BM2205 Investments: Reasons for Investing

Study Notes

Investing Overview

The main objective of investing is to generate a return or profit over time, typically exceeding inflation rates.

Investing vs. Saving

Investing focuses on long-term growth potential, often involving higher risk, while saving is typically safer and prioritizes liquidity for short-term needs.

Initial Steps for Investing

Establishing a solid financial foundation, including emergency savings and debt management, is crucial before allocating resources to investments.

Reasons for Investing in Businesses

Individuals invest in businesses to gain ownership, earn dividends, and benefit from potential growth in value and profit through various investment vehicles.

Financial Advisors' Recommendations

Advisors frequently suggest diversifying portfolios across different asset classes to mitigate risk and enhance growth potential.

Types of Investable Capitals

Capital types for investment include equity (stocks), debt (bonds), real estate, and cash equivalents.

Borrower's Interest Rate Perspective

For the borrower, the interest rate represents the cost of borrowing money and serves as compensation for the lender.

Real Rate of Interest

The real rate of interest accounts for inflation and reflects the true earning power of money over time.

Nominal Interest Rate

The nominal interest rate is also referred to as the stated or contractual interest rate, not adjusted for inflation.

Present Value Formula Application

The present value formula calculates the current worth of future cash flows by discounting them back to present terms, helping in investment decisions.

Significance of Present Value

Present value represents the maximum price a rational investor should pay today for a given future cash flow, influencing investment choices.

Inflation's Impact on Nominal Interest Rate

Inflation generally leads to an increase in the nominal interest rate, as lenders seek to maintain their real earnings by compensating for decreased purchasing power.

Purpose of Discounting in Investment Evaluation

Discounting is used to assess the value of future cash flows against current expenditures, aiding in determining investment viability and attractiveness.

Description

Learn about the reasons for investing and how it differs from saving. Understand the objective of investing to increase capital supply, whether it's physical or human capital. Explore the concept of consuming income to produce a capital resource.