Understanding

Investments
Chapter 1
Charles P. Jones, Investments: Analysis and Management,

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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

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Investments Defined
Investments is the study of the process of committing
funds to one or more assets
Concerned with management of investors wealth
Emphasis on holding financial assets (paper or electronic
claim on some issuers) and marketable securities
Concepts also apply to real assets
Foreign financial assets should not be ignored

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What Is An Investment?

Defining Investment: A current commitment of $ for a

period of time in order to derive future payments that
will compensate for:
The time the funds are committed
The expected rate of inflation
Uncertainty of future flow of funds

Reason for Investing: By investing (saving money now

instead of spending it), individuals can tradeoff present
consumption for a larger future consumption
Funds to be invested come from assets already owned,
borrowed money, savings or foregoing consumption
Investors are interested in managing and enhancing
their wealth by investing in optimal combination of
financial assets.

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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

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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
Investor risk tolerance affects expected return

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The Tradeoff Between

Expected Return and Risk
Investors manage risk at a
cost - lower expected
returns (ER)
Any level of expected
return and risk can be
attained
Investors decide on their
risk tolerance.

Financial Futures
Corporate Bonds

ER

Puts & Calls

Common Stocks
Risk-free Rate

Risk
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The Investment Decision

Process
Two-step process:
Security analysis and valuation
Valuation and analysis of individual securities
Necessary to understand security characteristics and the factors
affecting them

Portfolio management

Selected securities viewed as a single unit

How efficient are financial markets in processing new information?
How and when should it be revised?
How should portfolio performance be measured?

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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

or reduce risk
Quick adjustments needed to a adapt to a changing
environment
The Internet and investment opportunities
Institutional investors important

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