chapter 1 note - CHAPTER 1 AN INTRODUCTION TO INVESTMENTS...

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1 CHAPTER 1 AN INTRODUCTION TO INVESTMENTS By M. Metghalchi Investment : the commitment of current funds (giving up current consumption)or some other resources in anticipation of receiving a larger future flow of funds (for future consumption). For example if you buy $10,000 worth of IBM shares (Stock), you are committing your current money in anticipation that in the future you can sell these IBM share At higher prices for future consumption. 1. What is the distinction between liquidity and marketability? Answer: "Liquidity" in the professional investment community is generally used to mean the ease with which an asset may be sold at the current market price. With this definition, liquidity refers to the depth of the market. Marketability (in finance) refers to the ability to sell an asset in the secondary markets. Be certain to point out that the terms liquidity and marketability are not synonymous and that some assets may be liquid but not marketable (e.g., savings accounts) while others are marketable but not necessarily liquid (e.g., rental property). 2. What is risk? Risk refers to the possibility of loss. Uncertainty = possibility that expected results (outcome) will not occur. While the word "risk" has a negative connotation, uncertainty works both ways as events can turn out better than expected. Example of uncertainty: You think that if you buy IBM stock, by next year you will make 10% return on your investment on IBM. (Your expected return on IBM is 10%). Assume you buy IBM share at $100 per share and you expect a year from now to sell it at $110, therefore making 10% [(110-100)/100]on your investment over a year. But this outcome (selling IBM at $110) is not certain, nobody knows what will be the IBM stock price a year from now. If the econmy is very good over the next year, IBM’s stock could be higher that $110 you expected (assume it is $120), in that case your realized return is 20% (120-100/100) much more than your 10% expected return. On the other hand if over
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2 the next year the ecomy becomes very weak, IBM stock could suffer and its price could go down to $90; in this case your realized return for one year will be negative 10% (90- 100/100)much less than your expected ten percent. As you can see when you buy IBM stock, there is uncertainty that works both way, you
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This note was uploaded on 09/21/2011 for the course FINANCE 4320 taught by Professor Omaral-nasser during the Spring '11 term at University of Houston-Victoria.

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chapter 1 note - CHAPTER 1 AN INTRODUCTION TO INVESTMENTS...

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