CHAPTER 7 LECTURE. BACKGROUND.... WHY DO PEOPLE INVEST?... Individuals: – THE 25-YR-OLD "YUPPY" ?... – THE 25-YR-OLD "DINC" COUPLE ?... – THE 35-YR-OLD.

CHAPTER 7 LECTURE.CHAPTER 7 LECTURE.

BACKGROUND . . .

WHY DO PEOPLE WHY DO PEOPLE INVEST?...INVEST?...

Individuals:– THE 25-YR-OLD "YUPPY" ? . . .– THE 25-YR-OLD "DINC" COUPLE ? . . .– THE 35-YR-OLD "YOUNG FAMILY" ? . . .– THE 45-YR-OLD "MID-LIFE CRISIS" ? . . .– THE 65-YR-OLD "RETIREE" ? . . .

DIFFERENT LIFE STYLES, LIFE CYCLES, PERSONAL GOALS, LEVELS OF WEALTH

WHY DO PEOPLE WHY DO PEOPLE INVEST?...INVEST?...

Institutions:– LIFE INSURANCE COMPANIES– PENSION FUNDS– MUTUAL FUNDS– BANKS– FOUNDATIONS

DIFFERENT CONSTITUENCIES, EXPERTISE, LIABILITIES, REGULATIONS, SIZES

WHY DO PEOPLE WHY DO PEOPLE INVEST?...INVEST?...

===> DIFFERENT TIME HORIZONS, RISK TOLERANCES, NEEDS FOR INCOME vs GROWTH

Therefore, . . . (implications for financial services industry)

TWO MAJOR INVESTMENT TWO MAJOR INVESTMENT OBJECTIVESOBJECTIVES::

1) GROWTH (SAVINGS) - RELATIVELY LONG-TERM HORIZON (NO IMMEDIATE NEED);

2) INCOME (CURRENT CASH FLOW) -- SHORT-TERM & ON-GOING NEED FOR CASH.

MAJOR CONSTRAINTS & MAJOR CONSTRAINTS & CONCERNS:CONCERNS:

- RISK- LIQUIDITY- TIME HORIZON- MANAGEMENT BURDEN, EXPERTISE- AMOUNT OF FUNDS AVAILABLE FOR

INVESTMENT (SIZE)- CAPITAL CONSTRAINT

  Therefore (again), . . . What?

Exhibit 7-1: UNDERLYING ASSETS vs INVESTMENT Exhibit 7-1: UNDERLYING ASSETS vs INVESTMENT PRODUCTS, an Example from traditional corporate PRODUCTS, an Example from traditional corporate

finance:finance:Underl. Asset:

Invest. Products:  

Invest. Product:            

Invest. Products:

ABC Widgets Corporation(Collection of Physical, Human, & Legal Assets & Relationships)

ABC Common Stock(Subordinated claims)

- Moderate Risk- Moderate Total Return

- Low Cur.Yield

ABC Corporate Bonds(Senior claims)

- Low Risk- Low Total Return

- High Cur.Yield

Call Optionson ABC Stock

(Contingent claims)- High Risk

- High Total Return- Zero Cur.Yield

Various Mutual Funds(owning various different types of claims on ABC & other assets)

- Various Risk, Return, & Cur.Yield Configurations

Exhibit 7-2: AExhibit 7-2: A REAL ESTATE EXAMPLE of the REAL ESTATE EXAMPLE of the Investment SystemInvestment System

Underl. Asset:(Priv.Traded)

PrivateInvest. Products:

PublicInvest. Products:

            CMBSpublicly traded

securities basedon a pool of mortgs

Investors:individual,institutional

"Bricks & Mortar" (e.g., Grump Family Shopping Centers)(Rent-producing Real Properties )

e.g., Ltd Partnerships(or CREFs, Priv.REITs, etc)

Own equtiy in properties:LP Shares (units) privately held

& privately traded if at all

Commercial MortgagesSenior (debt) claims:

Privately held & traded("whole loans")

REITs“UPREIT” Owns

LP Units,Issues publiclytraded shares.

(May also directly own Underl.Asset, or Mortgs

& CMBS)

Small

&LargeInvestors

Large Investors

(Wealthy Individuals, Developers, Institutions)

Small&

LargeInvestors

Exhibit 7-3:End of Year Public vs Private Asset Mkt Commercial R.E. Values:

(Indexes set to have Equal Avg Values 1974-98)

1.0

1.2

1.4

1.6

1.8

2.0

2.2

74 76 78 80 82 84 86 88 90 92 94 96 98 2000

NAREIT (Unlevered) NCREIF (Unsmoothed)

Exhibit 7-4: Approximate Aggregate Value of Asset Classes, USA late 1990s ($Trillion)

2

11

12

8

Cash

Stocks

Bonds

Real Estate*

Exhibit 7-6: HISTORICAL Exhibit 7-6: HISTORICAL PERFORMANCE OF MAJOR INVESTMENT ASSET PERFORMANCE OF MAJOR INVESTMENT ASSET

CLASSES, COMPARED TO INFLATION (CPI), CLASSES, COMPARED TO INFLATION (CPI), 1970-98:1970-98:

Value of $1 with Reinvestment

$0

$5

$10

$15

$20

$25

$30

$35

$40

$45

69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98

CPI TBill SP500 LGBond RE

Stocks $39.14Real Est 14.91LT Bond 14.32TBills 6.67CPI 4.34

Exhibit 7-7a: Value of $1 with Reinvestment:1969-83

0

1

2

3

4

5

69 70 71 72 73 74 75 76 77 78 79 80 81 82 83

CPI TBill SP500 LGBond RE

Real Est 4.75Stocks 3.31TBills 2.83CPI 2.69Bonds 2.36

Exhibit 7-7b: Value of $1 with Reinvestment, 1983-98

$0

$2

$4

$6

$8

$10

$12

$14

83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98

CPI TBill SP500 LGBond RE

Stocks $11.83Bonds 6.05Real Est 2.97Tbills 2.36CPI 1.62

Exh.7-9a: Avg.Ann.Total Return (70-98)

0%

2%

4%

6%

8%

10%

12%

14%

16%

T Bills G Bonds Real Estate Stocks

Income Growth

Exh.7-9b: Annual Volatility (70-98)

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

T Bills G Bonds Real Estate Stocks

EXHIBIT 7-10: THE "ROLLER COASTER RIDE" IN EXHIBIT 7-10: THE "ROLLER COASTER RIDE" IN COMMERCIAL PROPERTY PRICES OVER THE COMMERCIAL PROPERTY PRICES OVER THE

LAST QUARTER-CENTURY . . .LAST QUARTER-CENTURY . . .

69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

2.0

Price Level Index U.S. Institutional Real Estate

REITs

REIT bust,Recession

ERISA: MPT=>P.F. demand

inflation fears

Boom, Tax incentivesS&L Dereg

Overbuilding Tax reform

Disinflation

Recession

S&L Crisis: FIRREA

Securitizatn: - REITs - CMBS