Chapter 1

Charles P. Jones, Investments: Principles and Concepts,

12th Edition, John Wiley & Sons

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Objectives
 Understand why return and risk are the two
critical components of all investing decisions.

 Appreciate the scope of investment decisions and

the operating environment in which they are
made.

 Follow the organization of the investment

decision process as we progress through the text.

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Suppose you are given $1 million from a relative.
He/She specifies only that you must invest this
money intelligently in financial assets within the
next six months, and not spend it on consumption,
and that you must be answerable to a trustee who
has the final say if you fail to make reasonable
decisions. You now face an enviable task—building
a portfolio of stocks, bonds, and so forth—and you
quickly realize that not only don’t know all the
answers, but you also don’t even know some of the
questions.

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 Having had a finance course in college, you
learned about return and risk, but now you must
really understand what these variables mean.
 You have heard some people talk about making a
“killing in the market,” but common sense tells
you it can’t be all that easy.
 Like the prospective investor asked the broker
when the latter was showing him the yachts
belonging to other brokers, “Where are the
customers’ yachts?”

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 Also, you have on several occasions read
about fraudulent investment schemes
leaving people broke, but wiser.
 You need to identify the important issues,

ask the right questions, and learn the basics

about successful investing.

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 The objective of this text is to help you
understand the investments field as it is currently
understood, discussed, and practiced so that you
can intelligently answer questions such as the
preceding and make sound investment decisions
that will enhance your economic welfare.
 To accomplish this objective, key concepts are
presented to provide an appreciation of the
theory and practice of investments.

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 The term investing can cover a wide range of
activities. It often refers to investing money in
certificates of deposit, bonds, common stocks, or
mutual funds.
 More knowledgeable investors would include
other “paper” assets, such as warrants, puts and
calls, futures contracts, and convertible
securities, as well as tangible assets, such as
gold, real estate, and collectibles.
 Investing encompasses very conservative
positions as well as aggressive speculation.

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 Investing encompasses very conservative
positions as well as aggressive speculation.
 An investment can be defined as the commitment
of funds to one or more assets that will be held
over some future time-period.
 Investments is concerned with the management
of an investor’s wealth, which is the sum of
current income and the present value of all future
income. (This is why present value and compound interest concepts
have an important role in the investment process.)
 Although the field of investments encompasses
many aspects, it can be thought of in terms of
two primary functions: analysis and management
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 In this course the term investments refers in
general to financial assets and in
particular to marketable securities.
 Financial assets are paper (or electronic)

claims on some issuer, such as the federal

government or a corporation.
 On the other hand, real assets are
tangible, physical assets such as gold,
silver, diamonds, art, and real estate.

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 Marketable securities are financial assets
that are easily and cheaply tradable in
organized markets.
 Technically, the word investments includes
both financial and real assets, and both
marketable and nonmarketable assets.
 Because of the vast scope of investment
opportunities available to investors, our
primary emphasis is on marketable securities;
however, the basic principles and techniques
discussed in this text are same for all.
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 We invest to make money!
 We invest to improve our welfare, which for

our purposes can be defined as monetary

wealth, both current and future.
 We assume that investors are interested

only in the monetary benefits to be

obtained from investing, as opposed to such
factors as the psychic income to be derived
from impressing one’s friends with one’s
financial prowess.

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 Funds to be invested come from assets already
owned, borrowed money, and savings or
foregone consumption.

 By foregoing consumption today and investing

the savings, investors expect to enhance their
future consumption possibilities by increasing
their wealth.

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 This text assumes that investors have established
their overall financial plan and are now interested
in managing and enhancing their wealth by
investing in an “optimal combination” of financial
assets(Portfolios),
 Which is important because our wealth, which we
hold in the form of various assets, should be
evaluated and managed as a unified whole.
 Wealth should be evaluated and managed within
the context of a portfolio, which consists of the
asset holdings of an investor.

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 Desire to manage and increase wealth
◦ Most individuals make investment decisions at
sometime, while employees in the past typically did
not have to concern themselves much with investing
decisions relative to their company’s retirement plan,
future employees will have to do so.
◦ Especially important for retirement, Your choices are
many, and your success—or lack thereof—will directly
affect your retirement benefits.
◦ Beyond that the study of investments is more
important than ever today. After being net sellers of
stocks for many years, individual investors swarmed
into the financial markets, either by force or by choice.

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 Essential part of a career in the field
◦ Investment banker, who arrange the sale of new
securities as well as assist in mergers and
acquisitions,
◦ Security analyst and portfolio manager,
Prepare research reports provided to customers,
valuation of firms as possible merger or acquisition
candidates
◦ Stockbrokers and Financial Advisors
◦ Chartered Financial Analyst (CFA) designation is
a professional designation for people in the
investments area, not unlike the CPA designation for
accountants.
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 Underlying investment decisions: the
tradeoff between expected return and risk
◦ Expected return does not usually equal realized
return
 Risk: the possibility that the realized return
will not equal expected return
◦ Investors choose risk tolerance, then look to
maximize returns
◦ Risk-return tradeoff is ex ante: made before
investment
 Ex post: after the fact (known)

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 Investors manage
risk at a cost - lower
expected returns
(ER) Financial Futures
 Any level of
Corporate Bonds
expected return and
ER Puts & Calls
risk can be attained
Common Stocks
Risk-free Rate
Risk

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 Two-step process:
◦ Security analysis and valuation
 Estimate expected returns and risk

◦ Portfolio management
 Once portfolio constructed, must be evaluated
 Evaluations used to revise portfolio

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 Uncertainty: the future unknown and must
be estimated
 Foreign financial assets: opportunity to
diversify
 The Internet and investment opportunities
 Institutional investors
 Ethics

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