Market Regulations, Benchmarks, Value Growth Investors Etc 2021

EQUITY INVESTMENTS
MBA Finance
“Market Regulations, BM, FIN-TECH &

Growth Investors”
Mrs Elsie Kambala

MSc Investment Analysis
Operations Manager/Head of Credit: Old Mutual Finance Namibia
(Lending) , 061 299 3555/0812609105
ekambala@oldmutual.com/enhamunyela@gmail.com 2021
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OUTLINE
19. What are the objectives of market regulation?

20. Distinguish between benchmarks and market indexes.
21. Compare the different weighting methods used in index construction.
22. Capital Asset Pricing Model (CAPM)
23. Describe the process of identifying, selecting, and contracting with equity managers
24. Contrast the top-down and bottom-up approaches to Equity Research.
25. Distinguish between positive and negative screens involving socially responsible investing criteria and discuss their
potential effects on a portfolio’s style characteristics.
26. What is Industry analysis?
27. What is FIN-TECH?
28. Business Life Cycle
29. Explain the rationale and primary concerns of value investors and growth investors and discuss the key risks of each
investment style.
30. How to Classify a Manager ?
31. Compare full replication, stratified sampling, and optimization as approaches to constructing an indexed
portfolio and recommend an approach when given a description of the investment vehicle and the index to be
tracked.
32. Discuss the rationale for passive, active, and semi-active (enhanced index) equity investment approaches
and distinguish among those approaches with respect to expected active return and tracking risk.
33. Discuss the role of equities in the overall portfolio.
34. Industry Life Cycle
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19. What are the objectives of market regulation?
 Control Fraud: market regulators put systems in place to prevent fraud as financial
customers aren’t always sophisticated enough to do so themselves.
 Control Agency Problems: regulators solve agency problems by setting minimum
standards of competence for agents like the CFA or Global Investment Performance
Standards (GIPS).
 Promote Fairness: regulators aim to reduce profits that insiders could extract from the
markets. Laws against insider trading, for instance, help to level the playing field.
 Set Mutually Beneficial Standards: regulators help analysts easily compare companies
by requiring compliance with accounting standards set by IASB, FASB, and others.
 Prevent Excessive Risk: regulators require financial firms to maintain minimum levels of
capital so that the firms honor their commitments and so that the firm’s owners have some
“skin in the game.”
 Ensure Liabilities are Funded: regulators watch over insurance companies and pension
funds to ensure adequate reserves are maintained to cover liabilities because managers of
these entities tend to underestimate long-term liabilities especially when there is an
incentive not to do so. th
Investments ( 9 ) & 10th Edition, Copyright © Bodie, Zvi, Alex Kane, and Alan J. Marcus.(2011). CFA
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20. Distinguish between benchmarks and market indexes.
 A benchmark is a standard yardstick against which the performance of a security or

investment manager can be measured. i.e.it is a reference point for evaluating
portfolio performance.
 An index represents the performance of a specified group of securities.The 3 most
widely followed indexes in the U.S. are the S&P 500, Dow Jones Industrial Average,
and Nasdaq Composite. The distinction between the a benchmark & Index is that an
index may or may not be a valid benchmark to evaluate the performance of a
specific portfolio.
Investments ( 9th ) & 10th Edition, Copyright © Bodie, Zvi, Alex Kane, and Alan J. Marcus.(2011). CFA
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Properties of well specified benchmark
1. Specified in advance. The benchmark is known to both the investment manager

and the fund sponsor. It is specified at the start of an evaluation period.
2. Appropriate. The benchmark is consistent with the manager’s investment
approach and investment style as well as the portfolio’s objectives and
constraints.
3. Measurable. Its value and return can be determined on a reasonably frequent
basis.
4. Unambiguous. Identities and weights of securities constituting the benchmark are
clearly defined.
5. Reflective of the manager’s current investment opinions. The manager has
current knowledge and expertise of the securities within the benchmark.
6. Accountable. The manager(s) should accept the applicability of the benchmark
and agree to accept differences in performance between the portfolio and
benchmark as reflecting active management.
7. Investable. It is possible to invest in the benchmark as an alternative to active
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management. th
21. Compare the different weighting methods used in index
construction (Capitalization, Price & Equal-weighted)
1.Capitalization weighted (market value weighted, value weighted, market cap weighting, or cap
weighted) is the most common form of index construction. The weight of each security is based on its
price multiplied by shares outstanding. In some cases, free float is used and shares that are not
available to trade are excluded from the calculation. The performance of such indexes is most heavily
influenced by the securities with the largest market cap (refers to the total market value of a company's
outstanding shares).
Advantages
 Based on an objective measure (the market price) of what every security is worth.
 Macro consistent because all securities are owned and therefore the aggregate portfolio of all investors
must be market capitalization weighted. A float adjusted, cap weighted index reflects what is available
for investors to own.
 Under the assumptions of the capital asset pricing model, it is the only efficient portfolio of risky assets.
 Does not require rebalancing for stock splits and stock dividends.
Disadvantages
 Exposed to market bubbles because it most heavily weights the largest market cap securities, which
may also be the most overvalued securities.
 Weighting by market cap can lead to overconcentration in a few securities and less diversification.
 May be unsuited as a benchmark for active managers who take substantially different risk exposures
than the market. 7
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construction (Capitalization, Price & Equal-weighted) Cont…
2. Price-weighted indexes reflect initially owning one share of each stock.

Their performance is most heavily influenced by the securities with the
highest price.
Advantages
 Easy to construct.
 Long price history are available.
Disadvantages
 Market cap better reflects a company’s economic importance.
Stocks that appreciate are more likely to split and the reduced post-split
price diminishes the impact of that security on the index. The method
effectively tends to reduce the weighting of the more successful
companies.
Does not reflect typical portfolio construction. Most portfolios are not built
with an equal number of shares in each security. 8
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construction (Capitalization, Price & Equal-weighted) Cont…
3. Equal-weighted indexes reflect the same initial investment in each security.

Advantages
 Compared to market cap weighting, it places more emphasis on smaller cap
securities that (1) may offer a return advantage and (2) provide greater
diversification (instead of concentrating in higher market cap assets).
Some argue that it reflects better how the market did because it reflects the
average return of each security in the index.
Disadvantages
 Biased to the performance of smaller issuers (when compared to market cap
weighted).
Requires constant rebalancing to maintain equal weight and will result in
selling (short) stronger performers and buying (long) weaker performers.
The emphasis on smaller cap securities can lead to increased liquidity
problems and higher transaction costs.
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22. Capital Asset Pricing Model (CAPM)
In finance, the capital asset pricing model (CAPM) is a model

used to determine a theoretically appropriate required rate of
return of an asset, to make decisions about adding assets to
a well-diversified portfolio. i.e. CAPM is used to calculate
expected return from an asset during a period in terms of the
risk of the return.
Risk of Return is divided into two parts: systematic risk and
nonsystematic risk.
Systematic risk is related to the return from the market as a
whole and can’t be diversified away.
Nonsystematic risk is unique to that asset and can be
diversified away by choosing a large portfolio of different
assets.
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22. Capital Asset Pricing Model (CAPM) Cont...
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Expected return on Asset =Rf+ β (RM-Rf)
Where Rf is the Risk free rate, RM is the

expected return on the market, usually
estimated as a return on a well diversified
stock index such as the S&P500. β
measures the sensitivity of its returns
from the market.
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CAPM: BETA
β can be estimated from historical data as the slope when

regressing excess returns on the asset over the risk-free
rate against the excess returns on the market over the
risk-free rate.
When β =0, an asset’s returns are NOT sensitive to
returns from the market and its expected return is the free-
risk rate.
When β =0.5, the excess return on the asset over the risk-
free rate is on average half of the excess return of the
market over risk-free rate.
When β =1, the excess return on the asset equals the
return on the market
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CAPM Example
Total market return S&P500 was RM = 10% in 2018, Beta

=1, Risk free rate (US-treasury bills) Rf = 3%, Beta = 0
Q: What should be the expected return of a stock with a beta
of 1.5?
Expected Return =0.03+1 (0.10-0.03) =10%
Expected Return =0.03+0 (0.10-0.03) =3%
Expected Return =0.03+1.5 (0.10-0.03) =13.5%
If the historical return in 2018 was lower than 13.5% sell
or don’t buy stock as in this case the return is not an
adequate compensation for the given market risk (beta).
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Calculation of Earnings Per Share
A company's expected Earnings Per share (EPS) can be determined as follows:

EPS = [sales x operating margin - depreciation - interest] x (1 - tax)
Where:
Sales= sales per share
Operating margin = the operating margin is typically calculated as a percentage of sales
Depreciation = this is determined by either continuing the trend of the current depreciation or
focusing on the expected capital expenditures and how that number relates to future dividends.
Interest = interest is determined by outstanding debt and the interest rate on that debt.
Example
Assuming the following estimates for a Namibian company: sales per share = N$60.00,
Operating margin = 50%, depreciation of N$10.00, interest of N$3.00 and corporate tax rate of
40%, calculate the forecasted EPS of the company.
Answer:
EPS = [60.00 x 50%=30 - 10.00 - 3.00=17] x (1 - 0.40) = N$10.20 per share
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Calculation of Sustainable growth rate
 The retention rate of a company is the amount of earnings a company retains for its internal
growth.
 A company's ROE is the return on the retained profits that are reinvested in the company.
 Note that the growth rate of the firm is the identified ability of a firm to grow its operations
and the ROE is the return the company is able to earn on invested funds
Formula: Growth rate = retention rate x ROE
Example
Old Mutual Namibia assumes a constant ROE of 25%. The company anticipates a retention rate
of 70% to fund new projects (i.e. a 30% equity payout ratio). What is Old Mutual Namibia 's
dividend growth rate?
Answer
g = Retention rate x ROE
g = 0.70 x 0.25
g = 0.18 (18%)
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Calculation of Gordon Growth Model (GGM)
 The Gordon (constant) growth model assumes that the annual growth rate of dividends, gc,
is constant. This means that the next period’s dividend, D1, is D0 x (1 + gc), the second year’s
dividend, D2, is D0 x (1 + gc)2, etc
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Calculation of Bond yield Plus Risk Premuim
 Bond yield Plus Risk premium (BYPRP) =YTM on the company's long term debt +
Risk premium.
i.e. BYPRP approach is another method we can use to determine the value of an
asset, specifically, a company's publicly traded equity. BYPRP allows us to estimate
the required return on an equity by adding the equity's risk premium to the yield to
maturity on company's long-term debt. Note: (YTM) is the total return anticipated on a
bond if the bond is held until it matures.
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Calculation of Weighted average cost of capital (WACC)
 The WACC is a financial ratio that calculates a company’s cost of financing and
acquiring assets by comparing the debt and equity structure of the business.i.e.,
it measures the weight of debt and the true cost of borrowing money or raising funds
through equity to finance new capital purchases and expansions based on the
company’s current level of debt and equity structure. Management typically uses
this ratio to decide whether the company should use debt or equity to finance new
purchases.
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Calculation of Weighted average cost of capital (WACC)
Let’s Assume FirstRand Namibia Limited Market Value of Equity is N$4000,

Total Value of Financing is N$9000, Cost of Equity is 20 %, Market Value of
Debt is N$5000, Cost of Debt is 10% and Tax Rate is 30%. Calculate the
WACC?
WACC=(4000/9000) x 0.20 + (5000/9000) x 0.10 x (1-0.30)
WACC=(0.44444 ) x 0.20 + (0.55556) x 0.10 x 0.70)
WACC=(0.08889 +(0.05556 x 0.70)
WACC= 0.12778 OR 12.78% is the rate that FirstRand Namibia Limited is
expected to pay on average to all its security holders to finance its
assets. Ideally you want WACC to be as low as possible.
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Calculation of Herfindahl Index
 The Herfindahl-Hirschman Index (HHI) is a commonly accepted measure of

market concentration. It is calculated by squaring the market share of each firm
competing in a market and then summing the resulting numbers. i.e. HHI is a measure
of the size of firms in relation to the industry and an indicator of the amount of
competition among them.
 The HHI formula is calculated by squaring the market share for each firm (up to
50 firms) and then summing the squares. In a perfectly competitive
market, HHI approaches zero. The HHI is 0.12 x 50 = 0.5. In a
monopoly, HHI approaches 10,000.
 i.e. The closer a market is to a monopoly, the higher the market's concentration (and
the lower its competition). If, for example, there were only one firm in an industry,
that firm would have 100% market share, and the HHI would equal 10,000, indicating
a monopoly. If there were thousands of firms competing, each would have nearly
0% market share, and the HHI would be close to zero, indicating nearly perfect
competition.
 Increases in the HHI generally indicate a decrease in competition and an increase
of market power, whereas decreases indicate the opposite.
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Calculation of Herfindahl Index Cont.
For Example the Namibian Lending Industry is composed of 5 firms with

market shares as follows: Company V has 40 %, Company W has 30 %,
Company X has 15 %, Company Y has 10 %, Company Z has 5 %, Calculate
the 3 firm concentration ratio for the Lending Industry in Namibia:
Solution:40%+30%+15%=85%
 Calculate the Herfindahl Index for the Lending Industry in Namibia:
 Solution: HHI=(0.40)2+ (0.30)2+ (0.15)2+ (0.10)2+ (0.05)2
HHI=(0.16)+ (0.09)+ (0.0225)+ (0.01)+ (0.00025)= 0.2853 OR 29%
The HHI for the Lending Industry in Namibia is 29%
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23. Describe the process of identifying, selecting, and contracting with equity
managers
 Past Performance :Past performance is often no guarantee of future performance. A manager

who achieves superior performance with a consistent staff and investment philosophy is more
likely to be hired.
 Manager Questionnaires : In the hiring process, a manager questionnaire is used to screen
potential managers. If the manager’s responses to the questionnaire are promising, the
questionnaire will be followed by personal interviews with the manager. E.g qualifications or
experience of staff or investment philosophy .
 Fee schedule: Important to assess how much annual fees are and ensure any incentive fees
are in line with the objectives of the portfolio.
Contrast the top-down and bottom-up approaches to equity research/analysis.
 The top-down approach uses macroeconomic considerations (i.e focuses on the "big picture"
or how the overall economy and macroeconomic factors drive the markets and ultimately
stock prices) to identify attractive and unattractive markets and sectors.
 The bottom-up approach aggregates the forecast for individual securities to make those
decisions. Can help investors pick quality stocks that outperform the market even during
periods of decline. i.e Analyst will examine the fundamentals of a stock regardless of market
trends. th
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24. What do equities analysis focuses on?
Top-down investment analysis includes:

 Economic growth or gross domestic product (GDP) both in the Namibia and across the globe.
 Monetary policy by the BoN including the lowering or raising of interest rates.
 Inflation and the price of commodities
 Bond prices and yields including Namibian GRN Treasuries.
Bottom-up analysis focus includes
 Financial ratios including the price to earnings (P/E), current ratio, return on equity, and net profit margin
 Earnings growth including future expected earnings
 Revenue and sales growth
 Financial analysis of a company's financial statements including the balance sheet, income statement, and
the cash flow statement.
 Cash flow and free cash flow show how well a company generates cash and is able to fund its operations
without adding more debt.
 Management's leadership and performance
 A company's products, market dominance, and market share
Investments ( 9th ) & 10th Edition, Copyright © Bodie, Zvi, Alex Kane, and Alan J. Marcus.(2011).
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24. Top-down vs Bottom-up approaches
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Typical Investment Process
 1. Set Investment Policy

 Objectives
 Amount
 Choice of assets class
 2. Conduct security analysis

 Examine securities (identify those which are mispriced?)
By Using
 a. Technical analysis – the examination of past prices for trends
 b. Fundamental analysis – true value based on future expected returns
 3. Portfolio Construction
 Identify assets
 Choose extent of diversification
 4. Portfolio Evaluation
 Assess the performance of portfolio
 5. Portfolio Revision
 Repeat previous three steps 29

Investment Process of one Asset Manager
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25. Distinguish between positive and negative screens involving
socially responsible investing criteria and discuss their potential
effects on a portfolio’s style characteristics.
 Socially responsible investing (SRI), also known as Ethical
investing, is the use of ethical, social, or religious concerns to
screen investment decisions. The screens can be negative,
where the investor refuses to invest in a company they believe is
unethical; or positive, where the investor seeks out firms with
ethical practices.
An Example of a negative screen is an investor who avoids
tobacco and alcohol stocks. An example of a positive screen
would be when the investor seeks firms with good labor and
environmental practices.
Most SRI portfolios utilize negative screens, some use both
negative and positive screens, and even less use only positive
screens. An increasing number of portfolio managers have clients
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26. What is Industry analysis?
 Industry analysis is a market assessment tool used by businesses and analysts

to understand the competitive dynamics of an industry. It helps them get a
sense of what is happening in an industry, i.e., demand-supply statistics,
degree of competition within the industry, state of competition of the industry
with other emerging industries, future prospects of the industry taking into
account technological changes, credit system within the industry, and the
influence of external factors on the industry.
 Industry analysis, for a company, is a method that helps it to understand its

position relative to other participants in the industry. It helps them to identify
both the opportunities and threats coming their way and gives them a strong
idea of the present and future scenario of the industry. The key to surviving in
this ever-changing business environment is to understand the differences
between yourself and your competitors in the industry and using it to your
full advantage. th
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There are three commonly used and important methods of
performing industry analysis.
 Competitive Forces Model (Porter’s 5 Forces)

One of the most famous models ever developed for industry analysis, famously known
as Porter’s 5 Forces, was introduced by Michael Porter in his 1980 book “Competitive
Strategy: Techniques for Analyzing Industries and Competitors. "According to
Porter, analysis of the five forces gives an accurate impression of the industry and
makes analysis easier.
1. Intensity of industry rivalry: The number of participants in the industry and their
respective market shares are a direct representation of the competitiveness of the
industry. Lack of differentiation in products tends to add to the intensity of competition.
High exit costs like high fixed assets, government restrictions, labor unions, etc. also
make the competitors fight the battle a little harder.
2. Threat of potential entrants: This indicates the ease with which new firms can enter
the market of a particular industry. If it is easy to enter an industry, companies face the
constant risk of new competitors. If the entry is difficult, whichever company enjoys
little competitive advantage reaps the benefits for a longer period. Those industries have
large barriers to entry and thus less competition from newcomers.
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Competitive Forces Model (Porter’s 5 Forces)…Cont.
3. Bargaining power of suppliers: This refers to the bargaining power of suppliers. If the
industry relies on a small number of suppliers, they enjoy a considerable amount of
bargaining power. This can affect small businesses because it directly influences the quality
and the price of the final product. Suppliers’ ability to raise prices or limit supply influences
industry profitability. Suppliers are more powerful if there are just a few of them and their
products are scarce. For example, Microsoft is one of the few suppliers of operating
system software and thus has pricing power.
4. Bargaining power of buyers : The complete opposite happens when the bargaining
power lies with the customers. If consumers/buyers enjoy market power, they are in a
position to negotiate lower prices, better quality or additional services and discounts.
Buyers’ ability to bargain for lower prices or higher quality influences industry profitability.
5. Threat of substitute goods/services: Substitute products limit the profit potential of an
industry because they limit the prices firms can charge by increasing the elasticity of
demand. The industry is always competing with another industry in producing a similar
substitute product. Hence, all firms in an industry have potential competitors from other
industries. This takes a toll on their profitability because they are unable to charge
exorbitant prices. Substitutes can take two forms – products with the same function/quality but
lesser price or products of the same price but of better quality or providing more utility.
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performing industry analysis…Cont.
 Broad Factors Analysis (PEST Analysis): Also commonly called the PEST
Analysis stands for Political, Economic, Social and Technological. PEST
analysis is a useful framework for analyzing the external environment. To use PEST
as a form of industry analysis, an analyst will analyze each of the 4 components of
the model.
1. Political: Political factors that impact an industry include specific policies and
regulations related to things like taxes, environmental regulation, tariffs, trade
policies, labor laws, ease of doing business, and the overall political stability.
2. Economic: The economic forces that have an impact include inflation, exchange
rates (FX), interest rates, GDP growth rates, conditions in the capital markets
(ability to access capital) etc.
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Broad Factors Analysis (PEST Analysis): …Cont.
3. Social: The social impact on an industry refers to trends

among people and includes things such as population growth,
demographics (age, gender, etc), and trends in behavior such
as health, fashion, and social movements.
4. Technological: The technological aspect of PEST analysis

incorporates factors such as advancements and developments
that change that way business operates and the ways which
people live their lives (i.e. advent of the FIN-TECH).
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performing industry analysis…Cont.
 SWOT Analysis: stands for Strengths, Weaknesses, Opportunities, and

Threats. It can be a great way of summarizing various industry analysis
methods and determining their implications for the business in question.
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27. What is FIN-TECH?
 Financial technology, often shortened to “fin-tech”, is the technology and innovation that aims
to compete with traditional financial methods in the delivery of financial services. It is an
emerging industry that uses technology to improve activities in finance. The use of smartphones for
mobile banking, investing services and cryptocurrency are examples of technologies aiming
to make financial services more accessible to the general public.
 What is a fin tech company?: At its core, fintech is utilized to help companies, business owners
and consumers better manage their financial operations, processes, and lives by utilizing
specialized software and algorithms that are used on computers and, increasingly,
smartphones.
 Fintech Examples: Crowdfunding Platforms. Companies like Kickstarter, Patreon, GoFundMe and
others illustrate the range of fintech outside of traditional banking.
 Fintech has disrupted traditional financial and banking industries - and potentially poses a
threat to traditional, brick-and-mortar banks or financial institutions. 39
FIN-TECH Examples…
 So how is fintech being used in 2019, and what are some of its traditional uses?
 1. Crowdfunding Platforms :Companies like Kickstarter, Patreon, GoFundMe and others illustrate the range of fintech outside
of traditional banking. Crowdfunding platforms allow internet and app users to send or receive money from others on the
platform, and have allowed individuals or businesses to pool funding from a variety of sources all in the same
place.Instead of having to go to a traditional bank for a loan, it is now possible to go straight to investors for support of a
project or company. And while their applications range from family and friends funding to fan and patron funding, the number of
crowdfunding platforms have multiplied over the years.
 2. Blockchain and Cryptocurrency: are trademark examples of fintech in action. Cryptocurrency exchanges like Coinbase and
Gemini connect users to buying or selling cryptocurrencies like bitcoin or litecoin.But in addition to crypto, blockchain
services like BlockVerify help reduce fraud by keeping provenance (i.e personal) data on the blockchain. And while
cryptocurrency and even blockchain may be somewhat controversial uses of fintech, they have certainly taken parts of the
investment world by storm in recent years.
 3. Mobile Payments : It seems as though everyone with a smartphone uses some form of mobile payments. In fact,
according to Statista data, the global mobile payment market is on track to surpass $1 trillion in 2019. e.g E-wallet, Blue-wallet etc
Using increasingly sophisticated technology, services have emerged that allow consumers to exchange money and payments
online or on mobile devices. Apple (AAPL - Get Report) and Alibaba (BABA - Get Report) got in on the mobile payment business
with Apple Pay or Alipay & even Facebook. 40
FIN-TECH Examples…Cont.
 4. Insurance: Fintech has even disrupted the insurance industry. In fact, insurtech (as it's been so called) has come to include
everything from car insurance to home insurance and data protection. Additionally, insurtech startups are increasingly attracting
funding, with insurance startup Oscar Health securing some $165 million in funding in March of last year 2018 - at a $3.2 billion
valuation, according to CNBC. Additionally, popular personal finance company Credit Karma was valued at $4 billion, according to
Forbes in 2019.
 5. Robo-Advising and Stock-Trading Apps: Robo-advising has disrupted the asset management sector by providing algorithm-
based asset recommendations and portfolio management that has increased efficiency and lowered costs. Since the rise of
more advanced technology that can analyze various portfolio options 24/7, financial institutions have adapted to offer online robo-
advising services - including the likes of Charles Schwab (SCHW - Get Report), Robinhood, Betterment and Vanguard. Perhaps one
of the more popular and big innovations in the fintech space has been the development of stock-trading apps. When once
investors had to go directly to a stock exchange like the NYSE or Nasdaq, now, investors can buy and sell stocks at the tap of a
finger on their mobile device.
 6. Budgeting Apps: One of the most common uses of fintech in 2019 is budgeting apps for consumers, which have grown
exponentially in popularity over the years. An example is the Old Mutual ”22seven” Budgeting and Investing App: is a free budgeting &
investing app that helps you manage your money more easily and invest it more smartly. Before, consumers had to create their own
budgets, gather checks, or navigate excel spreadsheets to keep track of their finances. But after the fintech revolution prompted the
development of financial services apps, consumers can easily and efficiently keep track of their income, expenses and other budgeting
tools that have revolutionized the way consumers think about their money. 41
FIN-TECH Terminologies
 Blockchain is a technology that allows individuals and companies to make instantaneous

transactions on a network without any middlemen (like banks). Transactions made
on blockchain are completely secure, and, by function of blockchain technology, are kept as a
record of what happened. Distributed ledger technology (DLT), also commonly referred to as
blockchain technology is a database technology that allows the creation, secure transfer (with
finality) and storage of information. Contrary to other ledgers, however, distributed ledgers are
not centrally controlled and administered. Rather, the responsibility for administering and
verifying transactions is shared across the users of the blockchain. DLT could potentially be
applied to any sort of financial transaction relating to payments, including, for example,
trading, post-trade settlements or insurance payouts. DLT has been used to establish
smart contracts, or arrangements which automatically execute the agreed transaction
when certain conditions are met. DLT could also be used for a variety of recordkeeping
tasks, which for example could facilitate managing information on ‘Know Your Customer’
(KYC) requirements more efficient, or to streamline a mortgage application process where
documents from numerous parties are required. However, the immutability
(unchangeable) of the underlying code and the subsequent irreversibility of transactions
could present potential problems for financial transactions, as ultimately the accuracy of
the underlying code is still exposed to human error.
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FIN-TECH Terminologies…Cont.
 An algorithms is a step by step procedure to solve logical and mathematical

problems (problem-solving operations) especially by a computer.
 Algorithmic trading is a method of executing orders using automated pre-
programmed trading instructions accounting for variables such as time, price, and
volume to send orders out to the market over time.
 Internet of Things (IoT): is a system of interrelated computing devices,
mechanical and digital machines, objects, animals or people that are provided with
unique identifiers and the ability to transfer data over a network without requiring
human-to-human or human-to-computer interaction. Simply put IoT refers to a set of
various connected devices capturing information on movements of objects in
the physical world, and therefore represents an increasing source of big data on
behaviour for example. Hence, such results can be used for tailoring of
products, risk profiling and pricing.
 Bitcoin is a digital and global money system currency. It allows people to send or
receive money across the internet, even to someone they don't know or don't trust.
The mathematical field of cryptography is the basis for Bitcoin's security. Bitcoin was
invented by someone using the name Satoshi Nakamoto. 43
 "Big data" is a field that treats ways to analyze, systematically extract information from, or
otherwise deal with data sets that are too large or complex to be dealt with by traditional data-
processing application software. “Big data” sourced from various unique forms such as text,
numeric, images, video and audio clips, from communication devices (e.g. smartphones,
Internet-connected PCs). ). Most importantly, the rapid advances in information technology
has now allowed the processing and analysis of such large data sets; this is technically known as
“big data analytics” and can potentially be used at every point along the value chain of financial
products and services, from conception to sale. Further, analysis of ‘big data’ could be used to
improve market research and inform product design, among other benefits, including
accurate risk profiling assessment of a target market, even leveraging a targeted
advertising.
 A Cryptocurrency (or crypto currency) is a digital asset designed to work as a medium of
exchange that uses strong cryptography to secure financial transactions, control the creation of
additional units, and verify the transfer of assets.
 Cloud Computing and Storage: Is a cloud-based service providing cost-efficient and relatively
easily scalable on-demand processing and storage capacity for the data. Hence, cloud
technology has greatly increased the capacity of financial institutions to collect and analyse
data, thereby facilitating the growth in data analytics and their various applications.
44 CFA
 Artificial intelligence is often used reference to machine learning, whereby machines

are trained to interpret historical data in order to be able to recognize associated
patterns and likely trends from classified projected new data sets. However, the
machine is not learning entirely on its own; rather, the learning process requires a
significant level of human input to make sure the data is interpreted correctly.
 Biometric Technologies: rely on the recognition of physiological or behavioural
characteristics, and can be used to identity authentication by detecting characteristics
unique to a specific individuals. Techniques that are now being used for verification
include fingerprint scanning, voice authentication, face recognition, iris
scanning, and gait recognition. Hence, could represent a great improvement in
security over verification by passwords, and could be used to increase the security of
financial transactions, thereby reducing the risk of fraud or data theft.
 Augmented/virtual reality: provide new ways for consumers to perceive or interact
with their environment. The difference between the two is that augmented reality
provides an enhanced view of the actual physical world in which individuals
find themselves, whereas virtual reality creates a simulated world.
45 CFA
28. Business Life Cycle
46
28. Business Life Cycle :There are five primary stages in the business
cycle.
1) Recession: This stage is described as being at the bottom of the business cycle. Attractive
investment opportunities in this stage usually include commodities and defensive stocks (Shares of
stock issued by companies that belong to a market sector that are less vulnerable to economic
downturns due to their non-cyclical nature.).
2) Recovery: In this phase the economy is starting to "recover" after the recession. Attractive
investment opportunities include investments such as cyclical investments and commodities.
3) Early Expansion: In this stage recovery begins to gain momentum. Attractive investment
opportunities include investments in the overall stock market and property.
4) Late Expansion: In this stage the expansion momentum continues and investor confidence is
strong. Attractive investment opportunities include bonds and interest sensitive investments.
5) Slowing into Recession: This stage occurs after the expansion phase and is the stage where the
economy begins to show signs of slowing down and even turning negative. Attractive investment
opportunities include bonds and interest sensitive investments.
47 CFA
29. Explain the rationale and primary concerns of value
investors and growth investors and discuss the key risks of
each investment style.
 Value investors focus on buying undervalued stocks that are often out of
favor. Low P/B, P/E, and P/D are typical. The price-to-book ratio, or P/B ratio, is
a financial ratio used to compare a company's current market price to its
book value . Behavioral finance could explain why out-of-favor stocks can be
unpopular and therefore underpriced. Value investors argue that growth
investors pay too much and their risk is too high. The risk in the value style
is the stock price stays low or gets worse. Value stocks have offered higher
returns than growth stocks over time.
 Growth investors favor higher growth in earnings and expect the stock
price to track the high growth rate. The primary risk is that if earnings growth
is disappointing, both E and P/E decline, resulting in a large price decline.
Growth stocks will outperform value stock for a time & then the opposite occurs.
 Market-oriented investors cannot be easily classified as value or growth.
Market-oriented investing is commonly done through indexing or quasi-
indexing. It can also be tilted towards the value or growth style.
48
30. How to Classify a Manager ?
 Value or growth: Does the manager invest in low P/E, low P/B, and high dividend yield
stocks? If so, the manager would be characterized as a value manager. A manager with
high P/E, high P/B, and low dividend yield stocks would be characterized as a growth
manager. A manager with average ratios would be characterized as market-oriented.
 Expected earnings per share growth rate: Does the manager have a heavy concentration in
firms with high expected earnings growth? If so, the manager would be characterized as a
growth manager.
 Earnings volatility: Does the manager hold firms with high earnings volatility? If so the manager
would be characterized as a value manager because value managers are willing to take
positions in cyclical firms. A cyclical company is a business whose success is determined
by the economy. Economic activity follows a cycle of fluctuations, known as the business cycle,
and the share price of a cyclical company is closely linked to this.
 Industry representation: Value managers tend to have greater representation in the utility and
financial industries because these industries typically have higher dividend yields and lower
valuations. Growth managers tend to have higher weights in the technology and health
care industries because these industries often have higher growth. Although industry
representation can be used as a guide, it should be used with the other characteristics described
above. Individual firms within industries do not always fit the industry mold, and the value/growth
classification of an industry will vary as the business cycle varies. 49
31. Compare full replication, stratified sampling, and
optimization as approaches to constructing an indexed
portfolio and recommend an approach when given a
description of the investment vehicle and the index to be
tracked.
 In full replication, all index weights and positions are matched. Tracking error (TE) is
minimized, but expenses are increased if there are more and illiquid securities in the index. TE
is the difference between a portfolio's returns and the benchmark or index it was meant to
mimic or beat. TE is sometimes called active risk. TE is a measure of the risk in an investment
portfolio that is due to active management decisions made by the portfolio manager; it
indicates how closely a portfolio follows the index to which it is benchmarked.
 In stratified sampling, securities are chosen to replicate index weights by cell (or group), but
not by individual positions. TE will be slightly higher, but costs can be reduced by avoiding
illiquid securities.
 Optimization uses a factor model (optimal PORT) to match the factor exposures of the index.
Exposures must be monitored and rebalanced; it is more complicated, but TE can be lower
than for stratified sampling.
 The information ratio (IR)combines expected active return and tracking risk into one risk-
adjusted return measure. It is the expected active return (excess return) divided by the TE, so
it shows the manager’s active return per unit of tracking risk . i.e IR measures the
performance of an investment compared to a benchmark index, after adjusting for its
th
additional risk. Investments ( 9 ) & 10th Edition, Copyright © Bodie, Zvi, Alex Kane, and Alan J. Marcus.(2011).
50 CFA
32. Discuss the rationale for passive, active, and semi-active
(enhanced index) equity investment approaches and
distinguish among those approaches with respect to expected
active return and tracking risk.
 Passive managers do not use forecasts to influence their investment
strategies. Long-term (Buy-Hold Strategy).Usually track an Index. May
underperform BM due to fees & Commissions.
Active managers use expectations to try and anticipate market changes
that can be exploited to add value.
Semi-active (enhanced indexing) managers attempt to earn a higher
return than the benchmark while minimizing the risk of deviating from the
benchmark.
Active return is the excess return of a manager relative to the
benchmark. Tracking risk is the standard deviation of active return and is
a measurement of active risk.
Passive managers have the lowest active return and tracking risk
whereas active managers have the highest (high return &high risk), with
semi-active managers between the two. th 51
33. Discuss the role of equities in the overall portfolio
 Equities are a good inflation hedge in the long run.

But in the short run, the correlation of their return with
inflation is imperfect because companies vary in their
ability to pass through inflation with higher product
prices and the tax code does not adjust for the effects
of inflation.
Increase diversification opportunities
Opportunity to invest in offshore markets to generate
higher returns
52 CFA
Impact of Inflation on Your Money
53
ASSET RETURNS AFTER STRIPPING OUT INFLATION
54
34. Industry Life Cycle
 Industries also have life cycles. Understanding the life cycle phase that an
industry is in is an important aspect of industry analysis. The industry life
cycle is made up of the following stages:
55 CFA
Industry Life Cycle Stages
 1) Pioneering/Embryonic Phase
In the embryonic stage, the industry has just started. The characteristics of this stage are as
follows:
 Slow growth: customers are unfamiliar with the product.
 High prices: the volume necessary for economies of scale has not been reached.
 Large investment required: to develop the product.
 High risk of failure: most embryonic firms fail.
2) Growth Phase
In the growth stage, industry growth is rapid. The characteristics of this stage are as follows:
 Rapid growth: new consumers discover the product.
 Limited competitive pressures: the threat of new firms coming into the market peaks during
the growth phase, but rapid growth allows firms to grow without competing on price.
 Falling prices: economies of scale are reached and distribution channels increase.
 Increasing profitability: due to economies of scale.
56 CFA
Industry Life Cycle Stages… Cont.
3) Shakeout phase
In the shakeout stage, industry growth and profitability are slowing due to strong competition. The characteristics of this stage
are as follows:
 Growth has slowed: demand reaches saturation level with few new customers to be found.
 Intense competition: industry growth has slowed, so firm growth must come at the expense of competitors.
 Increasing industry overcapacity: firm investment exceeds increases in demand.
 Declining profitability: due to overcapacity.
 Increased cost cutting: firms restructure to survive and attempt to build brand loyalty.
 Increased failures: weaker firms liquidate or are acquired.
4) Maturity Phase
In the mature stage, there is little industry growth and firms begin to consolidate. The characteristics of this stage are as follows:
 Slow growth: market is saturated and demand is only for replacement.
 Consolidation: market evolves to an oligopoly (small number of large sellers)
 High barriers to entry: surviving firms have brand loyalty and low cost structures.
 Stable pricing: firms try to avoid price wars, although periodic price wars may occur during recessions.
 Superior firms gain market share: the firms with better products may grow faster than the industry average.
57 CFA
Industry Life Cycle Stages… Cont.
5) Deceleration/Decline Phase
In the decline stage, industry growth is negative. The
characteristics of this stage are as follows:
Negative growth: due to development of substitute

products, societal changes, or global competition.
Declining prices: competition is intense and there are
price wars due to overcapacity.
Consolidation: failing firms exit or merge
58 CFA
Thank You
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EQUITY INVESTMENTS

“Market Regulations, BM, FIN-TECH &

Mrs Elsie Kambala

19. What are the objectives of market regulation?

 A benchmark is a standard yardstick against which the performance of a security or

1. Specified in advance. The benchmark is known to both the investment manager

2. Price-weighted indexes reflect initially owning one share of each stock.

3. Equal-weighted indexes reflect the same initial investment in each security.

In finance, the capital asset pricing model (CAPM) is a model

Expected return on Asset =Rf+ β (RM-Rf)

Where Rf is the Risk free rate, RM is the

β can be estimated from historical data as the slope when

Total market return S&P500 was RM = 10% in 2018, Beta

A company's expected Earnings Per share (EPS) can be determined as follows:

Let’s Assume FirstRand Namibia Limited Market Value of Equity is N$4000,

 The Herfindahl-Hirschman Index (HHI) is a commonly accepted measure of

For Example the Namibian Lending Industry is composed of 5 firms with

The HHI for the Lending Industry in Namibia is 29%

 Past Performance :Past performance is often no guarantee of future performance. A manager

Top-down investment analysis includes:

 1. Set Investment Policy

 Choice of assets class

 2. Conduct security analysis

 b. Fundamental analysis – true value based on future expected returns

 Choose extent of diversification

 Assess the performance of portfolio

 Repeat previous three steps 29

 Industry analysis is a market assessment tool used by businesses and analysts

 Industry analysis, for a company, is a method that helps it to understand its

 Competitive Forces Model (Porter’s 5 Forces)

3. Social: The social impact on an industry refers to trends

4. Technological: The technological aspect of PEST analysis

 SWOT Analysis: stands for Strengths, Weaknesses, Opportunities, and

 Blockchain is a technology that allows individuals and companies to make instantaneous

 An algorithms is a step by step procedure to solve logical and mathematical

 Artificial intelligence is often used reference to machine learning, whereby machines

 Equities are a good inflation hedge in the long run.

 Increasing industry overcapacity: firm investment exceeds increases in demand.

 Declining profitability: due to overcapacity.

 Increased failures: weaker firms liquidate or are acquired.

 Slow growth: market is saturated and demand is only for replacement.

 Consolidation: market evolves to an oligopoly (small number of large sellers)

Negative growth: due to development of substitute

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