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Introduction to Investments (Chapter 1). B 661. Outline. What is meant by “Investment”? Why do individuals invest? Basis of Investment Decisions Structuring the Decision Process New External Environment Globalization New versus Old Economy Technology. Meaning of Investments.

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outline
Outline
  • What is meant by “Investment”?
  • Why do individuals invest?
  • Basis of Investment Decisions
  • Structuring the Decision Process
  • New External Environment
    • Globalization
    • New versus Old Economy
    • Technology
meaning of investments
Meaning of Investments
  • Commitment of money that is expected to generate additional money
  • Current commitment of dollars for a period of time to desire future payments that will compensate the investor for
    • The time the funds are committed
    • The expected rate of inflation, and
    • The uncertainty of the future payments
  • The investor can can be an individual, a government, and/or a corporation
why do individuals invest
Why do individuals invest?
  • To achieve a higher level of consumption in the future by forgoing consumption today
  • To improve our welfare in the future
  • Investments help us achieve tradeoff between current consumption and future consumption
  • Basic element of all investment decisions: trade-off between expected return and risk
why study investments
Why Study Investments?
  • The Personal Aspects
    • To earn better returns in relation to the risk we assume when we invest
    • Knowledge of investments help investors understand the relationship between risk and return
  • Investment as a Profession
    • To become a licensed broker (series 7 exam), to become CFA/CFP/CMA, knowledge of investments is needed
investment decisions
Investment Decisions
  • Underlying investment decisions: the tradeoff between expected return and risk
    • Expected return is not usually the same as realized return
  • Risk: the possibility that the realized return will be different than the expected return
the tradeoff between er and risk
The Tradeoff Between ER and Risk
  • Investors manage risk at a cost - lower expected returns (ER)
  • Any level of expected return and risk can be attained

Stocks

ER

Bonds

Risk-free Rate

Risk

the investment decision process
The Investment Decision Process
  • Two-step process:
    • Security analysis and valuation
      • Necessary to understand security characteristics
    • Portfolio management
      • Selected securities viewed as a single unit
      • How efficient are financial markets in processing new information?
      • How and when should it be revised?
      • How should portfolio performance be measured?
factors affecting the process
Factors Affecting the Process
  • Uncertainty in ex post returns dominates decision process
    • Future unknown and must be estimated
  • Foreign financial assets: opportunity to enhance return or reduce risk
  • Quick adjustments needed to a changing environment
  • The Internet and investment opportunities
  • Institutional investors important
sources of risk
Sources of Risk
  • Interest Rate Risk
  • Purchasing Power Risk
  • Bull-Bear Market Risk
  • Default Risk
  • Liquidity Risk
  • Callability Risk
  • Convertibility Risk
  • Political Risk