Download ppt - Copyright © 2003 South-Western/Thomson Learning. All rights reserved. Investments An Introduction Seventh Edition By: Herbert B. Mayo The College of New

Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

InvestmentsAn Introduction

Seventh Edition

By: Herbert B. MayoThe College of New Jersey


Chapter 1

An Introduction to Investments


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


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


Preliminary Definitions

• Investments: lay usage v. economics

• Primary and secondary markets

• Value and valuation


Preliminary Definitions

• Return: income and capital gains

• Return: monetary units and percentages

• Risk: differentiated from speculation

• Marketability versus liquidity


Sources of Risk

Total Risk

Unsystematic(diversifiable)

Systematic(nondiversifiable)

•Business•Financial

•Market•Interest Rate•Reinvestment•Purchasing

Power•Exchange Rate


Diversification and Unsystematic Risk

• Diversification reduces (or eliminates) unsystematic risk

• Unsystematic risk is asset specific


Diversification and Unsystematic Risk

• For firms, unsystematic risk refers to business risk and financial risk

• Diversification does not reduce systematic risk


Efficient Markets

• Financial markets are efficient because

–fierce competition exists among investors

–participants may readily enter and exit financial markets

–information is readily available


Efficient Markets

• Efficient markets implies

–the investor should not expect to consistently outperform the market


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


The Internet

• Major source of information concerning investments

• Information is often available for little or no cost

• Problem of inaccurate information


The Importance of

•Beliefs

•Investment philosophy

•Understanding yourself

•Available time to make

investment decisions

•The investor's resources


Appendix 1

Supply and Demand


Supply and Demand Determine Price

• An equilibrium price occurs when:

–quantity demanded = quantity supplied

• At equilibrium - no incentive for the price to change


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


Supply of a Good or Service Depends on Several Variables

• The price of the good

• The cost of production

• The level of technology


The Interaction Between Supply and Demand


The Interaction Between Supply and Demand

• The equilibrium price equates the quantity demanded and the quantity supplied


Effect of a Lower Price - Excess Demand


Effect of a Higher Price - Excess Supply


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


An Increase in Demand


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


An Increase in Supply


An Increase in Supply

• Causes the price to fall and the quantity demanded to increase

• A decrease in supply causes prices to rise and the quantity demanded to fall