Definition

investment

as the process of, sacrificing something now for the prospect of gaining something later.

Various Investment Alternatives

As per Business management As per Economics As per Finance

Establishing Financial Goals

Typical Financial Goals Common Investment Goals

Capital accumulation Preservation of capital Maximizing returns Minimizing risk

Budgeting Methods of Increasing Savings

Chapter 12: Introduction to Investment Concepts

Investment Risks

(contd)

Risk and Return

There is a direct relationship between risk

and return. As the level of risk increases, the expected return increases, and as the level of risk decreases, the expected return decreases.

Liquidity vs. Marketability

Chapter 12: Introduction to Investment Concepts

Investment Choices

Lending investments
Default risk Interest rate risk

Ownership investments in business Ownership investments in real estate

Cash flow Depreciation deduction Low correlation with other assets

Chapter 12: Introduction to Investment Concepts

Investment Choice (cont.)

Derivatives
Options Puts Calls Futures

Direct vs. Indirect Investing

Chapter 12: Introduction to Investment Concepts

Measures of Risk
Beta a measure of systematic risk derived from regression analysis Standard Deviation measures total volatility (systematic and unsystematic risk) Semivariance measures downside volatility

Chapter 12: Introduction to Investment Concepts

Measures of Return
Holding period return Arithmetic mean Geometric mean Internal rate of return Real rate of return

Chapter 12: Introduction to Investment Concepts

Holding Period Return

HPR = EI BI +/- Cashflows BI EI = Ending Value of Investment BI = Beginning Value of Investment

Chapter 12: Introduction to Investment Concepts

Arithmetic Mean
HPR t
AM =
t=1 n

HPRt = Return for period t n = Number of periods

Chapter 12: Introduction to Investment Concepts

Geometric Mean
GM =
n

(1 + R 1) + (1 + R2 )( 1 + Rn ) 1

Rn = Return for period n n = Number of periods

Chapter 12: Introduction to Investment Concepts

Internal Rate of Return

PV =

CF1
( 1 + k )1

+ + CF n n ( 1 +k ) ( 1 +k )2

CF2

PV = Present Value CFn = Cash flow for period n n = Number of cash flows k = IRR
Chapter 12: Introduction to Investment Concepts

Types of Investments

Securities or Property
Securities: stocks, bonds, options Real Property: land, buildings Tangible Personal Property: gold,

artwork, antiques

Direct or Indirect
Direct: investor directly acquires a claim Indirect: investor owns part of a portfolio

Copyright 2005 Pearson Addison-Wesley. All rights reserved.

1-14

Types of Investments (cont'd)

Debt, Equity or Derivative Securities

Debt: investor lends funds in exchange for

interest income and repayment of loan in future (bonds) Equity: represents ongoing ownership in a business or property (common stocks) Derivative Securities: neither debt nor equity; derive value from an underlying asset (options)

Low Risk or High Risk

Risk: chance that actual investment returns will

differ from those expected

Copyright 2005 Pearson Addison-Wesley. All rights reserved.

1-15

Types of Investments (cont'd)

Short-Term or Long-Term
Short-Term: mature within one year
Long-Term: maturities of longer than a year

Domestic or Foreign
Domestic: India -based companies Foreign: overseas-based companies

Copyright 2005 Pearson Addison-Wesley. All rights reserved.

1-16

Types of Investors

Individual Investors
Invest for personal financial goals

(retirement, house)

Institutional Investors
Paid to manager other peoples money Typically manage large amounts of money Include: banks, life insurance companies,

mutual funds and pension funds

Copyright 2005 Pearson Addison-Wesley. All rights reserved.

1-17