Investment Defined and Its Process

Questions and Answers

What is the primary expectation when making a financial investment?

Minimal risks

Immediate profit

Tax benefits

Future return (correct)

What does buying stock in a publicly traded company represent?

Guaranteed profit

A type of bond investment

A loan to the company

Ownership stake in the company (correct)

What is the main disadvantage of investing in stocks?

Higher returns compared to bonds

Risk of losing money if the price goes down (correct)

Requires a financial advisor

Price of the stock could increase

How do bonds typically generate returns for investors?

Interest payments on the lent money Signup and view all the answers

Which of the following is a safety characteristic of Treasury bonds?

Considered very safe investments Signup and view all the answers

What are mutual funds primarily composed of?

A pool of many investors' money Signup and view all the answers

Which type of investment is likely to yield a lower return compared to stocks?

Bonds Signup and view all the answers

What role does a financial advisor play in investing?

Provides guidance on investment choices Signup and view all the answers

What best defines capital appreciation?

The increase in value of an asset over time Signup and view all the answers

Which factor does NOT typically influence the expectation of return from an investment?

Weather conditions Signup and view all the answers

What type of risk is defined as the variability in returns resulting from changes in the overall market?

Market risk Signup and view all the answers

Which of the following best describes liquidity in investments?

The ability to easily sell an investment without loss Signup and view all the answers

Return on investment (ROI) is commonly measured as which of the following?

Net income divided by original capital cost Signup and view all the answers

What encompasses the safety of an investment?

Certainty of capital return without loss Signup and view all the answers

Which of the following risks is directly associated with changes in interest rates?

Interest rate risk Signup and view all the answers

Which of the following statements about risk is NOT true?

Risk never varies over time. Signup and view all the answers

What is the formula for calculating ROI?

ROI = (Net Income - Cost of Investment) / Cost of Investment x 100 Signup and view all the answers

If an initial investment is $50,000 and the earnings are $80,000, what is the ROI?

60% Signup and view all the answers

Which of the following statements about ROI is true?

ROI can be less than zero. Signup and view all the answers

What does a higher ROI indicate?

Greater benefit earned. Signup and view all the answers

In the context of the ROI formula, what does 'Cost of Investment' refer to?

The initial amount invested before any returns. Signup and view all the answers

Which of the following equations correctly represents the investment gain calculation in ROI?

Investment Gain = Final Amount - Initial Investment Signup and view all the answers

Why is it important to understand ROI?

It quantifies the profitability of investments. Signup and view all the answers

What would be a consequence of a negative ROI?

The investment results in losses. Signup and view all the answers

What is the primary goal of an investment?

Generating income or appreciation Signup and view all the answers

Which of the following features is critical to the definition of investment?

Current sacrifice for future benefit Signup and view all the answers

How does economic investment differ from other interpretations of investment?

It includes commitment of funds for net additions to capital stock. Signup and view all the answers

What decision-making factors are involved in the investment process?

Type, mix, amount, timing, grade Signup and view all the answers

What is the significance of return on investment in the context of investing?

It assesses the efficiency of the investment in generating returns. Signup and view all the answers

Which of the following best differentiates investment from speculation?

Investment is based on careful analysis, while speculation is often based on chance. Signup and view all the answers

In the layman's terms, what does investment refer to?

A commitment of funds for any future benefit, not limited to monetary returns. Signup and view all the answers

What is an important risk associated with every investment?

The variability of returns Signup and view all the answers

What is the main objective of active portfolio management?

To outperform the market return Signup and view all the answers

Which of the following best describes passive portfolio management?

It seeks to replicate market returns. Signup and view all the answers

Which step follows the selection of the portfolio strategy in the investment process?

Selecting assets for the portfolio Signup and view all the answers

What critical factor should align with the selected assets during portfolio management?

Investment policies Signup and view all the answers

What is the primary expectation associated with all investments?

Generation of returns Signup and view all the answers

In which scenario is the active management strategy less likely to be appropriate?

When an investor prefers low risk Signup and view all the answers

What does portfolio performance evaluation measure?

Performance against both absolute and relative benchmarks Signup and view all the answers

Which of the following is NOT a characteristic of active portfolio management?

Lower transaction costs Signup and view all the answers

Study Notes

Overview of Investment

Investments are commitments of resources (time, money, effort) aimed at generating returns or appreciation in value.
Investments entail both the potential for returns and risks.
Understanding the investment process is essential for maximizing benefits and managing risks.

Definition of Investment

An investment is an asset acquired with the expectation of income generation or value appreciation.
It involves sacrificing present value for uncertain future rewards.
Can be analyzed from three perspectives: economic, layman, and financial.

Types of Investment

Stocks: Ownership stakes in publicly traded companies; expectations of price increase for profit, but with inherent risks of value depreciation.
Bonds: Lending money to entities (government or corporate) with returns primarily as interest payments. Generally lower risk compared to stocks.
Mutual Funds: Investment pools from multiple investors aimed at a diversified portfolio.

Investment Process

Portfolio Strategy Selection:
- Active Management: Aims to outperform market returns through strategic buying/selling—higher risk and return.
- Passive Management: Aims to mirror market returns—safer but might yield lower returns.
Asset Selection Decision:
- Investors must choose specific securities within asset classes aligned with investment objectives.
Evaluating Portfolio Performance:
- Necessary to measure performance against benchmarks to assess achievement of investment goals.

Characteristics of Investment

Return: Expected income (yield) and capital appreciation, influenced by market demand and investment nature.
Risk: Inherent possibility of loss or variable returns. Influencing factors include business performance, market fluctuations, and economic conditions.
- Types of Risks:
  - Interest Rate Risk: Variability in returns due to interest rate changes.
  - Market Risk: Return fluctuations correlated with overall market changes.
  - Inflation Risk: Inability of returns to match inflation rates.
Safety: Expectation of returning initial capital without loss or delay.
Liquidity: Ability to sell an investment quickly without losses.

Return on Investment (ROI)

ROI measures the benefit gained relative to the investment cost, commonly expressed as net income divided by initial investment.
A higher ROI indicates better profitability.
Common formulas:
- ROI = Net Income / Cost of Investment x 100
- ROI = Investment Gain / Investment Base x 100
Example of ROI calculation shows a 60% return from a 50,000investmentwithan50,000 investment with an 50,000investmentwithan80,000 return.

Conclusion

Understanding investments involves recognizing their types, the associated risks and returns, and key processes from strategic selection to performance evaluation.
Mastery of these elements is critical for making informed and profitable investment decisions.

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Description

This unit explores the fundamentals of investments, emphasizing the significance of the investment process. Learn how return expectations vary with risk and the overall importance of understanding these concepts in making informed investment decisions.