IA&PM Analysis of Asset Classes

Overview of Asset Classes and Products

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Investment Options

Equities

Fixed Income

Structured Products

Mutual FundsReal Estate

Commodities Commodities

Alternative Investments

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Fixed Income

Direct Equities

Gold


Risk

Return

Risk Return : Products

Mutual Funds

Real Estate

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History of asset bubbles over the last 30 years

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Economic Cycles

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How do Value Asset Classes

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Fundamental Analysis

Technical Analysis

Fixed Income

Equities

Candle Stick analysis, moving averages analysis , Break out analysis etc.


Free Cash Flow, Discounted Cash Flow, Dividend Yield, Ratio

Analysis etc.

Valuing bonds, Maturity, Modified Duration, Credit

Spread, Yield curve

Inherent valuation difficult, analysis of

alternative strategies


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Macro economic Analysis:Lag indicators………GDP, CPI, PMI etc.Lead indicators…….Confidence polls, PPICo incident indicators Industry AnalysisEquity Valuation Fixed Income Valuation Alternative Investments Valuation


Economic signals can be read through some indicators grouped as follows

• Lag Indicators• Co-incident indicators• Lead Indicators

Lag Indicators

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What is GDP…………………

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GDP: Gross domestic product is the market value of all the final goods and services produced within an economy in a given period of time

Y=C+I+G+NX where C is consumption, I is investment , G government purchases and NX is net exports

Is GDP calculated as real or nominal……….?

Nominal GDP

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… reflects the current price level of goods and services

… ignores the effect of inflation on the growth of GDP

Real Vs Nominal GDP

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Real GDP

… measures the value of goods and services adjusted for change in the price level. It reflects the real change in output

… This measure is calculated at constant prices

… indicates what the GDP would be if the purchasing power of the dollar has not changed from what it was in a base year. The government currently uses 2004-2005 as its base year for GDP

The new revised GDP base year will be 2011-2012

Lets see the Calculation of GDP

Real GDP for 2006

Real GDP= (2006 price of apples* 2006 quantity of apples) +( 2006 price of oranges* 2006 quantity of oranges)

Real GDP for 2008 would be keeping prices of 2006 constant Real GDP= (2006 price of apples* 2008 quantity of apples) +( 2006 price of oranges* 2008 quantity of oranges)

GDP deflator =Nominal GDP/Real GDP

GNP=GDP + Factor payments from abroad-Factor payments to abroad

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GDP Price Index

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Price Indexin a givenyear

=

Price of market basketin specific year

Price of same marketbasket in base year

x 100

Real GDP =Nominal GDP

Price Index(in hundredths)

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… a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.

CPI Consumer Price Index

Fundamental Analysis : Lead indicators

Co incident indicators are variables which change according to the present situation like purchase of luxury items etc.

Lead indicators can be surveys taken by companies or government to measure the confidence among consumers or companies

Markit measures PPI (purchasing pricing index) a monthly snapshot of countries calculated from the inputs by from senior purchasing managers in business

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Money..Money…Fiat money

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Fiat money is money with no intrinsic valueThe control over the money supply is called monetary policy delegated usually to an independent institution called the central bank i.e. RBI in India

Quantity theory of money M * V=P * T i.e MONEY * VELOCITY= PRICE * TRANSACTIONS

M is the quantity of money, V is the transaction velocity of money and measures the rate at which money circulates in the economy, P is the price of the typical transactions The equation can be replaced as M*V=PY where Y is the output of the economyKeeping V fixed we get MV=PY(Nominal GDP)So a change in the quantity of money must cause change in nominal GDPFisher EquationI= r+

where I is nominal interest rates, r is real interest rates

Fundamental Analysis : Interest rate views - Monetary Policy/ Central Bank operations

RBI is the central bank in India which regulates the monetary policy. During recessionary environment RBI cuts interest rates to boost consumption while when inflation is high it increases rates

RBI regulates the money supply in the economy through the following steps

• Vary the reserve requirements in depository institutions.. SLR,CRR• Vary the level of reserves through open market operations In this operation the government buys or sells government bonds in the market to regulate the money supply with the aim to control the short term rates and base money supply• Set key level of interest rates…Repo/Reverse repo

The level of interest rates also determines exchange rate

Factors affecting exchange rate

Relative interest rates, BOP, fiscal and monetary policies, central bank interventions In the market, interest rates and economic performance

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RBI defines money aggregate as follows :

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Reserve Money (M0): Currency in circulation + Bankers’ deposits with theRBI + ‘Other’ deposits with the RBI = Net RBI credit to the Government + RBI credit to the commercial sector + RBI’s claims on banks+ RBI’s net foreign assets + Government’s currency liabilities to the public – RBI’s net non-monetary liabilities

M1: Currency with the public + Deposit money of the public(Demand deposits with the banking system + ‘Other’ deposits with the RBI) M2: M1 + Savings deposits with Post office savings banks

M3: M1+ Time deposits with the banking system = Net bank credit to the Government + Bank credit to the commercial sector + Net foreign exchangeassets of the banking sector + Government’s currency liabilities to the public– Net non-monetary liabilities of the banking sector (Other than Time Deposits)

M4: M3 + All deposits with post office savings banks (excluding National Savings Certificates)

Is credit card included in money aggregate

Source: RBI

Annual returns S&P CNX Nifty

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Source: Nseindia.com

Annual returns

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Source: IIFL

Equities—NSE 50

Investors can trade on the stock exchange NSE and BSE directly through a broker or online trading platforms

Take exposure through mutual funds

Take private placements through block deals

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Equity: Valuing an asset

Non constant growthValue=CF1/(1+r)+CF2/(1+r)^2…….+CFn/(1+r)^n

Constant Growth

Value=CF1/r-g

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Equity: Stock Return

Total Return(TR)= dividend + change in market value

TR=dividend+ change in market value/beginning market value

TR yield= dividend yield + capital gains yield

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The future earnings growth of a company is measured through discounted cash flow method The value of the asset is the value of the present cash flows

Financial statement analysis consists of balance sheet, income statement and cash flow analysis of a company

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Discounted cash flow method…Dividend Discount Model

P0=Div1+P1/(1+r), P1=Div2+P2/(1+r), P2=Div3+p4/(1+r)

P0=Div1+P1/(1+r)=Div1/(1+r)+DIV2/(1+r)^2………….+Divn/(1+r)^n + Pn /(1+r)^n infinity

P0= Divt /(1+r)^t

t=1

The actual prices and profits of companies is not known but the market forms an expectation of the future dividends and profits which is built into the stock N

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Constant Dividend Growth

Lets assume the dividends grow at a constant growth of g per yearThe cash flows per year is as follows

Year Cash Flow

0 -P0 1 Div1 2 Div2 DIV1*(1+g) 3 Div3 DIV2*(1+g) Div1*(1+g)^2

P0=Div1/r-g where r is the expected rate of return and g is growth rate

ABC has paid a dividend of Rs15 per share which is expected to grow at 7% while the expected rate of return is 10%, calculate the market price of the share

Div0=15, r=10%=0.10, g=0.07Div1=Div0*(1+g)=15*1.07= 16.05 P0=16.05/(0.1-0.07)=16.05/0.03= 535

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Equity: What is Free Cash Flow Valuing an asset

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Three are three types of financial statements released by firms

Income statement, Cash flow and Balance sheet

How is Net Income derived

Net Income NI=(Sales-COGS-SG&A-Interest expense)*(1-T)

How do we derive FCF Free cash flow Net Income + Non cash charges (Depreciation & Amortization)+/- Changes in NWC excluding cash or S-T Account receivable

Inventories & other current assetsAccount payable

+/- Proceeds for sale or payment for FA+ After tax portion of interest expense- After tax portion of interest income

Free cash flow

Equity: What is Free Cash Flow Valuing an asset

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Some key facts• Increase in assets are cash outflows/decrease in assets are cash inflows• Increase in liabilities are cash inflows/decreases in liabilities are cash

outflows• Always add non cash expenses like depreciation, interest expense• Increase in net working capital is an outflow of cash and hence deducted

from the cash flow

Free cash flow to equity FCFE=FCFF-Interest (1-tax rate) – loan repayment The equity portion of the also be calculated =Value of the firm – loan repayment

Enterprise value is market value of all companies shares and market value of companies debt – cash and investments

EPS (Earnings per share)= net income-preferred dividends/weighted average no. of common shares o/s

Diluted EPS is calculated when dilutive securities like stock options, warrants, convertible debt or convertible preferred stock is converted into stock

Equity: Ratios

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A stock split refers to the division of each old share into a specific number of new shares For e.g.. A holder of 100 shares will receive 200 shares after 2 for 1 or 150 shares after 3 for 2 split

Equity: Ratios

Liquidity Ratios

Current ratio=CA/CLAcid Ratio=CA-inventory/CL Cash Ratio RATIO=Cash/CLOperating Cost=SG&A+COGS-Depreciation

Leverage RatioTo measure long term ability of companies to measure its obligations A higher ratio signifies it is in financial distressTo low a ratio signals its not deploying benefits of debt

Total Debt = TA-TE/TA Debt/equity ratio=TD/TE Equity Multiplier=TA/TE

Times interest earned=EBIT/interest

Cash coverage ratio=EBIT + depreciation/interest

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Equity: Ratios

Profitability

Profit Margin=NI/Sales ROA=NI/TAROE=NI/TE

Asset Use

How efficiently the firm uses its assets to generate profits Its signifies working capital management and varies according to industryTotal asset turnover=Sales/TA Fixed asset turnover=Sales/TA

Note: NI=Net Income, TA =Total Asset, TE=Total Equity

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Du Pont Ratio

ROE = NI/TE=NI/TE*TA/TA=NI/TA*TA/TE=ROA*Equity Multiplier

ROA=NI/TA=NI/Sales*Sales/TA= Profit Margin*Total Asset Turnover

ROE=ROA*Equity Multiplier =Profit Margin*Total Asset Turnover*Equity multiplier

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Fixed Income Securities

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What is a bond ………………

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A bond is a tradable instrument that represents a debt owed to the owner by the issuer. Most commonly, bonds pay interest periodically (usually semiannually) and then return the principal at maturity.

Safety of Bonds

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The safety of bonds derives mainly from two things:

Bondholders are in line ahead of both preferred and common stockholders for payment. Thus, if a firm falls on hard times, it must first pay its bondholders while stockholders may see dividends cut.

In the event that a company skips a payment or violates covenants of the indenture, the creditors may force it into bankruptcy to protect the value of their investment. Stockholders have no such right.

Bond Basics

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Type of Issuer

Sovereign: Issued by Indian government: RBI, State government and Corporate Bonds

Term to Maturity

Bonds of maturity between one to five year are termed as short term bondsBonds between 5 to 12 are intermediate bondsLong term bonds are with maturity more than 12 years

Zero-coupon bonds – no periodic interest payments; principal and interest paid at termFloating rate security – coupon rate is reset periodically

Bond Basics

When you buy a bond you are lending money to government, municipal or corporate depending on the bond.In return the issue pays you the interest rate on the bond ( coupon paid annually or half yearly and the principal back at maturity)

The Coupon Rate – This is the promised annual rate of interest. It is normally fixed at issuance for the life of the bond. To determine the annual interest payment, multiply the coupon rate by the face value of the bond. Interest is normally paid semiannually, and the semiannual payment is one-half the annual total payment

The Face Value – This is nominally the amount of the loan to the issuer. It is to be paid back at maturity

Yield to Maturity – This is the rate of return that will be earned on the bond if it is purchased at the current market price, held to maturity, and if all of the remaining coupons are reinvested at this same rate. This is the IRR of the bond

Yield is coupon/price of the bond

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Bond Basics

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Total Return: Sum of coupon payments and appreciation of the bond over the tenure of the bond

Risk of Bonds

Bonds are generally less risky than stocks, but they do suffer from several types of risk:

Credit risk – Risk of default measured by looking atv credit ratings given by rating agencies

Interest rate risk – Risk of unexpected changes in rates, causing a capital loss

Reinvestment risk – Risk that rates will fall and you will reinvest at a lower rate

Inflation Risk – Measure in terms of purchasing power because of variation of cash flows due to inflation

Call risk – Risk that the bond will be called because of lower rates

Liquidity risk – The risk that you will not be able to sell the bond at a price near its full value

Foreign exchange risk – Risk that a foreign currency will decline in value, causing a decline in the value of your interest payments and principal

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Fixed Income—US Treasury Sccurities

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Bills – matures in one year or less, issued at a discount

Notes – matures between 2-10 years, issued as a coupon security

Bonds –maturities longer than 10 years

Treasury inflation protection securities (TIPS) – principal is indexed to CPI- U with real rate being fixed

Fixed Income—Credit Risk

Bonds issued by government are called Sovereign bonds since they carry no risk…………..Based on an assumption government do not default on its own obligations..What about Russia in late 90s……………..

Non Sovereign Bonds have higher yields because of the credit risk

Yield spread: Difference between the sovereign bonds and non sovereign bonds

The benchmark sovereign bond is always the 10 year bond due to liquidity

In US the benchmark is the 10 year bond while in Euro the German 10 year bond the bund is the benchmark

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Risk of Bonds

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How to measure credit risk of bonds

Credit risk is the most important source of risk for owners of bonds

Rating agencies (S&P, Moody’s, Fitch, and Dominion Bond) assign grades to indicate the credit quality of various bond issues.

As you should guess, yields on lower rated bonds will be higher (more risk) than those on higher rated bonds (less risk)

Ratings on bonds are like grades (i.e., AAA is better than AA)

Bond Ratings

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Bond Ratings by AgencyMoody's S&P Fitch DBRS DCR Definitions

Aaa AAA AAA AAA AAA Prime. Maximum SafetyAa1 AA+ AA+ AA+ AA+ High Grade High QualityAa2 AA AA AA AAAa3 AA- AA- AA- AA-A1 A+ A+ A+ A+ Upper Medium GradeA2 A A A AA3 A- A- A- A-Baa1 BBB+ BBB+ BBB+ BBB+ Lower Medium GradeBaa2 BBB BBB BBB BBBBaa3 BBB- BBB- BBB- BBB-Ba1 BB+ BB+ BB+ BB+ Non Investment GradeBa2 BB BB BB BB SpeculativeBa3 BB- BB- BB- BB-B1 B+ B+ B+ B+ Highly SpeculativeB2 B B B BB3 B- B- B- B-Caa1 CCC+ CCC CCC+ CCC Substantial RiskCaa2 CCC - CCC - In Poor StandingCaa3 CCC- - CCC- -Ca - - - - Extremely Speculative

C - - - - May be in Default- - DDD D - Default- - DD - DD- D D - -- - - - DPSource: http://www.bondsonline.com/asp/research/bondratings.asp

Bond Default Rates

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Default Rate by S&P Bond Rating(15 Years)

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

S&P Bond Rating

Def

ault

Rat

e

Default Rate 0.52% 1.31% 2.32% 6.64% 19.52% 35.76% 54.38%

AAA AA A BBB BB B CCC

Fixed Income: 10 year Gsec

The most liquid sovereign bond in IndiaSource: Tradingeconomics.com

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Fixed Income—The Bond market in India

Money market is a part of bond market• Very liquid market with participants lend or borrow for a period of 1 year• Participants are Government , Financial institutions and large corporates • Very low risk with very low return

T-Bills

• Issued by RBI with maturities of 91 days, 182 and 364 days • Maturity between 3 months to 1 year• Issued like a zero coupon bond with face value at maturity • Issued at auctions with the value decided by bidding ( weekly issue of 91

days maturity, fortnightly issue of 182 and 364 days• Carry only sovereign risk N

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Fixed Income—The Bond market in India Money Market

Commercial Paper

• Issued as unsecured money market instruments issued by large corporates as promissory notes to take care of working capital

• CP can be issued by large corporates with investment grade ratings, primary dealers, satellite dealers, financial institutions

• Tenure from 15 days to 1 year• Issued as promissory notes or in demat form

Certificate of Deposits

• Term deposit with a bank ranging from 7 days to 3 years with a specified interest rate

• Cannot be withdrawn on demand unlike bank deposit• The denomination is very large with minimum of 1,00,000 and in multiples

thereafter• Freely negotiable and can be demat or promissory note

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Treasury notes and T-bonds

• Issued by central government and carry sovereign risk• Treasury notes are of duration of 10 years and t-bonds of duration till 30

years • Sold through auction and then traded in secondary market• Interest income is tax exempt; interest in the form of regular coupons• Carry interest rate and reinvestment risk

Government and Municipal government bonds

• Issued by state governments to finance projects like infrastructure bonds • Backed by guarantee by respective governments

Corporate Bond

• Issued by large corporates and very similar to T-bonds • Ratings are given by rating houses like Crisil

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Types of Corporate bonds

• Secured bonds are bonds backed by collateral

• Unsecured or debentures are not backed by any security but have a preference of equity in terms of bankruptcy of company

• Subordinate debentures have lower priority over other bonds in terms of liquidation

• High yield bonds or Junk bonds are bonds issued by companies with low investment ratings

Give very high interest rates but have very high riskThe market in India is very small but very big in US … Read Michael Milken

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Fixed Income—Types of bonds

Bond• Coupon or interest payments issued at regular intervals• Issued at Face value

Zero Coupon Bond• No coupon payment and issued at discount to face value

Convertible Bonds

• The bondholder has a right to convert the bond into equity• Gives a chance to participate in the upside of the company• Issued at lower interest rate in comparison to similar bonds • Work like warrants which have similar features

Callable/Puttable Bonds

• Issues a right ( not obligation) to buy/sell the bond back to the issuer for a specified price after a specified duration

• Carries a lower interest rate than comparable bonds of same duration

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Fixed Income—Repo , Reverse Repo and floating rate bonds

Repo Rate

• Overnight borrowing of Gsec for overnight liquidity among financial institutions; Repo rate 7%

• Repo rate is the rate which RBI uses to manage liquidity in the system

Floating rate

Worldwide Libor works as the benchmark for issuing floating rate securities the market estimated to be USD 130 trLibor moves in tandem with Fed rate …Now you see how the world is awash with liquidity due to very low interest rates but is helping world economy by increasing credit India the benchmark would be MIBOR which is not liquid N

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Fixed Income : Overview

The bond market in India is about USD 711bn (2011)

The participants in bond market are government( 85%), corporates and financial

The government debt is 40% of the GDP The corporate bond market is in nascent stage with only 6.5% of GDP in 2011 with 5% share of the overall bond marketThe share of corporate bonds to GDP is 10.6% in China, 41.7% in Japan and 49.3% in South KoreaThe bond market is not developed due to very low retail participation, high issuance costs, low gestation period for issuance, small size of issuance and very illiquid bonds. Sovereign bonds can only bought through a authorized primary dealer and hence low retail participation

Source: Resurgent India Report

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Source: Goldman Sachs BIS Report2011

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Fixed Income: India RBI updated rules 2013

Source: Moneycontrol.com

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RBI has increased the limits on government bond investments by USD5bn to USD 25bn for FII and to USD50bn for corporate bonds

Regarding corporate bonds, the RBI added FIIs would not able to buy certificates of deposits or commercial paper as part of the enhanced USD 5 billion limit

The RBI also removed the one-year lock-in period for USD 22 billion investments in infrastructure bonds

As part of the increase in government debt limits, the RBI announced the removal of the clause that had mandated first time FII purchasers of dated government bonds must buy securities with at least three-year residual maturity


By 2016 the bond market would double in India.. Will itSource: Goldman Sachs CCIL Report2011

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Fixed Income—Time value and Annuity

Future Value Pn=P0(1+r)^n where n=no. of periods, Pn=future value n periods from now, r=interest rate and P0 the original principal

Lets see how ordinary annuity is calculated

Annuity is referred to the same amount of money which is invested periodically while ordinary annuity refers to the annuity where the first investment occurs one period from now

Pn=A((1+r)^n-1))/r where A is the amount of annuity

Lets see an example

A portfolio manager purchases USD 20 mn par value of a 15 year bond which promises a 10% interest rate per year . Th issuer makes the first payment one year from now . How much will the portfolio manager have if 1) the bond is held for 15 years 2) annual payments are invested at an annual interest of 8%

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Fixed Income—Annuity

The amount the portfolio manager will have at the end of 15 years will be equal to

1. The USD 20 mn when the bond matures2. 15 annual interest payments of 2,000,000 (0.10*20 mn)3. The interest earned by investing the annual interest payments at 8% per year

According to the equation A =2,000,000 r=0.08, n=15

P15= 2000000((1.08)^15-1))/0.08=2000000(3.17217-1/0.08)=54,304,250

The future value of the ordinary annuity of 200000 for 15 years invested at 8% is 54,304,250. 30,000,000 is the total amount of interest payments while the balance ( 54,304,250-30,000,000) is the interest earned by reinvesting these annual interest payments.

Total amount at the end of 15 years Par value 20,000,000Interest Payments 30,000,000Interest on reinvestment of interest payments 24,304,250

74,304,250

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Fixed Income—Present Value of Annuity and pricing Zero coupon bonds

Now calculate the total return for the same bond when interest rate is paid every six months

Present value PV=Pn 1/(1+r)^n the present value of $1, i.e., it indicates how

much be set aside today, earning at interest rate of r per period, in order to have $1 n periods from now

Present value of an ordinary annuity

PV=A 1-1/(1+r)^n/r

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Fixed Income—Pricing Zero coupon bonds

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Pricing Zero coupon bonds

P=M/(1+r)^n For Zero coupon bonds the number if years is the maturity

Calculate the price of a zero coupon bond maturing 15 years from now of par value 1000, required yield 9.4%

M=1000, N=15*2=30, r=9.4/2=0.047

P= 1000/(1.047)^30 =252.12

Fixed Income—Price Yield Relationship

The fundamental property of the bond is the inverse relationship between price and yield; since price of the bond is the present value of its cash flows , the yield increases, PV of cash flows decreases, hence price decreases

Coupon rate < required yield price < par( discount bond)Coupon rate = required yield price = parCoupon rate > required yield price> par ( premium bond)

Yield

Price

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Fixed Income: Types of yield curve

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Fixed Income—Valuation

Bond Value=PV (Coupons and Face value)

Bond prices fall when interest rates rise and fall when interest rates fall

Bond Price= Coupon/(1+y)^t + Face value/(1+y)^T

T : time to maturity, t: time left for each coupon payment Coupon is the interest rate on the bond, y is the discount rate

Lets see an example

Calculate the value of a 3 year bond with face value of 1000 and coupon rate 8% paid annually Assume a discount rate of 9%

t

T

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Face value =1000, Coupon payment =0.08*1000=80

T=1 to 3 T=3, y=9%

Bond Price=80/1.09)+ 80/(1.09)^2+80/(1.09)^3+1000/(1.09)^3

Bond price= 974.68

Classroom Calculate bond price if discount rate is 10% and coupon is 7%

Coupon 80 80 80 1000

Discount Rate 1.09 1.1881 1.295029 1.295029

PV of cash flow 73.3945 67.3344 61.77468 772.1835

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A Rs 100 par value bond bears a coupon of 14% and matures in 5 years. Interest is paid semi annually. Calculate the price of the bond if the required rate of return is 16%.

Period 1 2 3 4 5 6 7 8 9 10

Coupon 7 7 7 7 7 7 7 7 7 107

Discount Fcator 0.925926 0.857339 0.793832 0.73503 0.680583 0.63017 0.58349 0.540269 0.500249 0.463193

PVF 6.481481 6.001372 5.556826 5.145209 4.764082 4.411187 4.084433 3.781882 3.501743 49.5617 93.28992

Discount Fcator 1.08


Yield to maturity (YTM)

The internal rate of return of the bond if held to maturity Helps in comparing the bonds of the same maturity There is a negative correlation between bond prices and yield

What is the YTM of a 5 year bond which is trading in the market for Rs 924.20

T=1 to 5, T=5, Coupon payment 8%

924.20= 80//(1+y)^t+1000/(1+y)^5

YTM =10%

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Bond—Rules

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Bond prices move inversely to interest rates

Longer maturity bonds respond more strongly to a given change interest rates

Price sensitivity increases with maturity at a decreasing rate

Lower coupon bonds respond more strongly to a given change in interest rates

Price changes are greater when rates fall than they are when rates rise (asymmetry in price changes)

Fixed Income—Macaulay Duration and Modified Duration

Duration

Where t is measured in years

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D m t w t t 1

T

P

)1/(

)(PV

)(PV ttt

t

yCF

Bond

CFw

w t 1t 1

q

Deriving Macaulay Duration

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D m t w tt 1

T

t P V ( C t )

P V ( B o n d )

t 1

T

1

C 1

( 1 y ) 1

2

C 2

( 1 y ) 2

. . . N

C N

( 1 y ) N

C 1

( 1 y ) 1 C 2

( 1 y ) 2 . . . C N

( 1 y ) N

Modified Duration (D*m)

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y

DD mm

1*

P

P D m

* y

Modified duration is used to estimate the price change or price volatility of the bond

Modified Duration (D*m)

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P C t

( 1 y ) tt 1

N

Py

11 y

t C t

( 1 y ) t

t 1

N

P

y D m

1 y P D m

* P

1PPy

D m*

D*m measures the sensitivity of the % change in bond price to 1% change in yield

y

DD mm

1*Where

Lets see an example

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Consider a 4 year 12% coupon bond selling at to yield 7%. Coupon payments are made annually. Assume Face value of the bond to be 1000

Duration 3.449246

Modified Duration 3.223595

Time 1 2 3 4

Coupon 120 120 120 1120

0.934579 0.934579 0.873439 0.816298 0.762895

112.1495 104.8126 97.95575 854.4426Coupon*Time 112.1495 209.6253 293.8672 3417.771 4033.413

Price 1169.361


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What are Alternative Investments

Investments which are very difficult to value

Investments which are traditionally not long on traditional investments like equities, fixed income etc.

Generally the underlying asset maybe be illiquid and might not be traded on an exchange like Art

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What are Alternative Investments-Types

Private Equity ( including mezzanine and distressed debt)

Hedge Funds

Structured Products

Real assets like Real Estate, REITS, Land and Infrastructure

Commodities

Art

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Major Alternative Assets Classes

Source: Russell Investments Survey 2010

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Private Equity Funds

In India in wealth management private equity funds are usually close ended funds usually of 7 years duration like ICICI Venture and Kotak PE Fund

PE have a higher investment horizon ranging between 3-5 years before exit

Work on a 2/20 principle 2% of assets under management as fund management fees20% of profits generated

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PE Funds usually collect large sums of amount ( in India above 1cr SEBI guidelines) for investment in companies and unlisted companies. PE don't operate under strict guidelines of a mutual fund with more freedom for investing

Depending on the style of the fund it is Venture capital, LBO, Mezzanine capital, Distressed assets and Growth Capital

In India PE are usually in Growth Capital( Investment in mature companies with minority stake)

In India in wealth management private equity funds are usually close ended funds usually of 7 years duration like ICICI Venture and Kotak PE Fund

PE have a higher investment horizon ranging between 3-5 years before exit

PE usually invested in unlisted companies to unlock their values but can also invest in listed companies called PIPE (Private Investment in Public Equity)

Private equity funds usually work on committed funds taken over a period of 3 years

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Work on a 2/20 principle

2% of assets under management as fund management fees20% of profits generated

Hurdle Rate Minimum return required to be generated for revenue generationRanges usually between 7-10%

Carried Interest The revenue generation profit earned by the investment manager when the hurdle rate is breached It is usually 20%

Exit strategies

• IPO. Initial Public Offering• Strategic sale back to the company invested or another PE ( Mergers and

Acquisition)

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Commodities

Broadly classified as metal commodities like iron ore, copper including precious metals and soft commodities which includes agricultural commodities

We will look at Gold as an asset class

Gold has been over the years used as money pre Bretton woods agreement

Gold serves as the best hedge against inflation

Gold moves inversely to the USD and is the best bet in risk averse environment

In rupee terms gold has returned between -14% to 34% in the last two decades

The upside in gold has been high in the last few years due to risk averse behavior Nis

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Gold Chart

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Commodities: Gold Investment Options

Gold ETF

Tracks an index in this case Gold ; held in demat form Each unit of gold is 1 gms and be converted into physical gold if more than 1 kgExempt from wealth tax and if held more than 1 year come under long term capital gains tax

Gold Index Works as fund of funds and invests in no. of ETFsNo physical delivery

Gold Futures Take positions in NCDEX and MCX; margin can be as low as 4% ; leverage 25 times your investment

Gold Indirect exposure to gold through gold mining and metal stocks; taxation as equity mutual funds

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Performance of ETFs

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How to invest in Commodities

Through commodity mutual funds or indirectly investing in companies in Mining and metal industry

Through futures market in commodities in NCDEX, MCX through a broker or online trading account

Most liquid contract is one month expiring on 25th of every month

No options in commodity exchange in India

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Real Assets: Real Estate

In India real estate can be classified as residential and commercial real estateReal estate can also be investment by HNI through real estate PE funds like ICICI Venture funds and Kotak real estate fund

Valuation is very difficult since the asset is illiquid; open to induviual assessment

The value is based on demand and supply as an intrinsic valuation .. No brainer with India’s population real estate will only move in one direction.Further valuation is beyond this course………..

Does India have an asset bubble in real estate………………..?

Real Estate indices In India National Housing Bank brings out Residex based on the real estate values of 15 cities … but not tested for long

Most liquid index is Case Shiller index in US

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Real Estate : Investment Options

Physically

Real Estate Sector Funds Investment in equities of companies which deal in real estate ( Taxation will be of equity oriented schemes)

Real Estate Mutual Fund SEBI has given a go ahead for these mutual funds although none has been launched as yet. There are some restrictions like 35% of the net assets to be invested in direct real estate etc.

REITS (Real Estate Investment Trusts ) have not listed in India due to regulatory approval …..REITS are listed in Singapore and Hong Kong in Asia

Private Equity/Venture Funds Investment amount minimum 1cr acc. SEBI(Taxation Long term capital gains more than 3 years )

Commercial Real Estate Banks like ICICI Bank sell commercial real estate with a pre decided lessee and with pre decided rental yields for a predefined time. Value play in terms of rental yields

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Art

Art is gaining in value over the last decade since it was very low correlation to economic slowdown

Depends on the artist history, his previous work, number of art pieces availableas well as his longevity

Some famous artists Van Gogh, Picasso

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Structured Products

Discuss in detail after our discussion of derivatives market especially options

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IA&PM Analysis of Asset Classes

Documents

Transcript of IA&PM Analysis of Asset Classes