Investments
An Introduction
Seventh Edition
By: Herbert B. Mayo
The College of New Jersey
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Chapter 1
An Introduction to
Investments
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Introduction of Portfolio Construction
•
•
•
•
Income is either spent or saved
Savings are invested
The investments constitute a portfolio
The composition of a portfolio
depends on investment goals
• Not all assets are appropriate for
each financial goal
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Possible Investment Goals
• Funds to meet emergencies
• Funds to finance education
expenses
• Funds to make a specified
purchase (e.g., a home)
• Funds for retirement
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Preliminary Definitions
• Investments: lay usage v. economics
• Primary and secondary markets
• Value and valuation
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Preliminary Definitions
• Return: income and capital gains
• Return: monetary units and
percentages
• Risk: differentiated from
speculation
• Marketability versus liquidity
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Sources of Risk
Total Risk
Unsystematic
Systematic
(diversifiable)
(nondiversifiable)
• Business
• Financial
• Market
• Interest Rate
• Reinvestment
• Purchasing Power
• Exchange Rate
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Diversification and
Unsystematic Risk
• Diversification reduces (or
eliminates) unsystematic risk
• Unsystematic risk is asset
specific
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Diversification and
Unsystematic Risk
• For firms, unsystematic risk
refers to business risk and
financial risk
• Diversification does not reduce
systematic risk
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Efficient Markets
• Financial markets are efficient
because
–fierce competition exists among
investors
–participants may readily enter and
exit financial markets
–information is readily available
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Efficient Markets
• Efficient markets implies
–the investor should not expect
to consistently outperform the
market
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Portfolio Assessment
• Popular press places emphasis on
return
• Higher return requires accepting
more risk
• Assessment should consider both
the return and the risk taken to
achieve the return
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
The Internet
• Major source of information
concerning investments
• Information is often available for
little or no cost
• Problem of inaccurate information
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
The Importance of
•Beliefs
•Investment philosophy
•Understanding yourself
•Available time to make
investment decisions
•The investor's resources
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Appendix 1
Supply and Demand
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Supply and Demand
Determine Price
• An equilibrium price occurs when:
–quantity demanded = quantity
supplied
• At equilibrium - no incentive for the
price to change
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Demand for a Good or Service
Depends on Several Variables
• The price of the good
• Consumer tastes
• Prices of substitute and
complementary goods
• Consumer incomes
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Supply of a Good or Service
Depends on Several Variables
• The price of the good
• The cost of production
• The level of technology
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
The Interaction Between
Supply and Demand
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
The Interaction Between
Supply and Demand
• The equilibrium price equates
the quantity demanded and the
quantity supplied
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Effect of a Lower Price Excess Demand
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Effect of a Higher Price Excess Supply
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Demand & Supply Graphs
• Relate price and quantity
• All other factors are held constant
• If any of these variables change, the
demand curve or the supply curve
shifts
• The shift causes the quantity and
price to change
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
An Increase in Demand
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
An Increase in Demand
• Causes the price to rise and the
quantity supplied to also
increase
• A decrease in demand has the
opposite effect - the price and
the quantity supplied fall
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
An Increase in Supply
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
An Increase in Supply
• Causes the price to fall and the
quantity demanded to increase
• A decrease in supply causes
prices to rise and the quantity
demanded to fall
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.