Chapter 1 The investment decision
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.
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.
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).
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Investments: Concepts and Applications Solutions Manual
1.3 The allocation decision
1 The allocation decision involves first identifying the available investments and then making a decision as to which investments to invest in. 2 This process involves such inputs as the