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Chapter 1 - x - Lecture Presentation Software to accompany...

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Lecture Presentation Software to accompany Investment Analysis and Portfolio Management Eighth Edition by Frank K. Reilly & Keith C. Brown
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Why Do Individuals Invest ? By saving money (instead of spending it), individuals tradeoff present consumption for a larger future consumption.
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04 . 1 $ % 4 00 . 1 $ = + How Do We Measure The Rate Of Return On An Investment ? The pure rate of interest is the exchange rate between future consumption (future dollars) and present consumption (current dollars). Market forces determine this rate.
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If the future payment will be diminished in value because of inflation , then the investor will demand an interest rate higher than the pure time value of money to also cover the expected inflation expense. How Do We Measure The Rate Of Return On An Investment ?
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If the future payment from the investment is not certain , the investor will demand an interest rate that exceeds the pure time value of money plus the inflation rate to provide a risk premium to cover the investment risk. How Do We Measure The Rate Of Return On An Investment ?
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Defining an Investment A current commitment of $ for a period of time in order to derive future payments that will compensate for: the time the funds are committed the expected rate of inflation uncertainty of future flow of funds.
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Measures of Historical Rates of Return Arithmetic Mean 1.4 yields period holding annual of sum the HPY : where HPY/ AM = = n
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Measures of Historical Rates of Return Geometric Mean 1.5 [ ] ( 29 ( 29 ( 29 n n HPR HPR HPR : follows as returns period holding annual the of product the : where 1 HPR GM 2 1 1 × = - = π π
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A Portfolio of Investments The mean historical rate of return for a portfolio of investments is measured as the weighted average of the HPYs for the individual investments in the portfolio, or the overall change in the value of the original portfolio
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