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Introduction to Investments (Chapter 1)

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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Introduction to Investments (Chapter 1)

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  1. Introduction to Investments (Chapter 1) B 661

  2. 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

  3. 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

  4. 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

  5. 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

  6. 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

  7. 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

  8. 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?

  9. 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

  10. Sources of Risk • Interest Rate Risk • Purchasing Power Risk • Bull-Bear Market Risk • Default Risk • Liquidity Risk • Callability Risk • Convertibility Risk • Political Risk

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