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

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

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

Copyright © 2003 South-Western/Thomson Learning. All rights reserved. Diversification and Unsystematic Risk Diversification reduces (or eliminates) unsystematic risk Unsystematic risk is asset specific

Copyright © 2003 South-Western/Thomson Learning. All rights reserved. Diversification and Unsystematic Risk For firms, unsystematic risk refers to business risk and financial risk Diversification does not reduce systematic risk

Copyright © 2003 South-Western/Thomson Learning. All rights reserved. Efficient Markets Financial markets are efficient because –fierce competition exists among investors –participants may readily enter and exit financial markets –information is readily available

Copyright © 2003 South-Western/Thomson Learning. All rights reserved. Efficient Markets Efficient markets implies –the investor should not expect to consistently outperform the market

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

Copyright © 2003 South-Western/Thomson Learning. All rights reserved. The Internet Major source of information concerning investments Information is often available for little or no cost Problem of inaccurate information

Copyright © 2003 South-Western/Thomson Learning. All rights reserved. The Importance of Beliefs Investment philosophy Understanding yourself Available time to make investment decisions The investor's resources

Copyright © 2003 South-Western/Thomson Learning. All rights reserved. Appendix 1 Supply and Demand

Copyright © 2003 South-Western/Thomson Learning. All rights reserved. Supply and Demand Determine Price An equilibrium price occurs when: –quantity demanded = quantity supplied At equilibrium - no incentive for the price to change

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

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

Copyright © 2003 South-Western/Thomson Learning. All rights reserved. The Interaction Between Supply and Demand The equilibrium price equates the quantity demanded and the quantity supplied

Copyright © 2003 South-Western/Thomson Learning. All rights reserved. Effect of a Lower Price - Excess Demand

Copyright © 2003 South-Western/Thomson Learning. All rights reserved. Effect of a Higher Price - Excess Supply

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

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

Copyright © 2003 South-Western/Thomson Learning. All rights reserved. An Increase in Supply

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