FIN8330_Chapter1_Slides0

FIN8330_Chapter1_Slides0 - Investment Analysis and...

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Investment Analysis and Portfolio Management C h a p t e r 1 The Investment Setting What Is An Investment Return and Risk Measures Determinants of Required Returns Relationship between Risk and Return
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1-2 What Is An Investment? Defining 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 Reason for Investing: By investing (saving money now instead of spending it), individuals can tradeoff present consumption for a larger future consumption.
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1-3 What Is An Investment? Pure Rate of Interest It is the exchange rate between future consumption (future dollars) and present consumption (current dollars). Market forces determine this rate. Example: If you can exchange $100 today for $104 next year, this rate is 4% (104/100-1). Pure Time Value of Money The fact that people are willing to pay more for the money borrowed and lenders desire to receive a surplus on their savings (money invested) gives rise to the value of time referred to as the pure time value of money.
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1-4 What Is An Investment? Other Factors Affecting Investment Value Inflation: 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. Uncertainty: 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 Pure Time Value of Money.
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1-5 What Is An Investment? The Notion of Required Rate of Return The minimum rate of return an investor require on an investment, including the pure rate of interest and all other risk premiums to compensate the investor for taking the investment risk. Investors may expect to receive a rate of return different from the required rate of return, which is called expected rate of return. What would occur if these two rates of returns are not the same?
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1-6 Historical Rates of Return Return over A Holding Period Holding Period Return (HPR) Holding Period Yield (HPY) HPY=HPR-1 Annual HPR and HPY Annual HPR=HPR 1/n Annual HPY= Annual HPR -1=HPR 1/n – 1 where n=number of years of the investment Investment of Value Beginning Investment of Value Ending HPR =
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Historical Rates of Return Example: Assume that you invest $200 at the beginning of the year and get back $220 at the end of the year. What are the HPR and the HPY for your investment? HPR=Ending value / Beginning value
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This note was uploaded on 01/19/2012 for the course FIN 4360 taught by Professor Davidbray during the Spring '12 term at Kennesaw.

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FIN8330_Chapter1_Slides0 - Investment Analysis and...

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