INVESTMENTS: Analysis and Management Third Canadian Edition W. Sean Cleary Charles P. Jones Prepared by Khalil Torabzadeh University of Lethbridge

Understanding Investments Chapter 1 Understanding Investments

Learning Objectives Define investment and discuss what it means to study investments. Explain why risk and return are the two critical components of all investing decisions. Outline the two-step investment decision process. Discuss key factors that affect the investment decision process. Cleary Jones/Investments: Analysis and Management, 3rd Canadian Edition, Chapter 1

Investments Defined Investments is the study of the process of committing funds to one or more assets. Emphasis is on holding marketable securities. Concepts apply to financial assets and real assets within domestic as well as international markets. Cleary Jones/Investments: Analysis and Management, 3rd Canadian Edition, Chapter 1

Investment Objectives Primary Objectives Safety of principal Income Growth of capital Secondary Objectives Liquidity Tax minimization Cleary Jones/Investments: Analysis and Management, 3rd Canadian Edition, Chapter 1

Investment Constraints Possible constraints for investors include: Legal Moral/ethical Emotional – including investment knowledge and risk tolerance Basic minimum income to be provided by the portfolio Realism – an understanding that some objectives are unrealistic (e.g., high returns with low risk) Other (e.g., illness, pending divorce, etc.) Cleary Jones/Investments: Analysis and Management, 3rd Canadian Edition, Chapter 1

Primary and Secondary Objectives Objectives and constraints must be related to the three primary investment objectives of safety, income, and growth, and to the secondary objectives of liquidity and tax minimization. The importance of safety relates to: risk, market timing, inflation, return, and emotion The importance of income relates to: taxation, return, risk, inflation, and basic minimum income The importance of growth relates to: taxation, risk, return, market timing, and emotional considerations Cleary Jones/Investments: Analysis and Management, 3rd Canadian Edition, Chapter 1

Why Study Investments? Most individuals make investment decisions sometime Individuals need sound framework for managing and increasing wealth Essential part of a career in the field Security analyst, portfolio manager, investment advisor, financial planner, Chartered Financial Analyst Cleary Jones/Investments: Analysis and Management, 3rd Canadian Edition, Chapter 1

Investment Decisions Underlying investment decisions: the tradeoff between expected return and risk Return: expected return is not usually the same as realized return Risk: the possibility that the realized return will be different than the expected return Cleary Jones/Investments: Analysis and Management, 3rd Canadian Edition, Chapter 1

The Tradeoff Between ER and Risk Any level of expected return and risk can be attained The expected return (ER) must be large enough to compensate for taking additional risk Stocks ER Bonds Risk-free Rate Risk Cleary Jones/Investments: Analysis and Management, 3rd Canadian Edition, Chapter 1

“Typical” Chart Cleary Jones/Investments: Analysis and Management, 3rd Canadian Edition, Chapter 1

The Investment Decision Process Two-step process: Security analysis Necessary to understand security characteristics and applied to these securities to estimate their price or value Portfolio management Selected securities viewed as a single unit How and when should it be revised? How should portfolio performance be measured? Cleary Jones/Investments: Analysis and Management, 3rd Canadian Edition, Chapter 1

Factors Affecting the Process Uncertainty in ex post returns dominates decision process Future unknown and must be estimated Foreign financial assets – opportunity to enhance return and/or reduce risk Investors must now cope with a changed investing environment Internet changes investments environment Institutional investors are important How efficient are financial markets in processing new information? Cleary Jones/Investments: Analysis and Management, 3rd Canadian Edition, Chapter 1

Corporate Governance Main issues: The accountability of the Board of Directors and Management A re-examination of accounting and auditing practices Management compensation arrangements such as executive stock option plans Disclosure requirements The effectiveness of existing regulatory bodies Cleary Jones/Investments: Analysis and Management, 3rd Canadian Edition, Chapter 1

Appendix 1A: The Chartered Financial Analyst® (CFA®) Program Individuals who are interested in the investment area should consider seeking a CFA ® designation The CFA institute administers the Chartered Financial Analyst ® curriculum and examination program Level I emphasizes tools and inputs Level II emphasizes asset valuation Level III emphasizes portfolio management For more information: www.cfainstitute.org Cleary Jones/Investments: Analysis and Management, 3rd Canadian Edition, Chapter 1

Appendix 1B: The Canadian Securities Institute (CSI) The CSI offers the Canadian Securities Course (CSC), which is a mandatory requirement for individuals who wish to become licensed to sell financial securities in Canada and to register to sell mutual funds Cleary Jones/Investments: Analysis and Management, 3rd Canadian Edition, Chapter 1

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