Investments Vicentiu Covrig 1 The Investment Setting (chapter 1)

Investments Vicentiu Covrig 2 Components Of The Expected or Required Rate of Return In order to part with their money, investors require compensation for: - the time resources are committed - the expected rate of inflation - the uncertainty of the future payments Nominal vs. real rate of return Why is the real risk-free rate of return positive?

Investments Vicentiu Covrig 3 Compensation for risk-bearing: Investors tend to be risk-averse, meaning that they need sufficient expected additional compensation in order to bear additional risk. If the future payment from an investment is uncertain, investors will demand an interest rate that exceeds the nominal risk-free rate of interest to provide a risk premium. Required/Expected rate of return: The sum of the nominal risk-free interest rate and the risk premium on an investment gives that investment’s required rate of return. Note that for riskier investments, the risk premium, and therefore the required rate of return, will be higher than for lower risk investments.

Investments Vicentiu Covrig 4 Issues That Investors Should Always Consider There is a trade-off between risk and expected return Developed financial markets are nearly efficient (i.e. it is hard to outperform the market) - It’s what is unexpected that moves the market (the genuinely new information in news). - We should be skeptical of investment strategies that claim to be able to beat the market on a consistent basis.

Investments Vicentiu Covrig 5 Issues That Investors Should Always Consider Focus on after-tax returns, net of expenses. Diversify across asset types, industries, and even countries - Diversification reduces risk without necessarily sacrificing expected return. - It’s a no-brainer!

Investments Vicentiu Covrig 6 The Paradox of Market Efficiency (The catch 22 in investments) If markets are perfectly efficient, it makes no sense to seek out superior investments. But if nobody seeks out superior investments, the market would not remain efficient!

Investments Vicentiu Covrig 7 What types of investments can one make? Real assets vs. Financial assets - Tangible assets vs. Claims on assets Direct vs. Indirect financial investments - Individual securities vs. “pools” of assets (e.g. mutual funds) Derivatives - Futures, options

Investments Vicentiu Covrig 8 Basic Investment Philosophies In forming an investment portfolio, several questions are paramount: In what types of securities should I invest? - Asset Allocation Within each security type, how do I select which assets to purchase? - Security Selection Finally, how active should I manage my portfolio? - Should I be an active or passive investor?

Investments Vicentiu Covrig 9 Ethics in Investments Financial markets are vitally important to a well- functioning economy. Trust in information and faith in fairness are essential. Codes of ethics for financial professionals and strict regulations attempt to create such an environment where financial markets can efficiently fulfill their economic function.

Investments Vicentiu Covrig 10 Jobs in Investments Sales - Registered representative of a brokerage firm - Financial planners Investment Analysis and Portfolio Management - Brokerage firms, banks, money managers, mutual fund managers, insurance companies Professional Designations - Chartered Financial Analyst (CFA) - Certified Financial Planner (CFP)

Investments Vicentiu Covrig 11 Learning objectives What is an investment? What are the components of the required rate of return? (pages 1-2) What type of investments can one make? Discuss some basic investment philosophies (pages 4-6). Why are the ethics a concern to all investment professional? What are some career paths available for persons interested in investments?