Brailsford3eSM_Ch01 - Chapter 1 The investment decision...

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Copyright © 2006 Nelson Australia Pty Limited Chapter 1 The investment decision Learning objectives After the completion of this chapter, the reader should be able to: understand the nature of an investment describe the key steps in the investment process recognise the major investment asset classes understand the role and function of financial markets understand the concept of return, and be able to distinguish between realised returns and expected returns understand the relationship between expected return and risk understand the basic notion of uncertainty and be able to calculate sample variance understand the role and importance of the normal distribution Key points 1 Investing involves allocating wealth to yield future returns. 2 Investments are typically measured according to risk and return. 3 The investment process can be broadly thought of as being comprised of an allocation stage, performance measurement and a review stage. Chapter outline 1.1 Introduction 1 Individuals are faced with the decision between current and future consumption. 2 At a point in time where current wealth exceeds current consumption, individuals save their excess wealth. These excess funds form what is known as the investment pool. 1.2 An overview of the investment process 1 The investment decision is concerned with how individuals can allocate excess funds in the investment pool among competing investments. 2 These investments can generally be attributed to the major asset classes (equities, cash, fixed interest or property) or the alternative investment classes (such as private equity, venture capital and hedge funds). 1.3 The allocation decision 1 The allocation decision involves first identifying the available investments and then making a decision as to which investments in invest in. 2 This process involves such inputs as the investor’s risk preference, holding period and management approach.
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2 Investments: Concepts and Applications Solutions Manual Copyright © 2006 Nelson Australia Pty Limited 1.4 Performance measurement 1 Performance evaluation occurs after the investment decision and focuses on analysing the return and risk of the investment over the holding period. 2 Return measures the increase in value over time and risk captures the dispersion of these values around the average value. 1.5 The review stage 1 The review stage typically occurs at the end of the holding period. 2 The purpose of this stage is to examine how well the investment performed. 3 After taking into account any changes in investor preferences or market conditions, the investor than makes changes to the investment allocation. Solutions to text problems Problems and applications 1 a The process of investment concerns the purchase of assets which will provide a future return to allow for future consumption or further investment. Individuals have to make choices between current and future consumption and because their pattern of income
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Brailsford3eSM_Ch01 - Chapter 1 The investment decision...

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