Lecture No.14 Chapter 4 Contemporary Engineering Economics Copyright © 2010 Contemporary Engineering Economics, 5th edition, © 2010.

Slides:



Advertisements
Similar presentations
Chapter 6 Interest and Bond.
Advertisements

Bennie D Waller, Longwood University Personal Finance Bennie Waller Longwood University 201 High Street Farmville, VA.
Chapter 4 Return and Risks.
Chapter 4 Return and Risk. Copyright ©2014 Pearson Education, Inc. All rights reserved.4-2 The Concept of Return Return –The level of profit from an investment,
Chapter 4 Return and Risks.
Investment Basics A Guide to Your Investment Options Brian Doughney, CFP® Wealth Management Senior Manager.
Interest Rates and Bond Valuation
Unit 5 Microeconomics: Money and Finance Chapters 11.2 Economics Mr. Biggs.
Valuation and Characteristics of Bonds.
Copyright ©2004 Pearson Education, Inc. All rights reserved. Chapter 16 Investing in Bonds.
Capital Markets.
Bonds Add in bond interest ex from book. Bonds Unit 7 - Investing.
Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill /Irwin 3-1 Chapter Three Interest Rates and Security Valuation.
The application of the present value concept
Chapter 13 Investing in Bonds Copyright © 2012 Pearson Canada Inc
7-1 Copyright (C) 2000 by Harcourt, Inc. All rights reserved. Chapter 7 Valuation Concepts Bond Values Stock Values Rates of Return Market Equilibrium.
Chapter 11 Investing Fundamentals Copyright © 2012 Pearson Canada Inc
Chapter 11 Bond Yields and Prices. Learning Objectives Calculate the price of a bond. Explain the bond valuation process. Calculate major bond yield measures,
Chapter 6 The Returns and Risks from Investing. Function of both return and risk – At the centre of security analysis How should realized return and risk.
(C) 2001 Contemporary Engineering Economics 1 Chapter 6 Principles of Investing Investing in Financial Assets Investment Strategies Investing in Stocks.
Chapter 7 Valuation Concepts © 2005 Thomson/South-Western.
Theory of Valuation The value of an asset is the present value of its expected cash flows You expect an asset to provide a stream of cash flows while you.
Chapter 6 The Returns and Risks from Investing. Explain the relationship between return and risk. Sources of risk. Methods of measuring returns. Methods.
Review Bond Yields and Prices.
Copyright ©2004 Pearson Education, Inc. All rights reserved. Chapter 18 Asset Allocation.
Investments: Analysis and Behavior Chapter 15- Bond Valuation ©2008 McGraw-Hill/Irwin.
© 2003 The McGraw-Hill Companies, Inc. All rights reserved. Interest Rates and Bond Valuation Lecture 6.
BOND PRICES AND INTEREST RATE RISK
Chapter 5 Valuation Concepts. 2 Basic Valuation From “The Time Value of Money” we realize that the value of anything is based on the present value of.
Investment Basics Clench Fraud Trust Investment Workshop October 24, 2011 Jeff Frketich, CFA.
Business in Action 7e Bovée/Thill. Financial Markets and Investment Strategies Chapter 19.
Bonds and other financial assets
© 2008 Thomson South-Western CHAPTER 12 INVESTING IN STOCKS AND BONDS.
Lecture No. 50 Chapter 15 Contemporary Engineering Economics Copyright © 2010 Contemporary Engineering Economics, 5th edition, © 2010.
1-1 1 A Brief History of Risk and Return. 1-2 A Brief History of Risk and Return Two key observations: 1. There is a substantial reward, on average, for.
19-1 Financial Markets and Investment Strategies Chapter 19.
Chapter 11 Investing for Your Future. Goals for Chapter 11.1 Investing fundamentals Describe the stages of investing and the relationship between risk.
Copyright © 2012 Pearson Education Chapter 6 Interest Rates And Bond Valuation.
A History of Risk and Return
6-1 Lecture 6: Valuing Bonds A bond is a debt instrument issued by governments or corporations to raise money The successful investor must be able to:
Contemporary Engineering Economics, 6 th edition Park Copyright © 2016 by Pearson Education, Inc. All Rights Reserved Investing in Financial Assets Lecture.
Financial Markets and Institutions
CHAPTER 33 Stocks: Selling Ownership to Raise Capital.
CHAPTER TWO UNDERSTANDING RISK AND RETURN © 2001 South-Western College Publishing.
Chapter McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. Cost of Capital 11.
Financial Economics Chapter 35 Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent.
Financial Markets Investing: Chapter 11.
Goal of the Lecture: Understand how to properly value a stock or bond.
Copyright © 2011 Pearson Education, Inc. Managing Your Money.
UNDERSTANDING RISK AND RETURN CHAPTER TWO Practical Investment Management Robert A. Strong.
McGraw-Hill/Irwin Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. 5-1 Chapter 5 History of Interest Rates and Risk Premiums.
BONDS (DEBT FINANCE). CORPORATE FINANCE (sources of funds) COMPANIES: 1. generate internal cash flows / undistributed profits 2. issue shares (equity.
Investment Fundamentals. Introduction Simply saving will not result in financial success. You will need to invest in good times and bad. Successful investors.
Summary of Last Lecture Future Value of Simple Interest Future Value = Present Value + Interest Amount Interest amount = Principal amount x Interest rate.
Investment Risk and Return. Learning Goals Know the concept of risk and return and their relationship How to measure risk and return What is Capital Asset.
(C) 2001 Contemporary Engineering Economics 1 Investing in Financial Assets Investing in Financial Assets Investment Strategies Investment Strategies Investing.
Bond Valuation and Risk
Business in Action 6e Bovée/Thill Financial Markets and Investment Strategies Chapter 19.
The Investment Decision Process Determine the required rate of return Evaluate the investment to determine if its market price is consistent with your.
Exam 2 Review. Basic Concepts  Fisher Effect -- (1 + k rf ) = (1 + k*) (1 + IRP) -- (1 + k rf ) = (1 + k*) (1 + IRP)  Expected rate of return -- k =
HIDDEN DESCRIPTION SLIDE — NOT TO BE SHOWN TO THE PUBLIC Basics of Mutual Fund Investing Catalogue code: B18 Full presentation or module? Presentation.
Managing Money 4.
Chapter 11 Cost of Capital Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.
Investing Fundamentals. Investing for the Future: Goal Setting Investment goals should be specific and measurable. Develop your goals by asking questions:
G. M. Wali Ullah Lecturer, School of Business Independent University, Bangladesh (IUB) Chapter 10 Risk and Return FIN 302 (3) Copyright.
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill /Irwin Chapter Three Interest Rates and Security Valuation.
Estimating the Value of ACME 1. Steps in a valuation Estimate cost of capital (WACC) – Debt – Equity Project financial statements and FCF Calculate horizon.
Investing in Financial Assets
Basics of Mutual Fund Investing
OUTLINE Questions? News?
Presentation transcript:

Lecture No.14 Chapter 4 Contemporary Engineering Economics Copyright © 2010 Contemporary Engineering Economics, 5th edition, © 2010

A. Investment Basics The three basic investment objects are: growth, income, and liquidity. Liquidity – How accessible is your money? Risk – What is the safety involved? Return – How much profit will you be able to expect from your investment? The two greatest risks investors face are inflation and market volatility. Contemporary Engineering Economics, 5th edition, © 2010

Real Return2% Inflation4% Risk premium0% Total expected return 6% Real Return2% Inflation4% Risk premium20% Total expected return 26% Basic Concept - How to Determine Your Expected Return Risk-free real return Inflation Risk premium U.S. Treasury Bills An internet stock Very safe Very risky

Figuring Average Versus Compound Return Contemporary Engineering Economics, 5th edition, © %10% 12% Average rate of returnCompound Rate of Return

Contemporary Engineering Economics, 5th edition, © 2010 Compound Versus Average Rate of Return InvestmentCase 1Case 2Case 3Case 4Case 5 Case 6 Average return9.00% Balance at the end of year 3 $1,295$1,294$1,284$1,270$1,264$1,224 Compound return9.00%8.96%8.69%8.29%8.13%6.96% Annual Investment Yield (Base investment of $1,000) InvestmentCase 1Case 2Case 3Case 4Case 5 Case 6 Year 19%5%0% -1%-5% Year 29%10%7%0%-1%-8% Year 39%12%20%27%29%40%

Risk refers to the chance that some unfavorable event will occur. Volatility measures the deviation from the expected value, or sudden swings in value—from high to low, or the reverse. Standard deviation measures the degree of volatility when you have the probabilistic information about the uncertain event. Beta measures how closely a fund’s performance correlates with broader stock market movement. Alpha shows whether a fund is producing better or worse returns than expected, given the risk it takes. Contemporary Engineering Economics, 5th edition, © 2010 How to Determine Expected Financial Risk

B. Investment Strategies Trade-Off between Risk and Reward Cash: the least risky with the lowest returns Debt: moderately risky with moderate returns Equities: the most risky but offering the greatest payoff Broader diversification reduces risk - by combining assets with different patterns of return, it is possible to achieve a higher rate of return without increasing significant risk. Broader diversification increase expected return Portfolios with long-term horizons need equities to offset inflation while short time frames requires debt and/or cash investments to reduce volatility Contemporary Engineering Economics, 5th edition, © 2010

Broader Diversification Increases Return

Expected Value in 25 Years  Option 1: Invest $10,000 in one asset category (say, bond with 7% interest )  Option 2: Invest $10,000 in five different classes of assets. Contemporary Engineering Economics, 5th edition, © 2010

C. Investing in Stocks Investing in stocks and bonds is one of the most common investment activities among investors. Stocks: Ownership in a corporation Ownership: If a company issues 1M shares, and you buy 10,000 shares, you own a 10% of the company. Valuation: (1) cash dividend and (2) share appreciation at the time of sale Contemporary Engineering Economics, 5th edition, © 2010

Conceptual Stock Valuation  Given:  Stock price as of May 1, 2010: $72/share  Earnings growth for next 5 years: 8%  Expected cash dividend in 2010: $2.00/share  Expected stock price in 3 years: $95/share  Required return on your investment: 10%  Find: Current value of stock Valuation: Contemporary Engineering Economics, 5th edition, © 2010 $95 $2 $2(1+0.08) $2(1+0.08)

D. Investing in Bond Bonds: Loans that investors make to corporations and governments. Face (par) value: Principal amount (typically $1,000 or $10,000) Coupon rate: Nominal interest rate quoted on par value Maturity: the length of the loan Contemporary Engineering Economics, 5th edition, © 2010

Types of Bonds and How They are Issued in the Financial Market Contemporary Engineering Economics, 5th edition, © 2010

How Do Prices and Yields Work? Yield to Maturity: The actual interest earned from a bond over the holding period Current Yield: The annual interest earned as a percentage of the current market price Contemporary Engineering Economics, 5th edition, © 2010

Bond Quotes Contemporary Engineering Economics, 5th edition, © 2010 AT&T 7s20 6.5% 5 million 108 1/4 Coupon rate of 7% Maturity (2020) Current yield Trading volume Closing Market price $1, $70/ = 6.47%

Example 4.20 Yield to Maturity and Current Yield  Given: Initial purchase price = $996.25, coupon rate = 9.625% per year paid semi-annually, and 10-year maturity with a par value of $1,000  Find: (a) Yield to maturity and (b) current yield  Solution: (a) Yield to maturity i = % per semi-annual (b) Current yield Contemporary Engineering Economics, 5th edition, © 2010 Cash Flow Transaction Associated with Investing in Delta Corporate Bond

Bond Value Over Time  Mr. Gonzalez wishes to sell a bond that has a face value of $1,000. The bond bears an interest rate of 8% with bond interests payable semiannually.  Four years ago, $920 was paid for the bond. At least a 9% return (yield) in investment is desired.  What must be the minimum selling price? Solution: Semiannual interest payment = $40 Required semiannual return = 4.5% Desired selling price of the bond (F): Contemporary Engineering Economics, 5th edition, © 2010