Understanding Investments Chapter Charles P Jones, Investments: Analysisand Management, Tenth Edition, John Wiley & Sons Prepared by G.D Koppenhaver, Iowa State University 1-1 Objectives To understand the investments field as currently practiced To help you make investment decisions that will enhance your economic welfare To create realistic expectations about the outcome of investment decisions 1-2 Investments Defined Investments is the study of the process of committing funds to one or more assets Emphasis on holding financial assets and marketable securities Concepts also apply to real assets Foreign financial assets should not be ignored 1-3 Why Study Investments? Most individuals make investment decisions sometime Need sound framework for managing and increasing wealth Essential part of a career in the field Security analyst, portfolio manager, registered representative, Certified Financial Planner, Chartered Financial Analyst 1-4 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 Investor risk tolerance affects expected return 1-5 The Tradeoff Between Expected Return 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 1-6 The Investment Decision Process Two-step process: Security analysisand 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? 1-7 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 andinvestment opportunities Institutional investors important 1-8 Copyright 2006 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United states Copyright Act without the express written permission of the copyright owner is unlawful Request for further information should be addressed to the Permissions department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein 1-9 ... understand the investments field as currently practiced To help you make investment decisions that will enhance your economic welfare To create realistic expectations about the outcome of investment. .. Investment Decision Process Two-step process: Security analysis and valuation Necessary to understand security characteristics Portfolio management Selected securities viewed as a single... assets should not be ignored 1-3 Why Study Investments? Most individuals make investment decisions sometime Need sound framework for managing and increasing wealth Essential part of a career