Investment Flashcards
To invest
To invest is to allocate money in the expectation of some benefit/return in the future.
To invest in other words
In other words, to invest means owning an asset or an item with the goal of generating income from the investment or the appreciation of your investment which is an increase in the value of the asset over a period of time.
the formal definition of investment
the current commitment 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
individual can trade-off present consumption for larger future consumption.
Pure rate of interest
it is an exchange rate between future consumption and present consumption. market force determines this rate.
Pure time value of money
the fact that people are willing to pay more for the money borrows and lenders desire to receive a surplus on their savings (money investing) gives rise to the value of time referred to as a pure value of money.
Market forces
the actions of buyers and sellers that cause the prices of goods and services to change without being controlled by the government: the economic forces of supply and demand The value of these commodities is determined by market forces.
There are four major factors that cause both long-term trends and short-term fluctuations.
These factors are government, international transactions, speculation and expectation, and supply and demand
inflation
is 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 respected inflation expenses
uncertainty
if the future payment for 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 cover the investment risk.
Required rate of return (RRR)
the minimum rate of return an investor requires on an investment, including the pure rate of interest, and all other risk premiums to compensate the investors for taking the investment risk.
expected rate of return
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 rate of return are not the same?
holding period return (HPR)
ending value of investment / begging value of investment
Holding Period Yield (HPY)
HPR - 1
Annual HPR
HPR**1/n
Annual HPY
Annual HPR - 1 = HPR**1/n - 1
computing means historical returns
for measure mean annual return in the condition when we have a set of annual return for an investment
computing means historical returns
Arithmetic mean return (not calculating flactuation)
Geometric mean return (consider fluctuation also)
Arithmic mean return
sigma HPY/n
Geometric mean return
Pnumber*HPR**1/n - 1
AM and GM comparison
when rates of return are the same for all years AM and GM are equal.
When the rate of return not the same for all years Am always higher than GM.
AM best for expected value for an individual year
GM best measure of an asset long term performance
portfolio HPY
the mean historical rate of return for a portfolio of investment measure as the weighted average of HPYs for the individual investment for the portfolio, or the overall change in the value of the original portfolio.
Ending market value (EMV)
is the total value of each various class of securities held in an investment account at the end of the reporting period. For example, an account with a number of investments including stocks, bonds, options, and mutual funds will have the EMV calculated for each type of investment.
Beginning market value (BMV)
is the valuation at which a property or investment should exchange at the date of origination, and then at the beginning of each subsequent period. The beginning market value at the start of every period is thus equal to the ending market value of the previous period.
Risk
refers to the uncertainty of the future outcomes of an investment
1. there are many possible returns due to an uncertainty
2. possibility is the likelihood of outcomes
3. the sum of probability of all possible outcomes is equal to 1.00 (expected return)
Sigma Pi*Ri
possibility * possible return
measure the risk should reflect the uncertainty
because risk refers to the uncertainty on an investment
The common measure of risk
the variance of the rate of return distribution of an investment
Expected return
the sum of probability of all possible outcomes is equal to 1.00
Sigma Pi*Ri
possibility * possible return
measuring the risk of expected return
the variance measure
Sigma probability*[Ri - E(Ri)]
Ri= possible return , E(Ri): expected return
Standard deviation measure
the square root of variance measure
Coefficient of variation (CV)
measure the risk per units of expected return and is a relative measure of risk
Coefficient of variation (CV) formula
Standard deviation measure / Expected rate of return
Risk of the historical rate of return calculation
variance of the series = sigma [HPY - E(HPY)]**2 / n
