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Transcript
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 • 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? • 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? • 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 • 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 • 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 • 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 • 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 • • • • • • • • Interest Rate Risk Purchasing Power Risk Bull-Bear Market Risk Default Risk Liquidity Risk Callability Risk Convertibility Risk Political Risk