10 Year $1,000,000 Government of
Canada bond with a 4% coupon:
You receive the following interest payment each year
1
$40k
2
$40k
3
$40k
4
5
$40k $40k
6
7
8
$40k $40k $40k
9
10
$40k
$40k
Total payments over 10 years is $400,000 ($40k per year for 10 years)
Receive your principal of $1,000,000 back from the
Government of Canada after 10 years, when bond matures
Total money received over 10 years is $1,400,000
13
Bonds: Changing Interest Rates


Interest rates affect the price of most fixed
income securities, especially bonds
Interest rates (yields) go up and down,
depending on what is happening in the economy;
generally the better the economy, the higher the
interest rate
14
Bonds: Changing Interest Rates

Interest rates and the price of bonds move in
opposite directions, i.e. when interest rates go
up, bond prices go down; when interest rates go
down, bond prices go up
Interest rates
Bonds prices
15
Bonds: Time to Maturity Can Have A
Large Impact on Bond Prices

The longer the time to maturity, the more volatile the
bond price for a given change in interest rates


a change in interest rates of 1% will not affect the price of a bond
that matures tomorrow.
however, a 1% change in interest rates will have a much larger
effect on a bond that matures in 10 years
16
Bonds: Time to Maturity Can Have A
Large Impact on Bond Prices
$3
$2
$1
$0
2 years
5 years
10 years
25 years
$ Change for 1% Change in Interest Rates
17
Credit Rating Agencies



How do you know which bonds to buy and which to
avoid?
Your investment counsellor starts the process by
reviewing what independent credit rating agencies say
about the bond
Two examples of credit rating agencies are Dominion
Bond Rating Service and Standard & Poors
18
Credit Rating Agencies



DBRS and S&P look at things like cash flows, earnings
growth, the firm’s competitive position and future capital
expenditures.
The agencies come up with a grade representing the
credit quality of the borrower.
The better the credit quality, the higher the credit rating;
the higher the rating, the lower the interest rate the
borrower must pay on the debt.
19
Fixed Income – Credit Qualities
Quality Counts
Investment Grade
Non-Investment
Grade (Junk Bonds)
Bond
Interest
Rating
Rate
AAA
3%
AA
4%
A
6%
BBB
8%
BB
10%
B
15%
CCC
???
20
Best Quality (lowest risk, pays lowest rate of
interest)
Worst Quality (highest risk, pays higher rate
of interest)
Equities
(Stocks)
(Shares of Companies)
21
Stocks

What They Are




Called equities or common shares
Ownership of a piece of the company
Create earnings (sales – expenses)
Provide a return





Capital gains (stock price goes up)
Dividends
Listed on a stock exchange
Can be traded
Can be risky
22
Stocks

Why a Company Issues Shares

Raise Money






Start up the company
Provide extra cash to run the business
Buy property, plants, equipment
Acquire other companies
Alternative to borrowing money
Spread the Risk of Ownership
23
Stocks

What A Company Does With Earnings (profits)




Reinvest in the Company (retained earnings)
Buy back their own Shares
Acquire another Company
Pay Dividends to Shareholders
24
Stocks

Why Investors Buy Them

Investors – First Nations




Provide long term Growth to a Portfolio
Typically buy to hold for longer periods than
traders/speculators
For Total Return
 Capital gains
 Dividend income
Traders/Speculators – NOT First Nations


Make quick profits from an increase in price
Capital Gains
25
Stock Returns
ABC Company
Stocks can provide two types of returns:
1. Dividends – Provides Income
2. Capital Gains – Provides Growth
Stock Price
= $100
Dividend
= $4 ($1.00 paid each quarter)
Dividend Yield = 4%
Every year ABC stock pays $4/per share. So if you own
1,000 shares, you receive $4,000 in dividends each year for
as long as you hold the stock
26
Stock Returns
If ABC stock price rises you enjoy a Capital Gain
Buy Price
= $100 per share
Price rises
= $125 per share
Capital Gain
= $25 per share
So if you bought 1,000 shares of ABC stock at $100 and the price
goes to $125, you have a capital gain of $25,000
($25 x 1000 shares)
27
Stocks

What Makes Them Change In Price

Earnings or Expected Earnings



Company
 Business model
 Competitive position
 Revenues and Expenses
Industry
 Anything affecting the particular industry or business of
the company
Economy
 Affects people’s ability to by Company’s products
 Consumer and Business spending
 Employment / Unemployment
 Interest Rates
28
Stocks

What Makes Them Change In Price

Demand for a Company’s Stock


Information
 What is know or factual about the Company
 Company reports and results
 Past performance , Earnings, etc.
Speculation
 What is assumed about the Company and its prospects
 Anticipation of changes to business and potential
earnings
 Rumours about the Company
 Takeovers
 New business opportunities
29
Asset Mix: Combining Stocks
and Bonds
30
Asset Mix



Asset mix is another way of saying how much do you
have in stocks and how much do you have in bonds
Each Trust has its own unique return requirements and
risk tolerance
Asset mix will determine the risk/return levels in your
trust portfolio

generally, the more stocks you have the more risk you take
31
Asset Mix

How do you decide on asset mix?

Assessment of First Nation’s




financial needs & long term goals
ability to tolerate short-term loss in value
ability to tolerate permanent loss of capital
Professional help is recommended


do it right the first time (very costly to fix later)
avoid actual losses or lost opportunities
32
Asset Mix

Example of asset mix choices:

Under three years:


Three to five years


fixed income only
balanced account with more fixed income than equities, i.e.
70% fixed income and 30% equities
More than five years

balanced account with more equities than fixed income, i.e.
40% fixed income and 60% equities
EACH FIRST NATION/TRUST HAS IT’S OWN UNIQUE
FINANCIAL OBJECTIVES AND CONSTRAINTS.
33
Diversification
Balanced Portfolio
Stocks
Return
Bonds
Cash
Time
34