People invest to accumulate funds for specific purposes like wealth creation, financial security, and retirement planning. Investments require sacrificing something today for future returns. There are real assets like real estate and equipment, and financial assets that are claims against real assets like stocks and bonds. Risk and expected return are directly related - higher risk investments are expected to provide higher returns. Setting clear investment objectives involves considering factors like risk tolerance, time horizon, need for income versus capital appreciation, tax implications, and more. The relationship between risk and return is a key principle in investing.

1. Principles of Investing
FIN 330
Chapter 1
The Investment Setting
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2. Student Learning Objectives
A. Why do people invest?
B. How do real assets differ from financial
assets?
C. What is the relationship between risk and
return?
D. What are the forms of investment?
E. What things should consider?
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3. Why do people invest?
A. Accumulate funds for a particular
purpose:
1. Wealth creation
2. Financial security
3. Retirement planning
B. Benefits to society and the economy
1. Capital formation
2. Job creation
3. Economic expansion
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4. A. An investment is anything you purchase
with the hope that it will provide you with
income either now or in the future.
1. Financial Asset
a. Financial claim on an asset
2. Real Asset
a. Tangible asset that may be seen, felt, held, or
collected
Investments

5. B. Investments have opportunity costs in that
they require you to sacrifice something
today on the hope that the sacrifice will pay
off later.
1. Most people do not like making sacrifices.
2. If you’re going to sacrifice, do it earlier
rather than later.
Investments
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6. Real versus Financial Assets
A. Real Assets
1. Real estate: land, buildings
2. Equipment: machines, rolling stock
B. Financial Assets (claims against real assets)
1. Equities: Common and Preferred stock
(ownership)
2. Fixed Income Securities: bills, notes, bonds
(creditors)
C. Derivative Securities
1. Claims against financial assets
2. Used to hedge or to speculate
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7. Forms of Investment
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8. A. Risk and Safety of Principal
1. What factors can affect the value of my PF?
2. Surprises: i.e., Black Swan events
B. Current Income versus Capital Appreciation
1. Income: dividends, interest
2. Capital Appreciation: gains in price
C. Liquidity Considerations
1. Ability to sell at near market prices
2. Transactions cost
D. Short-Term versus Long-Term Orientation
1. Speculation: e.g., day traders, technicians
2. Investments: Buy and Hold
Setting Investment Objectives
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9. E. Tax Factors
1. Retirement accounts: 401(K), 403(B), IRA’s
2. Ability to right off losses
3. Use of tax shelters
F. Ease of Management
1. Person management: time demands
2. Investment Advisor: CFP, Ch.FC, Broker
G. Retirement and Estate Planning Considerations
1. Defined Benefit vs. Defined Contribution
2. Start early
3. Be realistic
4. What to do along the way
5. Protecting your nest egg
Setting Investment Objectives
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10. Setting investment objectives
H. Managing Risk: Diversification, Buy/Hold vs.
Active Management
“I’m not so worried about the return on my money as I
am the return of my money.” - Will Rogers
I. Establishing Investment Objectives
1. Income or Capital Appreciation or Both
2. Wealth building phase: capital appreciation
3. Payout phase: Income and capital preservation
4. Expected Returns:
a. Function of risk tolerance: required risk premiums
b. Impact of inflation (net real returns)
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11. Setting investment objectives
J. Importance of Liquidity
1. Ease of buying and selling is very important
2. Illiquid securities more costly to buy and sell
K. Holding period - how long to hold
[particular] investments
1. Short-term (less than one year)
2. Long-term (greater than one year)
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12. Setting investment objectives
L. Other considerations
1. Tax status
a. Marginal tax rate
b. Tax deferred investments
2. Personal time required to manage investments
a. Availability of time
b. Retaining a financial advisor
M. Investment management
1. Monitor performance
2. Making adjustments through life stages
a. Changes in risk tolerance
b. Changes in investment goals
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13. Risk versus Return
A. All investments are subject to risk
B. Trade-off: The greater the risk, the greater
the expected return
C. Risk = a probability distribution
D. In finance, risk is defined as the standard
deviation of expected future cash flows
Problematically, we use recent market price
volatility data to estimate future volatility
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14. E. Additional Sources of Risk
1. Tax risk
a. Changes in marginal rates
b. Limitations on write-offs
2. Operating risk
a. Economic cycles
3. Financial risk
a. Changes in cost of debt
4. Management risk
a. Changes in advisors
Risk versus Return
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15. A. The real rate of return.
1. After removing the impact of inflation
2. The anticipated inflation factor.
B. The risk premium
1. Return in excess of the risk-free rate to
compensate for market risk
2. RROR = Real + Inflation + Risk Premium
Consideration of Required Returns
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16. HOMEWORK ASSIGNMENT
A. Discussion Questions: 2, 5, 7, 11, 13
B. Career Opportunities: Read Appendix 1A
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