Chapter 11 In-Class Notes

Types of Investments Mutual funds Exchange traded funds Stocks Primary versus secondary market Types of investors: institutional, individual, day traders Growth, value, and income stocks Common versus preferred stocks Bonds Real estate 11-2Copyright © 2009 Pearson Education Canada

Investment Return and Risk, and Trade-off between Return and Risk 11-3Copyright © 2009 Pearson Education Canada Investment return (R) R = [(P t – P t -1 ) + D] ÷ P t -1 Investment risk Investment return is uncertain Measurement  range of returns, standard deviation, subjective measurement Trade-off between return and risk Risk premium (RP) RP = R – R f

How Diversification Reduces Risk Asset allocation: the process of allocating money across financial assets (such as mutual funds, stocks, and bonds) with the objective of achieving a desired return while maintaining risk at a tolerable level Construct a Portfolio Portfolio: a set of multiple investments in different assets A portfolio can reduce risk when its investments do not move in step 11-4Copyright © 2009 Pearson Education Canada

How Diversification Reduces Risk (Continued) Factors That Influence Diversification Benefits: Volatility  the more volatile the returns of individual investments in a portfolio, the more volatile the portfolio’s returns are over time Correlation  the more similar the returns of individual investments in a portfolio, the more volatile the portfolio’s returns are over time 11-5Copyright © 2009 Pearson Education Canada

Strategies for Diversifying Industry Diversification A portfolio of stocks diversified across several industries is less risky than a portfolio of stocks in the same industry Industry diversification is less effective when economic conditions in Canada are weak Country Diversification Diversifying with investments in other countries makes the portfolio less vulnerable to economic conditions in any one country 11-6Copyright © 2009 Pearson Education Canada

Asset Allocation Strategies Including Bonds in Your Portfolio Not highly correlated to stocks Prices are inverse to interest rates As you allocate more of your investment portfolio to bonds, you reduce your exposure to stock market risk but increase your exposure to interest rate risk In general, the larger the proportion of your portfolio that is allocated to bonds, the lower your portfolio’s overall risk 11-7Copyright © 2009 Pearson Education Canada

Asset Allocation Strategies (Continued) Including Income Trust Investments in Your Portfolio Income trust: a flow-through investment vehicle that generates income and capital gains for investors Almost 100 percent of the income generated by the trust assets is “flowed through” to the investors who have purchased units in the trust An income trust is similar to a stock investment Types: royalty income trusts, business investment trusts, real estate investment trusts (REITs) 11-8Copyright © 2009 Pearson Education Canada

Factors That Affect Your Asset Allocation Decision Your stage in life Your degree of risk tolerance Your expectations about economic conditions Learning from the mistakes of others Making decisions based on unrealistic goals Borrowing to invest Taking risks to recover losses from previous investments 11-9Copyright © 2009 Pearson Education Canada