The Investment Basics series of pages takes concepts familiar to you and puts them in a simplified form for greater understanding. The Advanced Investment Topics series of pages builds on the basic concepts and explains some lesser know ideas in a simplified way
The framework for the Investment Basics and Advanced Investment Topics series of pages comes from UCLA lecture notes taught by SCM’s founder for two courses: Investments for Professionals and Security Analysis. The reference texts can be found on our Site Reference Credit page.
This page provides an summary of our Advanced Investment Topics group of pages. We hope to breakdown some of the more intense concepts of the subject to make it easier to understand. Your can click on the section title to go to the detailed topic page.
Advanced Topics
- Overview
- Investment Prologue
- Market Elements
- Investment Theory
- Valuation Principles
- Bond Analysis and Management
- Portfolios, Pros, and Performance
Investment Prologue
An investment is the current commitment of dollars for a period of time in order to derive future payments. This Investment Prologue lays out a background for our advanced topic discussion of the field.
Payback for
- Time of the funds are laid out
- Expected rate of inflation
- Risk of future payments
This page offers an Investment Prologue for a deeper study in the advanced topics of investing. We open with a discussion of the factors in risk and return. Then, we describe how the management of the portfolio starts with studying your goals and needs. Finally, we delve into tot he other side of the decision: capital markets.
Market Elements
On the first section of Market Elements, we start by describing market elements and how they work. We then look a little deeper into how to tell what is going on in them. Finally we list the sources for market info.
Market Functions
A market is the means through which the buyers and sellers are brought together to aid in the transfer of goods and/or services.
In this section, we describe what makes a good market. Then, we talk about the types of assets out there and how they come to life. Then, we talk about exchanges and how they work. Finally, we look at broad market trends.
Market Keys
Figuring out what’s happening in markets at any point in time is tough. Like a thermometer, you can get a reading from a narrow set of tissues to get a feel for the body as a whole.
A stock index performs the same function and requires interpretation to derive value. Markets have a fair amount of correlation. A look at how indexes are structured and the links between can help put together a picture of the market environment.
Also in this section, we talk about taking the temperature of markets. Then, we delve into indexes and show how they are constructed. Finally, we discuss how the index changes over time.
Info Sources
Relevant info for decision-making is both key and hard to obtain. In addition to individual issue research, the trend is moving towards Exchange Traded Funds (ETFs). Sources of descriptions considered along with info on their track record.
Finally in this section, we talk about the places you can info on the economy. Then, we show where you can info about markets and industries. After that, we finish up with where you can find info on specific stocks and funds.
Investment Theory
Several developments in Investment Theory have influenced how we specify and measure risk in the valuation process.
On this page, we will discuss the latest market consensus thoughts on efficient markets. Probably the most important innovation in recent years, Modern Portfolio Theory (MPT), will be laid out. Finally, we will talk about the latest thinking on asset pricing models.
Perfect Markets
We begin this section with a description of the efficient market hypothesis (EMH). Then, we break it down in the various degrees of efficiency. The testing of EMH is then discussed. Finally, we talk about how to use the results.
An efficient capital market is one in which asset prices adjust rapidly to the arrival of new info. Therefore, the current prices of assets reflect all info about the asset.
Efficient markets have been the most widely studied concept over the last four decades due its significance in the real world. At the same time, efficient markets have been the most controversial due to the wide variety of opinions.
Portfolio Theory
One of the major advances in the field has been the notion an optimum portfolio. It is not simply a matter of mixing a lot of unique assets with good risk-return traits. You must consider the links among the holdings.
In this section, we describe MPT. We talk about how it is measured and how the optimal portfolios line up to form an efficient frontier.
Asset Pricing Models
After Markowitz came up with MPT, two other major theories have been proposed to derive a model for the value of risky assets. In this section, we discuss assumptions for them, describe their models and go over the testing.
In this section we apply some MPT principles for pricing individual assets with CAPM. Then, we discuss an alternate theory, APT. Finally, we talk about the testing of these theories.
Valuation Principles
The theory and practice of estimating the value of various securities is the heart of investing and leads to the construction of a portfolio consistent with your risk and return objectives. The understanding of these Valuation Principles are essential to successful investing.
On this page, we kick off the discussion with a run through of financial statements. Then, we set the table by talking about some valuation basics. Finally, we look at how macro factors influence valuation.
Statement Analysis
Financial statements are the main source of info for major investment decisions. In this section, we talk about the major statements. Then, describe ratios used to break down the info and find ways to use them.
In this section, we go over the major financial statements. Then, we introduce ratio analysis. Finally, we use these ratios to get a feel for what’s going on in a firm.
Valuations Intro
An investment is giving up funds for a period of time to receive a rate of return. It pays you back for the time which the funds were given.
Investments Steps
- Figure your required rate of return
- Estimate your asset’s intrinsic value based cash flows and your required rate of return
- Compare the intrinsic value with the current market price to decide when to buy or not
There are two main ways to value: the top-down, three-step approach or the bottom-up, stock-picking approach. The difference between the two ways is the perceived strength of macro and sector role on single firms and their shares.
At SCM, we are top-down because of its logic and tested support. We believe it is harder to win with bottom-up because stock-pickers ignore major info from the market and the firm’s sector.
In this section we lay out the three-step process of top-down valuation. Then, we get into the theory of valuation. The dividend discount model is also discussed. Finally we use what we learned to make the purchase or sale decision.
Macro Factors
Security markets reflect what is going on in an economy because the value of an investment is determined by its expected cash flows and required rate of return. Both are influenced by the aggregate economic environment.
The evidence indicates a strong relationship between stock prices and the economy. It shows stock prices consistently turn before the economy does. It might mean markets are based on expectations or the market may be reacting to various leading indicators.
In this section we start by going over the importance of economic forecasting. Then, we talk about the how monetary variables play a part. Finally, we discuss valuation on a global basis.
Bond Analysis
A bond is a debt investment in which an investor loans money to an entity (typically corporate or governmental) which borrows the funds for a defined period of time at a variable or fixed interest rate. Bond Analysis is used by companies, municipalities, states and sovereign governments to raise money and finance a variety of projects and activities. Owners of bonds are debt-holders, or creditors, of the issuer.
On this page, we talk about the basic fundamentals of bonds. Then, we get into the analysis and valuation of these ‘Rodney Dangerfields’ of assets. Finally we discuss how to manage them in portfolios.
Basic Fundamentals
The bond market is large and diverse, larger than the stock market. Thus, it represents an important investment opportunity.
In this section, we present some of their features and types. Then, talk markets around the world. Finally, we get into the entities who issue them.
Bond Analysis and Valuation
The value of bonds can be described in terms of dollar values or the rates of return they promise under a set of factors. The value of the bond equals the present value of expected cash flows. The cash flows from the bond are the periodic interest payments and the repayment of par. However, the only factor which affects its value is the market discount rate- its required rate of return.
Relationship of Market Yield and Price
- The bond is priced at premium if the yield is below coupon rate
- The bond is priced at discount if the yield is above the coupon rate
- Also, a link between yield and price is convex- as yields decline the price goes up at an increasing rate, same in declining case
In this section, we start by talking about the various bond yield measures. Then we talk about theories of bond prices. Finally, we get into the reasons and measure of volatility.
Bond Management
Prior to 1960, bonds were managed by simply buying and holding bonds in a group. At the time, purchases were made based on rate guesses and value models.
The early 1970s were hit by record-breaking inflation and rates. The intro of new finance types were in response to increased return risk. As a result, techniques such as matching funds or contingent portfolio were offered to meet the changing needs of big clients.
In this section, we describe passive ways to manage bonds. Then, we talk about a more active approach where we wring out more return and control risk. There are matching funds techniques and contingent procedures. Finally, we talk about theoretical implications.
Portfolios, Pros and Performance
Constructing a balanced portfolio involves putting together many concepts such as portfolio theory, macro research industry analysis and issue selection. It takes years of experience to get it right. Our Portfolios, Pros, Performance discussion breaks down how the investment industry approaches these concepts.
On this page we talk about various ways to put these portfolios together. Also, we discuss the industry of professionals who do it day in and day out. Finally, we will talk about how we can see how well a portfolio does.
Portfolio Management
The key decision in investing is the asset allocation decision as it relates to your goals. Generally, the mix remains fixed and only changes when your needs change. There should be no attempt to time the market.
Passive management attempts to achieve the track record of an index. Active management sets a goal to earn a total return which exceeds the return of a benchmark index. There is no middle ground.
In this section, discuss the merits of passive versus active approaches to managing portfolios.Then, we touch on style attribution. And finally, we wind about with asset allocations strategies.
Pro Asset Management
Using a pro money manager entails setting up a private account with an advisor or buying shares of an ETF or mutual fund.
In this section, we go over the structure of professional asset management. Then, we talk about the various challenges it presents. At the end, we cover the ethics of the industry and who is supposed to regulate it.
Portfolio Performance
It is both costly and time-consuming to review and select assets in an account. You or the big firm should decide whether this effort is worth the time and money. It’s key to decide whether the track record covers the cost.
The two major requirements of an advisor are the skill to get above-average returns for a given risk level and to spread the risk to control all unsystematic risk.
In this section, we go over the measures used to judge the performance of portfolios. Then, we get into the skills needed to do a good job. Finally, we go over the requirements for reporting performance.
