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
returns (ER)
Any level of
expected return
and risk can be
attained

Stocks

ER

Bonds

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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