Understanding

Investments
Chapter 1
Charles P. Jones, Investments: Analysis and
Management,
Tenth Edition, John Wiley & Sons

Prepared by
G.D. Koppenhaver, Iowa State University

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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
 Emphasis on holding financial assets and
marketable securities
 Concepts also apply to real assets
 Foreign financial assets should not be
ignored

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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
Stocks
returns (ER)
ER
 Any level of Bonds
expected return
and risk can be
attained Risk-free Rate
Risk

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The Investment Decision Process

 Two-step process:
 Security analysis and valuation
 Necessary to understand security characteristics
 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
changing environment
 The Internet and investment
opportunities
 Institutional investors important
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