Investments -

Eighth Edition

An Introduction to Investment_CH1

Done by: Dr. Ahmad Gharaibeh

Objectives
Investment Goals
Deferent Between Liquidity and Marketability Distinguish Between Primary and Secondary

Market
Identify the Sources of Risk and the Sources of

Return
Financial Markets are Efficient

Portfolio construction and planning

Portfolio: An accumulation of assets

(e.g., Stocks, Bonds, Derivatives) owned by the investor and designed to transfer purchasing power to the future

Some Preliminary Definitions

Investment (in Economics): The purchase of a

physical asset ( e.g., plant, equipment, or inventory). Investment (in Lay Term): Acquisition of an asset such as a stock or a bond. Secondary market: A market for buying and selling previously issued securities. Primary market: The Initial sale of securities.

Some Preliminary Definitions

Value: What something is worth; the present value

of future benefits. Valuation: The process of determining the current worth of an asset, In some cases it is relatively easy, but in others are not so readily identified. Return: The sum of income plus capital gains earned on an investment in an asset. Income: The flow of money or its equivalent produced by an asset; dividends and interest.

Some Preliminary Definitions

Rate of return: The annual percentage return realized on an

investment. Risk: The Possibility of loss; the uncertainty of future returns. Speculation: An investment that offers a potentially large return but is also very risky; a reasonable probability that the investment will produce a loss. Marketability: The ease with which an asset may be bought and sold. Liquidity: Moneyness; the ease with which assets can be converted into cash with little risk of loss of principal.

Sources of Risk
Systematic risk: Associated with

fluctuation in security prices; e.., market risk.

Unsystematic risk: The risk associated

with individual events that affect a particular security.

Sources of Risk
Total Risk

Unsystematic Risk (diversifiable)

systematic Risk (nondiversifiable)

Business Risk

Financial risk

Market Risk

Purchasing Power Risk

Interest rate Risk

Reinvestment Rate Risk

Exchange rate risk

Sources of Risk
Business risk: The risk associated with the nature

of a business. Financial risk: The risk associated with a firm's sources of financing. Market Risk: Systematic risk; the risk associated with the tendency of a stock's price to fluctuate with the market. Interest Rate Risk: The uncertainty associated with changes in interest rates; the possibility of loss resulting from increases in interest rates.

Sources of Risk
Reinvestment Rate Risk: The risk associated with

reinvesting earning or principal at a lower rate than was initially earned. Purchasing Power risk: The uncertainty that future inflation will erode the purchasing power of assets and income. Exchange Rate Risk: The uncertainty associated with changes in the value of foreign currencies.

Efficient and Competitive Markets

Investors participate in efficient and competitive

financial markets. Financial Markets tend to be very efficient Efficient markets imply that investors cannot expect on average to beat the market consistently. So, they should not consistently under perform the market. Thus, efficient financial markets imply that investors should, over and extended period of time, earn neither excessively positive nor excessively negative returns.