1. Lecture No.1 By M Fahad Siddiqi Lecture (Finance) IBMS

2. What is investment An asset or item that is purchased with the hope that it will generate income or appreciate in the future. In an economic sense, an investment is the purchase of goods that are not consumed today but are used in the future to create wealth. In finance, an investment is a monetary asset purchased with the idea that the asset will provide income in the future or appreciate and be sold at a higher price.

3. Objective of investment Investment is a conscious act of an individual or any entity that involves deployment of money (cash) in securities or assets issued by any financial institution with a view to obtain the target returns over a specified period of time. Target returns on an investment include: 1. Increase in the value of the securities or asset, and/or 2. Regular income must be available from the securities or asset.

4. Definition of Investment Specifically, an investment is the current commitment of dollars for a period of time in order to derive future payments that will compensate the investor for (1) the time the funds are committed, (2) the expected rate of inflation, and (3) the uncertainty of the future payments (Frank Reilly and Keith Brown)

5. Issues with investment 1.The Time The Funds Are Committed In other words it is sacrifice like in investing, the investor delay their current consumption (delaying consumption is kind of sacrifice) 2. The expected rate of inflation Investment loses value in periods of inflation (3) the uncertainty of the future payments giving your money to someone else involves risk

6. Returns If you buy an asset of any type, your gain (or loss) from that investment is called the return on your investment. Return will usually have two components. First, you may receive some cash directly while you own the investment. Second, the value of the asset you purchase may change.

7. Example Case1 Case2 Ending Stock Prices69.9639.78 Jan 1st value5000 Dec 31 value69963978 Dividend Income81 Capital Gain or Loss1,996? suppose you purchased 100 shares of stock in Harley-Davidson on January 1. At that time, Harley was selling for $50 per share, so your 100 shares cost you $5,000. At the end of the year, you want to see how you did with your Investment ?

8. Dividend income At the beginning of the year, on January 1, the stock is selling for 50 per share, and, as we calculated above, your total outlay for 100 shares is 5,000. Over the year, Harley pays dividends of $.81 per share. So Your dividend income is Dividend income =.81 * 100 =$81

9. Capital Gain In Case 1. December 31, Harley was selling for $69.96, meaning that the value of your stock increased by $19.96 per share. Your 100 shares are now worth $6,996, so you have a capital gain of Capital gain = ($69.96 - $50) * 100 =$1,996. Can you tell the capital gain/loss in case 2

10. PERCENTAGE RETURNS Case 1Case 2 January 1 stock Prices, P t 50.00 Dec 31 st stock Prices, P t+1 $69.96$39.78 Dividend Income, D t+1.81 Capital Gain or losses 19.9610.22 dividend yield: The annual stock dividend as a percentage of the initial stock prices. Dividend yield = D t+1 / P t =$.81 / $50 = 0.0162 = 1.62%

11. PERCENTAGE RETURNS capital gains yield The change in stock price as a percentage of the initial stock Price capital gains yield = (P t+1 - P t )/P t =($69.96 -$50) / $50 =$19.96/$50 =.3992 = 39.92%

12. PERCENTAGE RETURNS Total Percent Return: The return on an investment measured as a percentage that accounts for all cash flows and capital gains or losses. Percentage return =Dividend yield +Capital gains yield Percentage return = D t+1 / P t + (P t+1 - P t )/P t = (D t+1 + P t+1 - P t ) / P t

13. ANNUALIZING RETURNS effective annual return (EAR) The return on an investment expressed on a per-year, or “annualized,” basis For example, suppose you bought 200 shares of XYZ at a price of $48 per share. In three months, you sell your stock for $51. You didn’t receive any dividends. What is your return for the three months? What is your annualized return?.

14. Return when no Dividend capital gains yield = (P t+1 - P t )/P t = (51-48)/48 =.0625 = 6.2% effective annual return (EAR)= 1 + EAR = (1 + holding period percentage return) m where m is the number of holding periods in a year. = (12/3) = 4 1+ EAR= (1 +.0625) 4 =1.2744 So, your annualized return is 27.44 percent.

15. QUESTIONS 1 Suppose you buy some stock in Qwest (no, that’s not a typo, that’s how the company spells it) at a price of $8 per share. Four months later, you sell it for $8.40. No dividend is paid. What is your annualized return on this investment?

16. QUESTION 2 Suppose you buy some stock in Johnson & Johnson (JNJ) at a price of $50 per share. Three years later, you sell it for $62.50. No dividends were paid. What is your annualized return on this investment?

17. Lets Play with Data And find pattern in Historical returns in Pakistani Stock Market.

18. 10- 18 Arithmetic vs. Geometric Mean Arithmetic average: ◦ Return earned in an average period over multiple periods ◦ Answers the question: “What was your return in an average year over a particular period?” Geometric average: ◦ Average compound return per period over multiple periods ◦ Answers the question: “What was your average compound return per year over a particular period?” Geometric average < arithmetic average unless all the returns are equal

19. 10- 19 Geometric Average Return: Formula Where: R i = return in each period T = number of periods Equation 10.4

20. 10- 20 Geometric Average Return Where: Π = Product (like Σ for sum) T = Number of periods in sample R i = Actual return in each period

21. 10-21 Example: Calculating a Geometric Average Return Example 10.4

22. 10- 22 Arithmetic vs. Geometric Mean Which is better? The arithmetic average is overly optimistic for long horizons The geometric average is overly pessimistic for short horizons Depends on the planning period under consideration 15 – 20 years or less: use arithmetic 20 – 40 years or so: split the difference between them 40 + years: use the geometric