1
Lecture 4:
Investing
I.
Why Invest?
To transfer resources to the future and at least keep pace with inflation.
Inflation erodes the purchasing power of dollars  if keep "money in a mattress",
it loses value.
II. What Do You Look for When You Invest?
Want to earn the highest
real interest rate
(nominal or observed interest rate
minus inflation rate) for the level of
risk
you're willing to take.
Example of real interest rate
Nominal, or observed, interest rate = 10%
Inflation rate =
4%
Real interest rate =
6%
Risk = chance of losing your invested money
Reality:
Risk and real interest rate (also called "real rate of return") usually go
together:
the greater the chance you're willing to take with your
investments, the higher the
potential
reward you must receive
Impact of taxes:
Taxes come "off the top"  they are charged on the nominal
interest rate.
The
"aftertax" nominal interest rate
would be
calculated as:
nominal rate  (tax rate x nominal rate)
Example: Nominal rate = 10%
Tax rate = 30%, or .3
Aftertax nominal interest rate = 10%  (.3 x 10%) = 7%
Then, can also talk about
real aftertax interest rate
, where take
Aftertax nominal interest rate and subtract the inflation rate:
Aftertax nominal interest rate = 7%
Inflation rate =
4%
Real aftertax interest rate =
3%
III. Basic Kinds of Investments
Stocks = ownership of net assets of a company
Inflation hedges = real estate, precious metals, collectibles
Cash = investments easily convertible to cash, like moneymarket funds and
very short term CDs (certificates of deposit)
This preview has intentionally blurred sections. Sign up to view the full version.
View Full Document2
Longterm bonds = investments earning a fixed interest rate over a long period
Each investment has performance tied to stages of the business cycle, as shown
This is the end of the preview.
Sign up
to
access the rest of the document.
 Fall '08
 ERYURUK
 Finance

Click to edit the document details