Understanding Investments
Chapter 1
Jones, Investments: Analysis and Management
Why study Investments
 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
Investments Defined
 Investments is the study of the process of committing funds to one or more assets that
will be held over some future time period.
 Concerned with the management of an investor’s wealth (sum of current
income and the present value of all future income)
 Emphasis on holding financial assets and marketable securities
 Financial assets—paper claims on some issuer
 Marketable securities—financial assets that are easily and
cheaply tradable in organized markets
 Non-marketable securities—represent personal transactions
between the owner and issuer (savings accounts, nonnegotiable
CDs MMDA,US government savings bonds)
 Concepts also apply to real assets—tangible assets
(gold,silver,diamonds,collectables,etc.)
 Foreign financial assets should not be ignored
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
Financial Decision Making
 Develop an overall financial plan
 Buy or rent housing
 Insurance
o Types-health, disability, life, etc
 Emergency reserve funds
 Create portfolio---asset holdings of an investor
 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
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Investment Decision Process Involves a Tradeoff Between ER and Risk
 Investors manage risk at a cost - lower expected returns (ER)

Risk-chance that the actual return will not be the expected return

Expected return (ex-ante)- anticipated return

Realized return (ex-post) – actual return
 Any level of expected return and risk can be attained

Level depends on investors risk aversion
o Risk-averse investor-an investor who will not assume a given
level of risk unless there is an expectation of an adequate
compensation for having done so
The Investment Decision Process
 Two-step process:
 Security analysis and valuation
 Necessary to understand security characteristics
 Application of valuation model
 Portfolio management
 Selected securities viewed as a single unit (portfolio)
 Allocation mix
 How and when should it be revised?
 How should portfolio performance be measured?
 Passive Investment vs Active Investment Strategy
 Market Efficiency—prices securities do not depart for any length of
time from the justified economic values that investors calculate for
them
 Economically efficient
 Which strategy believes/uses EMH
Factors Affecting the Investment Decision Process
 Uncertainty in ex post returns dominates decision process
 Future is unknown and must be estimated
 Estimates are by definition not accurate
 Foreign financial assets: opportunity to enhance return or reduce risk
 Institutional investors important influence on market
 How efficient are financial markets in processing new information?
The Rise of the Internet
 Revolutionized the flow of investment information
 Dramatically lowered commission rates for individual investors
Global Movement
 Many US Cos derive a very large percentage of their revenue from abroad
 Foreign capital inflows to US has increased
 Rates of return on foreign securities may be higher
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
Risk reduction (possible)
Categories of Investors
 Individual
 Institutional
Advantages of Institutional Investor Over the Individual Investor
Advantages of Individual Investor Over the Institutional Investor
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