FIN 644 Lecture 2
FIN 644 Lecture 2
FIN 644 Lecture 2
(Fall 2024)
Lecture 2
Readings: Chapter 4 & 5
Prepared by Changjie Hu
9/10/2024
Recap
▪ What is investment?
▪ Current commitment of money/resources in the expectation of future benefits
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Investment Companies
▪ Do investors usually trade securities by themselves?
▪ More commonly, they direct funds to investment companies to trade on their behalf.
2. Closed-end funds:
▪ Unable to redeem shares at their NAV, must sell shares to other investors
▪ Shares traded on exchange (through brokers) at market prices (may be different from NAV)
▪ Do you think the share typically trade above or below its NAV?
▪ https://www.cefconnect.com/closed-end-funds-daily-pricing
▪ ETF shares are traded intra-day through a broker whereas mutual fund once a day at NAV based
on market close price.
▪ ETF started out exclusively as an index tracker (i.e., indexed ETFs) until about 2008
Source: https://www.fool.ca/
▪ Much larger than individual investors but still not efficient to be managed separately
▪ Contain redemption constraints such as lockups, a side pocket and a gate. Why?
▪ Allowing longer term investment without worrying about redemption => higher expected return
Style Strategy
Global macro Involves long and short positions in capital or derivative markets across the world. Portfolio
positions reflect views on broad market conditions and major economic trends.
Emerging Goal is to exploit market inefficiencies in emerging markets. Typically, long only because short-
markets selling is not feasible in many developing markets. Can be invested across asset classes (and
currency).
Managed futures Use financial, currency, or commodity futures. May make use of technical trading rules or a less
structured judgmental approach.
Multistrategy Opportunistic choice of strategy depending on outlook.
Fund of Funds Fund allocates its-cash-to several other-hedge-funds-to be managed.
2. Equity Funds
▪ Invest primarily in stocks (sometimes also fixed-income and others)
▪ Holds some money-market instrument to maintain liquidity for redemption
▪ Can be classified as income funds or growth funds
▪ Essentially stocks with higher dividend vs. higher capital gain potential
3. Sector Funds
▪ Focusing on a particular industry (e.g., biotech, utilities, energy, telecom)
5. International Funds
▪ International focus with securities in different part of the world (e.g., emerging market funds)
6. Balanced Funds
▪ Designed as an “appropriate” investment portfolio for individuals
▪ Good mix of equities and fixed-income
▪ Life-cycle funds target different age groups vs. target-date funds decrease risks gradually
2. Front-End Load
▪ A commission or sales charge when first purchase and paid to the broker
▪ Typically, will not < 6% and might decrease when the investment is larger
▪ E.g., a $1000 payment = $940 invested in the fund if 6% load
4. Others
▪ 12b-1 Charges (distribution costs approved by SEC)
▪ Trailer/trailing fees in Canada (similar to 12b-1)
▪ Example: A fund has an initial NAV of $20 at the start of the month, makes
income distributions of $0.15 and capital gain distributions of $0.05, and ends the
month with NAV of $20.10. What is the monthly rate of return?
▪ Note:
▪ EAR is the actual return gained per year
▪ Example: Suppose you bought a share at the beginning of the year for $100. The end-
of-year price per share is $110 and cash dividends over the year amount to $4. What is
the HPR?
▪ Note that:
▪ Dividend yield = $4/$100 = 4%
▪ Capital gain = $110/$100 = 10%
▪ If returns follow normal distribution, what does it mean to have an expected return of 10% and
standard deviation of 20%?
▪ Suppose the expected return is 10% and SD is 15% => 1% VaR = 10% - 2.33(15%) = -24.75%
▪ There is 99% chance that the loss in the next period will not be worse than -24.75%
▪ Suppose a particular investment had annual returns of 10%, 12%, 3% and -9% over the
past 4 years. What is the geometric average return and the arithmetic average
return?
▪ Answer:
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