FINA 4310 Survey of Investments Dr. Mayhew Spring 2002

1
FINA 4310Survey of InvestmentsDr. MayhewSpring
2002

• Unit 1 Introduction

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Overview

• Real Assets vs. Financial Assets (BKM 1.1)
• Taxonomy of Financial Assets (BKM 1.2)
• The Investment Process (BKM 1.4)
• Key Concepts (BKM 1.5)
• Time Value of Money
• Risk-Return Tradeoff
• Diversification
• Market Efficiency

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Real and Financial Investment
Individuals
Banks
Investment Companies
Investment Banks
Corporations
Government
Real Investment
Consumption
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Real Assets

• Productive factor inputs that can be owned
• Land
• Buildings
• Machines
• Raw materials
• Durable consumption goods

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Inputs for the Production of Goods and Services

• Buildings/Factories
• Machines
• Human Resources
• Labor (time/effort)
• Human capital (education/skills)
• Natural Resources
• Land
• Raw materials
• Energy
• Knowledge

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Durable Consumption Goods

• Continue to provide consumption benefits for an
  extended period of time
• Homes
• Vehicles
• Appliances
• Art

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Financial Assets

• Claims on real assets
• Money
• Fixed-income securities (bonds)
• Equity (common stock)
• Commodity Futures
• Derivative Securities
• Stock Options CBOE Webpage
• Financial Futures CME Webpage

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Savings and Investment Choices

• Allocate time
• Work
• Leisure
• Investment in human capital (education)
• Consumption vs. saving decision
• Investment Portfolio
• Asset Allocation Schwab SmartMoney
• Security Selection

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Investment Philosophies/Approaches

• Choosing the level of control
• Do everything yourself
• Take advice from a broker
• Use a financial planner
• Top-down vs. Bottom-up
• Passive vs. active management

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Time Value of Money

• Dollar today is worth more than a dollar tomorrow
• Discount future cash flows to find value today
• Cash flow of F...
• realized in T years,
• discounted at the simple interest rate R
• PV F/(1R)T
• Compound current investment to find future value
• FV F (1R)T

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Power of compounding

• 1000 today invested for 40 years
• One percent return 1,489
• Five percent return 7,040
• Ten percent return 45,259
• 100 per month for 40 years
• One percent return 59,081
• Five percent return 148,956
• Ten percent return 559,560

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Risk-Return Tradeoff

• Assets with higher Expected Return have higher
  Risk
• Example TIAA-CREF Retirement Annuities

13
Diversification

• By diversifying assets into multiple assets one
  can reduce risk without sacrificing expected
  return
• Diversification across asset classes
• Diversification across securities
• International Diversification

14
Market Efficiency

• An investor beats the market if performance is
  better than is justified given the amount of risk
  taken.
• Anyone can get lucky
• It is very difficult to consistently beat the
  market
• Investors with undiversified high-risk portfolios
  are likely to have extreme returns (both
  good and bad)