INVESTMENTS:
Analysis and Management
Second Canadian Edition
W. Sean Cleary
Charles P. Jones
Chapter 1
Understanding
Investments
Learning Objectives
• Define investment and discuss what it means to
study investments.
• Explain why risk and return are the two critical
components of all investing decisions.
• Outline the two-step investment decision process.
• Discuss key factors that affect the investment
decision process.
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
Investment Objectives
• Primary Objectives
 Safety of principal
 Income
 Growth of capital
• Secondary Objectives
 Liquidity
 Tax minimization
Investment Constraints
• Possible constraints for investors include:






Legal
Moral / Ethical
Emotional – including investment knowledge and
risk tolerance
Basic minimum income to be provided by the
portfolio
Realism – an understanding that some objectives
are unrealistic (e.g., high returns with low risk)
Other (e.g., illness, pending divorce, etc.)
Primary and Secondary Objectives
• Objectives and constraints must be related to the
three primary investment objectives of safety,
income, and growth, and to the secondary
objectives of liquidity and tax minimization.

The importance of safety relates to: risk, market
timing, inflation, return, and emotion
 The importance of income relates to: taxation, return,
risk, inflation, and basic minimum income
 The importance of growth relates to: taxation, risk,
return, market timing, and emotional considerations
Why Study Investments?
• Most individuals make investment decisions
sometime

Individuals need sound framework for
managing and increasing wealth
• Essential part of a career in the field

Security analyst, portfolio manager, investment
advisor, financial planner, Chartered Financial
Analyst
Investment Decisions
• Underlying investment decisions: the tradeoff
between expected return and risk
• Return: 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
“Typical” Chart
RT
RELATION
RISQUE-RENDEME
RISK- EXPECTED RETURN RELATIONSHIPS
12
Options/Futures
High
Art objects
10
Coins and stamps
Real estate (commercial)
8
Common shares
6
Expected
Return
Rendement
Real estate (residential)
Preferred shares
4
Corporate bonds
Government bonds
2
Treasury bills
0
0
Low
2
4
6
Risk
8
10
12
High
The Investment Decision Process
• Two-step process:

Security analysis
•

Necessary to understand security characteristics
and applied to these securities to estimate their
price or value
Portfolio management
•
•
•
Selected securities viewed as a single unit
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 and/or reduce risk
• Investors must now cope with a changed investing
environment
• Internet changes investments environment
• Institutional investors are important
• How efficient are financial markets in processing
new information?
Corporate Governance
Main issues:
• The accountability of the Board of Directors and
Management
• A re-examination of accounting and auditing
practices
• Management compensation arrangements such as
executive stock option plans
• Disclosure requirements
• The effectiveness of existing regulatory bodies
Appendix 1-A: The Chartered Financial
Analyst® (CFA®) Program
• Individuals who are interested in the
investment area should consider seeking a
CFA designation



Level I emphasizes tools and inputs
Level II emphasizes asset valuation
Level III emphasizes portfolio management
• For more information: www.cfainstitute.org
Appendix 1-B:
Professional Educational Alternatives
• Canadian Securities Institute (CSI)

The CSI offers the Canadian Securities Course (CSC),
which is a mandatory requirement for individuals who
wish to become licensed to sell financial securities in
Canada and to register to sell mutual funds
• CFA Institute (formerly Association for Investment
Management and Research (AIMR))

The CFA institute administers the Chartered Financial
Analyst ® curriculum and examination program
Appendix 1-B:
Professional Educational Alternatives
• Financial planners

The Financial Planners Standards Council (FPSC)
developed a set of minimum standards regarding
education, experience, and ethical and moral conduct
for financial planners
Copyright
Copyright © 2005 John Wiley & Sons Canada, Ltd. All rights
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