Understanding Investments Chapter 1 Charles P Jones Investments

Understanding Investments Chapter 1 Charles P. Jones, Investments: Analysis and Management, 12 th Edition, John Wiley & Sons 11

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 ◦ Being able to recognize pitfalls and scams extremely important 12

Investments Defined Investment is study of process of committing funds to one or more assets ◦ Emphasis on marketable securities ◦ Concepts also apply to real assets Funds to be invested come from assets owned, borrowed money, savings, foregone consumption Portfolio is set of assets owned 13

Why Study Investments? Desire to manage and increase wealth ◦ Most individuals make investment decisions sometime ◦ Especially important for retirement Essential part of a career in the field ◦ Investment banker, security analyst, portfolio manager, financial adviser, Chartered Financial Analyst 14

Investment Decisions Underlying investment decisions: the tradeoff between expected return and risk ◦ Expected return does not usually equal realized return Risk: the possibility that the realized return will not equal expected return ◦ Investors choose risk tolerance, then look to maximize returns ◦ Risk-return tradeoff is ex ante: made before investment Ex post: after the fact (known) 15

The Tradeoff Between Expected Return and Risk Investors manage risk at a cost - lower expected returns (ER) Financial Futures Any level of expected return and risk can Corporate Bonds be attained ER Puts & Calls Common Stocks Risk-free Rate Risk 16

The Investment Decision Process Two-step process: ◦ Security analysis and valuation Estimate expected returns and risk ◦ Portfolio management Once portfolio constructed, must be evaluated Evaluations used to revise portfolio 17

Factors Affecting the Process Uncertainty: the future unknown and must be estimated Foreign financial assets: opportunity to diversify The Internet and investment opportunities Institutional investors Ethics 18

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