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The Role and Scope of Investments
The Role and Scope of Investments
• Learning Goals
1. Understand the term investment and how to differentiate
among types of investments.
2. Describe the investment process and types of investors.
3. Discuss the principal types of investment vehicles.
4. Describe the steps in investing, especially establishing
investing goals and managing personal tax issues.
5. Discuss investing over the life cycle and in different
economic environments.
6. Understand the popular types of short-term
investment vehicles.
1-2
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What is an Investment?
1-3
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Types of Investments
• Securities or Property
– Securities: stocks, bonds, options
– Real Property: land, buildings
– Tangible Personal Property: gold,
artwork, antiques
• Direct or Indirect
– Direct: investor directly acquires a claim
– Indirect: investor owns part of a portfolio
1-4
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Types of Investments (cont'd)
1-5
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Types of Investments (cont'd)
• Short-Term or Long-Term
– Short-Term: mature within one year
– Long-Term: maturities of longer than a year
• Domestic or Foreign
– Domestic: U.S.-based companies
– Foreign: overseas-based companies
1-6
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Key Participants
in Investment Process
• Government
– Federal, state and local projects & operations
– Typically net demanders of funds
• Business
– Investments in production of goods and services
– Typically net demanders of funds
• Individuals
– Some need for loans (house, auto)
– Typically net suppliers of funds
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Figure 1.1
The Investment Process
1-8
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Types of Investors
• Individual Investors
– Invest for personal financial goals
(retirement, house)
• Institutional Investors
– Paid to manager other people’s money
– Typically manage large amounts of money
– Include: banks, life insurance companies,
mutual funds and pension funds
1-9
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Table 1.1
Overview of Investment Vehicles
1-10
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Steps in Investing
1-11
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Steps in Investing (cont'd)
1-12
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Steps in Investing (cont'd)
1-13
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Taxes in Investing Decisions
1-14
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Taxes in Investing Decisions (cont'd)
1-15
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Taxes in Investing Decisions (cont'd)
• Ordinary Income
– Active, portfolio and passive income included
– Taxed at progressive tax rates (rates go up as income goes up)
1-16
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Table 1.2
Tax Rates and Income Brackets
1-17
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Taxes in Investing Decisions (cont'd)
1-18
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Tax-Advantaged Retirement Vehicles
1-19
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Investing Decisions
Over Investor Life Cycle
• Investors tend to follow different investment
philosophies as they move through different stages
of the life cycle.
• Youth Stage
– Twenties and thirties
– Growth-oriented investments
– Higher potential growth; higher potential risk
– Stress capital gains over current income
• What are some examples of age-
appropriate investments?
– Common stocks, options or futures
1-20
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Investing Decisions
Over Investor Life Cycle (cont'd)
• Middle-Aged Consolidation Stage
– Ages 45 to 60
– Family demands & responsibilities become important
(education expenses, retirement savings)
– Move toward less risky investments to preserve capital
– Transition to higher-quality securities with lower risk
• What are some examples of age-
appropriate investments?
– Low-risk growth and income stocks, preferred stocks,
convertible stocks, high-grade bonds
1-21
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Investing Decisions
Over Investor Life Cycle (cont'd)
• Retirement Stage
– Ages 60 and older
– Preservation of capital becomes primary goal
– Highly conservative investment portfolio
– Current income needed to supplement
retirement income
• What are some examples of age-
appropriate investments?
– Low-risk income stocks, government bonds, quality
corporate bonds, bank certificates of deposit
1-22
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Investing in Different
Economic Environments
• Market Timing: process of identifying the current
state of the economy/market and assessing the
likelihood of its continuing on its present course
• Three Conditions of the U.S. Economy
– Recovery or expansion
• Corporate profits are up, which helps stock prices
• Growth-oriented and speculative stocks do well
– Decline or recession
• Values and returns on common stocks tend to fall
– Uncertainty
1-23
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Figure 1.2 Different Stages
of an Economic/Market Cycle
1-24
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Investing Decisions
and Interest Rates
• Interest rates are the single most important
variable in determining returns to investors for
bonds and fixed-income securities.
1-25
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The Role of Short-Term Vehicles
1-26
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The Advantages and Disadvantages
of Short-Term Vehicles
• Advantages
– High liquidity
– Low risks of default
• Disadvantages
– Low levels of return
– Loss of potential purchasing power
from inflation
1-27
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Table 1.3 Popular Short-Term
Investment Vehicles (Part A)
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Table 1.3 Popular Short-Term
Investment Vehicles (Part B)
1-29
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Table 1.3 Popular Short-Term
Investment Vehicles (Part C)
1-30
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Investment Suitability
1-31
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Table 1.4
Popular Short-Term Vehicles
1-32
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Chapter 1 Homework
• End-of-Chapter Exercises
– Problems (page 31) : P1.1, 1.3. (answers available at
the textbook website)
– Excel Spreadsheet Review (Page 33): details at the
textbook website under Student Resources, Chapter 1.
• Textbook website
http://wps.aw.com/aw_gitman_fundinv_9
– Self-assessment quiz (Student Resources, Chapter 1)
1-33
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