Investments Basics Introduction

This section is a Investments Basics Introduction. Its purpose is to give you an overview of the concepts found in our Investment Basics guide.

Portfolio Building

A portfolio is an group of assets owned and designed to transfer your purchasing power to the future. Factors include your goals ,risks involved, the taxes imposed on your income and gains and knowledge of the asset choices. Asset picking looks at the merits of the asset while portfolio management looks at the impact that an asset has on your overall holdings.

Basic Terms

  • Investment- The purchase of a asset such as plant, gear or inventory. Or purchase of an asset such as a stock or a bond.
  • Secondary Markets-  A market for buying and selling previously issued assets
  • Primary Markets– The initial sale of assets
  • Value- What something is worth; your present value of future cash flows
  • Valuation- The process of finding your current worth of an asset.
  • Return- The sum of your income plus gains earned on your asset.
  • Income- The flow of money  produced by an asset; dividends and interest.
  • Capital Gain- An increase in the value of an asset, such as a stock.
  • Rate of Return- The yearly return realized on your investment.
  • Risk- The possibility of loss; the uncertainty of your future returns.
  • Speculation- An investment which offers large returns but is also very risky; a rchance exists the investment will produce a loss.
  • Marketability- The ease with which your asset may be bought and sold.
  • Liquidity- Moneyness; the ease with which your assets can be converted into cash with little risk of loss of principal.Investments Basics Introduction

Sources of Risk

  • Systematic risk- Changes in asset prices; risk.
  • Unsystematic risk- The risk based on single events which affect a single asset
  • Business risk- The risk on the nature of a business.
  • Financial risk- The risk on a firm’s sources of finds.
  • Market risk- Systemic risk; the risk with the chance of a stock’s price to change with the market.
  • Interest Rate risk- The uncertainty  with changes in interest rates; the chance of loss resulting from increases in interest rates.
  • Reinvestment Rate risk- The risk with reinvesting earnings or principal at a lower rate than first earned.
  • Purchasing Power risk- The uncertainty future inflation will erode the purchasing power of assets and income.
  • Exchange Rate risk- The uncertainty with changes in the value of foreign currencies.

Efficient and Competitive Markets

Markets with many participants who may enter and exit freely will be competitive. An efficient financial market implies the security’s price embodies all the known information concerning the potential return and risk with the single asset. Although security prices and returns are ultimately determined by the interactions of buyers and sellers, there is little an individual can do to affect a security’s price.

Investments and Business Finance

Finance can be studied from the perspective of the investor who puts up the funds or the corporate manager who is responsible for using the funds to earn a profit. While it is assumed the manager will take action in the best interests of the shareholder, they might pursue their own best interests. Higher management salaries reduce earnings and your actual return.

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The info on this Investments Basics Introduction and Investment Basics pages are  from Dave’s lecture notes for the Investments for Pros course taught at UCLA 1998-2005 and three decades on the job. See our Site Credits page for sources.