MODULE : INV2601
,INV2601 Exam
Study Notes
Contains:
✓ Exam Detailed Revision Notes
✓ Comprehensive
✓ No need to make notes
,Investments: An Introduction
Table of Contents
STUDY UNIT 1: THE INVESTMENT SETTING ............................................................................................ 11
Investment....................................................................................................................................................... 12
Return .............................................................................................................................................................. 12
Risk .................................................................................................................................................................. 13
Types of Financial Risks: .............................................................................................................................. 13
Market Risk: .................................................................................................................................................... 14
Credit Risk: ..................................................................................................................................................... 14
Liquidity Risk:.................................................................................................................................................. 14
Operational Risk:............................................................................................................................................ 15
Legal Risk: ...................................................................................................................................................... 15
Risk and Return.............................................................................................................................................. 15
Risk vs Return ................................................................................................................................................ 15
Holding Period Return/Yield' ........................................................................................................................ 16
Real Rate Of Return' ..................................................................................................................................... 16
The risk and return principle: ........................................................................................................................ 17
Measures of Risk ........................................................................................................................................... 18
Coefficient of Variance Formula .................................................................................................................. 20
Diversification ................................................................................................................................................. 20
Case 1: Correlation Coefficient = 1 ......................................................................................................... 21
Case 2: Correlation Coefficient = -1 ........................................................................................................ 22
Case 3: Correlation Coefficient = 0 ......................................................................................................... 23
The Real World .............................................................................................................................................. 24
Investment Management Process ............................................................................................................... 24
STUDY UNIT 2: ORGANISATION AND FUNCTIONING OF SECURITIES MARKETS ........................ 27
Securities Market ........................................................................................................................................... 28
Characteristics of a well-functioning securities market ............................................................................ 28
Exchange markets, over-the-counter markets and other related markets ............................................ 29
Primary and secondary capital markets ..................................................................................................... 29
South African securities markets ................................................................................................................. 30
The Johannesburg Stock Exchange (JSE) ................................................................................................ 30
Trading and Settlement Procedures ........................................................................................................... 30
STRATE .......................................................................................................................................................... 30
The Bond Exchange Of South Africa (Besa) ............................................................................................. 30
The Central Depository (CD) ........................................................................................................................ 31
National Payment System ............................................................................................................................ 31
Regulation ....................................................................................................................................................... 31
Benefits from listing and trading on this exchange include the following: ............................................. 32
For companies: ........................................................................................................................................... 32
Types of Orders.............................................................................................................................................. 33
Market order................................................................................................................................................ 33
Limit order ................................................................................................................................................... 33
Short sale .................................................................................................................................................... 33
Stop-loss order ........................................................................................................................................... 33
Stop-buy order ............................................................................................................................................ 33
Equity market indices and bond market indices ........................................................................................ 34
How are debt instruments different from equity instruments? ................................................................. 34
Why are these markets important? ............................................................................................................. 35
Weighting schemes used in constructing market indices ........................................................................ 35
The price-weighted index .......................................................................................................................... 35
The market-capitalization weighted index .............................................................................................. 36
Other weighting schemes ......................................................................................................................... 38
Global securities markets ............................................................................................................................. 39
Efficient capital market .................................................................................................................................. 42
The Three Basic Forms of the EMH ............................................................................................................ 42
Share market efficiency for fundamental analysis and technical analysis............................................. 42
Pg. 3
, Implications of efficient markets for the portfolio management process and the role of the portfolio
manager .......................................................................................................................................................... 43
Implications of market efficiency .............................................................................................................. 43
EMH and the Portfolio Management Process ........................................................................................... 44
Rationale for investing in index funds ......................................................................................................... 44
Risk aversion .................................................................................................................................................. 45
Attitudes towards risk ................................................................................................................................ 45
Markowitz Portfolio Theory's ........................................................................................................................ 45
Assumptions of the Markowitz Portfolio Theory .................................................................................... 45
Investment Efficient Frontier......................................................................................................................... 46
Capital Market Line (CML) ............................................................................................................................ 47
Assumptions: .............................................................................................................................................. 47
Security Market Line (SML) .......................................................................................................................... 48
Capital Asset Pricing Model (CAPM) .......................................................................................................... 48
STUDY UNIT 4 THE TIME VALUE OF MONEY ........................................................................................... 52
Interest Rates ................................................................................................................................................. 53
Nominal Interest Rate .................................................................................................................................... 53
Real Interest Rate .......................................................................................................................................... 53
Effective Interest Rate ................................................................................................................................... 54
Time Value of Money..................................................................................................................................... 54
Time value of money calculations ........................................................................................................... 54
Present Value and Future Value of a lump sum ................................................................................... 55
Example: Future Value .............................................................................................................................. 56
Annuities ...................................................................................................................................................... 56
Example – Ordinary Annuity ......................................................................................................................... 57
Future Value ............................................................................................................................................... 57
Present Value ............................................................................................................................................. 58
Example – Annuity Due................................................................................................................................. 59
Future Value ............................................................................................................................................... 59
Present Value ............................................................................................................................................. 60
Uneven Cash flows ........................................................................................................................................ 61
Present Value ............................................................................................................................................. 61
Future Value ............................................................................................................................................... 61
Growth Rates .................................................................................................................................................. 62
Net present value (NPV) ............................................................................................................................... 63
Internal Rate of Return .................................................................................................................................. 65
STUDY UNIT 5: VALUATION PRINCIPLES AND PRACTICES ................................................................ 66
Par value, market value, book value and fair (intrinsic) value ................................................................. 67
Par value ..................................................................................................................................................... 67
Market value ............................................................................................................................................... 67
Book value .................................................................................................................................................. 67
Intrinsic value .............................................................................................................................................. 67
Valuations of Financial Assets ..................................................................................................................... 67
Valuation of Bonds ......................................................................................................................................... 67
Important Aspects to consider on Bonds .................................................................................................... 68
Bond terminology: ...................................................................................................................................... 69
Bond valuation model with annual coupons: ......................................................................................... 69
Bond valuation model with semi-annual coupons: ................................................................................ 69
Zero Coupon bond valuation model: ....................................................................................................... 69
Bond Valuation: Important Relationships ................................................................................................... 72
Bond Yields ..................................................................................................................................................... 72
Equity Valuation ............................................................................................................................................. 73
Balance Sheet Methods / Techniques: ....................................................................................................... 73
Discounted Cash Flow Methods / Techniques .......................................................................................... 74
Dividend Discount Model: ......................................................................................................................... 74
Constant Growth Model ............................................................................................................................ 75
Single Period Model .................................................................................................................................. 75
Rationale for Using Single Period Model:............................................................................................... 76
Limitations of Single Period Model: ......................................................................................................... 76
Zero Growth Model .................................................................................................................................... 77
Multi-period Model ..................................................................................................................................... 77
Pg. 4
,INV2601 Exam
Study Notes
Contains:
✓ Exam Detailed Revision Notes
✓ Comprehensive
✓ No need to make notes
,Investments: An Introduction
Table of Contents
STUDY UNIT 1: THE INVESTMENT SETTING ............................................................................................ 11
Investment....................................................................................................................................................... 12
Return .............................................................................................................................................................. 12
Risk .................................................................................................................................................................. 13
Types of Financial Risks: .............................................................................................................................. 13
Market Risk: .................................................................................................................................................... 14
Credit Risk: ..................................................................................................................................................... 14
Liquidity Risk:.................................................................................................................................................. 14
Operational Risk:............................................................................................................................................ 15
Legal Risk: ...................................................................................................................................................... 15
Risk and Return.............................................................................................................................................. 15
Risk vs Return ................................................................................................................................................ 15
Holding Period Return/Yield' ........................................................................................................................ 16
Real Rate Of Return' ..................................................................................................................................... 16
The risk and return principle: ........................................................................................................................ 17
Measures of Risk ........................................................................................................................................... 18
Coefficient of Variance Formula .................................................................................................................. 20
Diversification ................................................................................................................................................. 20
Case 1: Correlation Coefficient = 1 ......................................................................................................... 21
Case 2: Correlation Coefficient = -1 ........................................................................................................ 22
Case 3: Correlation Coefficient = 0 ......................................................................................................... 23
The Real World .............................................................................................................................................. 24
Investment Management Process ............................................................................................................... 24
STUDY UNIT 2: ORGANISATION AND FUNCTIONING OF SECURITIES MARKETS ........................ 27
Securities Market ........................................................................................................................................... 28
Characteristics of a well-functioning securities market ............................................................................ 28
Exchange markets, over-the-counter markets and other related markets ............................................ 29
Primary and secondary capital markets ..................................................................................................... 29
South African securities markets ................................................................................................................. 30
The Johannesburg Stock Exchange (JSE) ................................................................................................ 30
Trading and Settlement Procedures ........................................................................................................... 30
STRATE .......................................................................................................................................................... 30
The Bond Exchange Of South Africa (Besa) ............................................................................................. 30
The Central Depository (CD) ........................................................................................................................ 31
National Payment System ............................................................................................................................ 31
Regulation ....................................................................................................................................................... 31
Benefits from listing and trading on this exchange include the following: ............................................. 32
For companies: ........................................................................................................................................... 32
Types of Orders.............................................................................................................................................. 33
Market order................................................................................................................................................ 33
Limit order ................................................................................................................................................... 33
Short sale .................................................................................................................................................... 33
Stop-loss order ........................................................................................................................................... 33
Stop-buy order ............................................................................................................................................ 33
Equity market indices and bond market indices ........................................................................................ 34
How are debt instruments different from equity instruments? ................................................................. 34
Why are these markets important? ............................................................................................................. 35
Weighting schemes used in constructing market indices ........................................................................ 35
The price-weighted index .......................................................................................................................... 35
The market-capitalization weighted index .............................................................................................. 36
Other weighting schemes ......................................................................................................................... 38
Global securities markets ............................................................................................................................. 39
Efficient capital market .................................................................................................................................. 42
The Three Basic Forms of the EMH ............................................................................................................ 42
Share market efficiency for fundamental analysis and technical analysis............................................. 42
Pg. 3
, Implications of efficient markets for the portfolio management process and the role of the portfolio
manager .......................................................................................................................................................... 43
Implications of market efficiency .............................................................................................................. 43
EMH and the Portfolio Management Process ........................................................................................... 44
Rationale for investing in index funds ......................................................................................................... 44
Risk aversion .................................................................................................................................................. 45
Attitudes towards risk ................................................................................................................................ 45
Markowitz Portfolio Theory's ........................................................................................................................ 45
Assumptions of the Markowitz Portfolio Theory .................................................................................... 45
Investment Efficient Frontier......................................................................................................................... 46
Capital Market Line (CML) ............................................................................................................................ 47
Assumptions: .............................................................................................................................................. 47
Security Market Line (SML) .......................................................................................................................... 48
Capital Asset Pricing Model (CAPM) .......................................................................................................... 48
STUDY UNIT 4 THE TIME VALUE OF MONEY ........................................................................................... 52
Interest Rates ................................................................................................................................................. 53
Nominal Interest Rate .................................................................................................................................... 53
Real Interest Rate .......................................................................................................................................... 53
Effective Interest Rate ................................................................................................................................... 54
Time Value of Money..................................................................................................................................... 54
Time value of money calculations ........................................................................................................... 54
Present Value and Future Value of a lump sum ................................................................................... 55
Example: Future Value .............................................................................................................................. 56
Annuities ...................................................................................................................................................... 56
Example – Ordinary Annuity ......................................................................................................................... 57
Future Value ............................................................................................................................................... 57
Present Value ............................................................................................................................................. 58
Example – Annuity Due................................................................................................................................. 59
Future Value ............................................................................................................................................... 59
Present Value ............................................................................................................................................. 60
Uneven Cash flows ........................................................................................................................................ 61
Present Value ............................................................................................................................................. 61
Future Value ............................................................................................................................................... 61
Growth Rates .................................................................................................................................................. 62
Net present value (NPV) ............................................................................................................................... 63
Internal Rate of Return .................................................................................................................................. 65
STUDY UNIT 5: VALUATION PRINCIPLES AND PRACTICES ................................................................ 66
Par value, market value, book value and fair (intrinsic) value ................................................................. 67
Par value ..................................................................................................................................................... 67
Market value ............................................................................................................................................... 67
Book value .................................................................................................................................................. 67
Intrinsic value .............................................................................................................................................. 67
Valuations of Financial Assets ..................................................................................................................... 67
Valuation of Bonds ......................................................................................................................................... 67
Important Aspects to consider on Bonds .................................................................................................... 68
Bond terminology: ...................................................................................................................................... 69
Bond valuation model with annual coupons: ......................................................................................... 69
Bond valuation model with semi-annual coupons: ................................................................................ 69
Zero Coupon bond valuation model: ....................................................................................................... 69
Bond Valuation: Important Relationships ................................................................................................... 72
Bond Yields ..................................................................................................................................................... 72
Equity Valuation ............................................................................................................................................. 73
Balance Sheet Methods / Techniques: ....................................................................................................... 73
Discounted Cash Flow Methods / Techniques .......................................................................................... 74
Dividend Discount Model: ......................................................................................................................... 74
Constant Growth Model ............................................................................................................................ 75
Single Period Model .................................................................................................................................. 75
Rationale for Using Single Period Model:............................................................................................... 76
Limitations of Single Period Model: ......................................................................................................... 76
Zero Growth Model .................................................................................................................................... 77
Multi-period Model ..................................................................................................................................... 77
Pg. 4
