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Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
InvestmentsAn Introduction
Seventh Edition
By: Herbert B. MayoThe College of New Jersey
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Chapter 1
An Introduction to Investments
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Introduction of Portfolio Construction
• Income is either spent or saved• Savings are invested• The investments constitute a portfolio• The composition of a portfolio depends
on investment goals• Not all assets are appropriate for each
financial goal
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Possible Investment Goals
• Funds to meet emergencies
• Funds to finance education expenses
• Funds to make a specified purchase (e.g., a home)
• Funds for retirement
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Preliminary Definitions
• Investments: lay usage v. economics
• Primary and secondary markets
• Value and valuation
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Preliminary Definitions
• Return: income and capital gains
• Return: monetary units and percentages
• Risk: differentiated from speculation
• Marketability versus liquidity
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Sources of Risk
Total Risk
Unsystematic(diversifiable)
Systematic(nondiversifiable)
•Business•Financial
•Market•Interest Rate•Reinvestment•Purchasing
Power•Exchange Rate
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Diversification and Unsystematic Risk
• Diversification reduces (or eliminates) unsystematic risk
• Unsystematic risk is asset specific
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Diversification and Unsystematic Risk
• For firms, unsystematic risk refers to business risk and financial risk
• Diversification does not reduce systematic risk
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Efficient Markets
• Financial markets are efficient because
–fierce competition exists among investors
–participants may readily enter and exit financial markets
–information is readily available
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Efficient Markets
• Efficient markets implies
–the investor should not expect to consistently outperform the market
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Portfolio Assessment
• Popular press places emphasis on return
• Higher return requires accepting more risk
• Assessment should consider both the return and the risk taken to achieve the return
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The Internet
• Major source of information concerning investments
• Information is often available for little or no cost
• Problem of inaccurate information
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The Importance of
•Beliefs
•Investment philosophy
•Understanding yourself
•Available time to make
investment decisions
•The investor's resources
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Supply and Demand Determine Price
• An equilibrium price occurs when:
–quantity demanded = quantity supplied
• At equilibrium - no incentive for the price to change
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Demand for a Good or Service Depends on Several Variables
• The price of the good
• Consumer tastes
• Prices of substitute and complementary goods
• Consumer incomes
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Supply of a Good or Service Depends on Several Variables
• The price of the good
• The cost of production
• The level of technology
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
The Interaction Between Supply and Demand
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The Interaction Between Supply and Demand
• The equilibrium price equates the quantity demanded and the quantity supplied
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Effect of a Lower Price - Excess Demand
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Effect of a Higher Price - Excess Supply
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Demand & Supply Graphs
• Relate price and quantity• All other factors are held constant• If any of these variables change, the
demand curve or the supply curve shifts• The shift causes the quantity and price
to change
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
An Increase in Demand
• Causes the price to rise and the quantity supplied to also increase
• A decrease in demand has the opposite effect - the price and the quantity supplied fall