FNCE 625 – Investment Analysis and Management

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Investments: Analysis and Management

Fourteenth Edition

Gerald R. Jensen and Charles P. Jones

Chapter 1

Understanding Investments

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 is extremely important

Investments Defined

Investments - the study of the 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 the set of assets owned

Why Study Investments?

Desire to manage and increase wealth

All individuals make investment decisions

Especially important for retirement

Essential part of a career in the field

Investment banker, security analyst, portfolio manager, financial adviser, Chartered Financial Analyst

Investment Decisions

Underlying principle is the tradeoff between risk and expected return

Expected and realized return usually differ

Risk: possibility that realized return will not equal expected return

Investors choose risk tolerance, then look to maximize return

Risk-return tradeoff is ex ante: made before investment

Ex post: after the fact (known)

Risk and Expected Return

Risk and return are the two most prominent characteristics in finance

Fundamental principle: there is a positive relationship between risk and expected (required) return

Referred to as the risk - return tradeoff

A strategy that yields consistently higher returns should be regarded as riskier unless documented otherwise

The Tradeoff Between Risk and Expected Return

Investors manage risk at a cost → lower expected return (E R)

Any level of risk and expected return can be attained

The Investment Decision Process

Two-step process:

Security analysis and valuation

Estimate risk and expected return

Portfolio management

Once portfolio is constructed, it must be evaluated

Evaluations used to revise portfolio

Factors Affecting the Process

Uncertainty: the future is unknown and must be estimated

Foreign financial assets: offer opportunity to diversify

The Internet and investment opportunities

Institutional investors

Ethics

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FNCE 625 – Investment Analysis and Management

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