💲Intro to Investments Unit 1 – Intro to Investments & Financial Markets

Key Concepts and Terminology

• Financial markets facilitate the exchange of financial assets and instruments between buyers and sellers
• Investments involve committing money or capital with the expectation of generating a profit or positive return
• Risk refers to the uncertainty and potential for financial loss associated with an investment
• Return represents the gain or loss generated from an investment over a specific period
• Liquidity describes the ease and speed at which an asset can be converted into cash without affecting its market price
• Diversification involves spreading investments across different asset classes, sectors, or geographies to manage risk
• Market efficiency hypothesis suggests that asset prices reflect all available information and trade at fair value
  • Efficient markets make it difficult for investors to consistently outperform the market

Types of Financial Markets

• Capital markets enable companies and governments to raise long-term funds through the issuance of stocks and bonds
  • Primary markets involve the initial sale of securities to investors (initial public offerings)
  • Secondary markets facilitate the trading of previously issued securities among investors (stock exchanges)
• Money markets provide short-term funding and investments with maturities of less than one year (Treasury bills, commercial paper)
• Derivatives markets trade financial instruments whose value is derived from an underlying asset (futures, options, swaps)
• Foreign exchange markets enable the trading of currencies and determine exchange rates
• Commodities markets facilitate the buying and selling of physical goods (precious metals, agricultural products, energy)
• Cryptocurrency markets involve the trading of digital or virtual currencies that use cryptography for security (Bitcoin, Ethereum)

Investment Instruments and Assets

• Stocks represent ownership in a company and provide investors with potential capital appreciation and dividend income
  • Common stocks grant voting rights and variable dividends based on company performance
  • Preferred stocks offer fixed dividends and priority in receiving payments but typically do not carry voting rights
• Bonds are debt securities that obligate the issuer to make periodic interest payments and repay the principal at maturity
  • Government bonds are issued by national governments and are considered low-risk investments (Treasury bonds)
  • Corporate bonds are issued by companies and offer higher yields but carry more default risk
• Mutual funds pool money from multiple investors to purchase a diversified portfolio of stocks, bonds, or other securities
• Exchange-traded funds (ETFs) trade like stocks on exchanges and track the performance of an underlying index or asset class
• Real estate investments include direct property ownership, real estate investment trusts (REITs), and mortgage-backed securities
• Commodities can be invested in directly or through futures contracts, providing diversification and potential hedging benefits

Risk and Return Fundamentals

• Risk and return are positively correlated higher potential returns generally come with higher levels of risk
• Systematic risk affects the entire market and cannot be diversified away (interest rates, inflation, economic downturns)
• Unsystematic risk is specific to individual securities or companies and can be mitigated through diversification
• Standard deviation measures the dispersion of returns around the mean, indicating the level of volatility
• Beta measures the sensitivity of an asset's returns to market movements a beta greater than 1 indicates higher volatility than the market
• Sharpe ratio assesses risk-adjusted returns by comparing the excess return of an investment to its standard deviation
• Capital Asset Pricing Model (CAPM) describes the relationship between systematic risk and expected returns for securities

Market Analysis Techniques

• Fundamental analysis involves evaluating a company's financial health, management, and competitive position to determine its intrinsic value
  • Key metrics include price-to-earnings ratio (P/E), debt-to-equity ratio, and return on equity (ROE)
  • Discounted cash flow (DCF) analysis estimates the present value of future cash flows to determine fair value
• Technical analysis uses historical price and volume data to identify trends and predict future price movements
  • Chart patterns (head and shoulders, cup and handle) and trend lines are used to generate trading signals
  • Moving averages and oscillators (RSI, MACD) help identify momentum and overbought/oversold conditions
• Sentiment analysis gauges market sentiment through surveys, news analysis, and social media monitoring
• Quantitative analysis employs mathematical and statistical models to identify profitable trading opportunities
• Efficient Market Hypothesis (EMH) suggests that market prices reflect all available information, making it difficult to consistently outperform

Investment Strategies

• Value investing focuses on identifying undervalued securities trading below their intrinsic value (Warren Buffett)
• Growth investing targets companies with strong earnings growth potential and high price-to-earnings ratios
• Income investing prioritizes regular income generation through dividends and interest payments (bonds, dividend-paying stocks)
• Momentum investing involves buying securities that have recently outperformed and selling those that have underperformed
• Contrarian investing takes positions opposite to prevailing market sentiment, betting on reversals in trends
• Dollar-cost averaging involves investing fixed amounts at regular intervals to smooth out market fluctuations
• Asset allocation determines the mix of asset classes in a portfolio based on risk tolerance and investment goals
  • Strategic asset allocation sets long-term targets for each asset class
  • Tactical asset allocation makes short-term adjustments based on market conditions

Regulatory Environment

• Securities and Exchange Commission (SEC) regulates the securities industry, enforces federal securities laws, and protects investors
• Financial Industry Regulatory Authority (FINRA) oversees broker-dealers and enforces rules governing their activities
• Sarbanes-Oxley Act (SOX) enhances financial disclosures and corporate responsibility to protect investors from fraudulent practices
• Dodd-Frank Wall Street Reform and Consumer Protection Act aims to prevent another financial crisis through stricter regulations
• Insider trading laws prohibit trading based on material, non-public information and ensure fair access to information for all investors
• Anti-money laundering (AML) regulations require financial institutions to detect and prevent the laundering of illicit funds
• Know Your Customer (KYC) rules mandate that financial institutions verify the identity and assess the risk profile of their clients

Practical Applications and Case Studies

• Portfolio construction involves selecting a mix of assets that aligns with an investor's goals, risk tolerance, and time horizon
  • Modern Portfolio Theory (MPT) emphasizes diversification to maximize returns for a given level of risk
  • Black-Litterman model incorporates investor views and market equilibrium to optimize asset allocation
• Performance evaluation measures the success of an investment strategy relative to a benchmark or target return
  • Treynor ratio, Sortino ratio, and Information ratio are common risk-adjusted performance metrics
• Behavioral finance examines the psychological factors that influence investor decision-making and market anomalies
  • Prospect theory suggests that investors are more sensitive to losses than gains and make decisions based on perceived gains and losses
  • Herd behavior occurs when investors follow the crowd, leading to market bubbles and crashes
• Robo-advisors use algorithms and technology to provide automated, low-cost investment management services
• Environmental, Social, and Governance (ESG) investing incorporates non-financial factors into investment decisions to promote sustainability and social responsibility
• Case studies
  • The dot-com bubble of the late 1990s demonstrates the importance of fundamental analysis and the dangers of market speculation
  • The 2008 global financial crisis highlights the systemic risks posed by complex financial instruments and the need for robust regulations