Chapter 1 IAPM: introduction – general concepts & investment process
Introduction – some recent trends
What factors explain the sharp global stock market
decline in Feb–Mar 2025?
Trump with his tariffs, this created a lot of
uncertainty, and investors don’t like this.
ð In march the price recovered, people saw
that the tariffs weren’t as bad it seemed.
ð Less uncertainty
ð If you wait the markets will recover
MCQ:
From a European investor’s perspective, did the US stock market perform well last year?
A. Yes, because the return was positive in USD.
B. No, because after converting to EUR the return was negative.
C. It depends, both A and B are correct.
D. I don’t know.
Explanation:
If you want to look at the return as an European investor, then you will need to express it in €.
ð Look at the green on the previous dia.
ð Which should be a negative return.
ð Look at the returns in your own currency.
Exchange rates: At the bottom you can see the depreciation of the US
dollar by 11%.
This explains why we have negative returns when
investing in the US market expressed in €.
If you invest outside of Europe, then you have to take
into account the currency risk.
The € has become more valuable, appreciated for a
lot of countries → is a disadvantage for european
investors.
1
,Government bond yields: You buy them and hold them for 10 years.
ð There are some fluctuations.
ð Intrest rate in the US is typically higher than
in Europe.
ð Growth is higher in the US, than in Europe.
ð In the US they have a lot of debt; the higher
the debt of the country, the higher the
interest rates you have to pay on your debt.
Bitcoins: Depends on when you buy & on when you sell.
Þ Difficult to explain why it’s going up or
down → with stock markets it’s easier to
explain why they are fluctua-ting.
Þ Not clear what the clear value of the bitcoin
is.
Þ Not advised to buy bitcoins.
Þ If you combine it with some assets in your
portfolio, then you can “control” your
fluctuations.
Introduction – historical perspective
We see that investing in individual stocks has big
potential to go up (Apple).
ð You take a lot of risk
ð Putting all your money in 1 specific asset has
a lot of risk = the reason why you should
diversify
During a crisis, the stock market will go down, but in
the end you will have made a lot of money.
You need to wait until it recovers (if you have a LT
perspective), this will give you trouble if you need
money on short term.
Trade-off between risk & return.
2
,For highly creditworthy countries, government bond interest rates are negative (as of 2016):
ð Investors are therefore willing to accept a loss in order to park their money safely.
ð Why?
o Security: investors want certainty that they will get their money back and are willing to pay a
price for that.
o Falling interest rate expectations: they expect interest rates to decline further, which would push
up the prices of existing bonds (since bond prices and interest rates move in opposite
directions).
§ This situation changes in the event of deflation.
o Exchange rate risk: for example, suppose you invest in a Japanese bond.
§ If the JPY appreciates, this will create a foreign exchange gain.
o Institutional investors: some investors, such as pension funds, are required to invest a certain
amount in government bonds, and thus must accept negative interest rates.
Stylized facts:
Individual stocks - Can fluctuate a lot
- Great potential for high gains, but also high risk of losing money
Stock indices - Do fluctuate less in general than individual stocks
- Less potential for high gains, but also less risk of losing money
- Diversification potential
Bond indices - Do fluctuate less in general than stock indices
- Less potential for high gains, but also less risk of losing money
2 basic concepts – return & risk
1. Return & risk
Return: what you earn on your investment.
ð Why invest? People want to invest, because they want a return.
ð ó of return = no investment, keeping your money at home (holding cash), you have the opportunity
cost of losing purchasing power (money decreases in value) & not earning a return.
Expected return - = the anticipated return for a future period.
- Something you estimate.
- Return you expect to have over x years.
- We will learn how to calculate and estimate this.
Realized return - = the annual return over a past period.
- What you really realize.
- The return you actually have from your investment.
ó Expected return ≠ realized return → this is where risk comes in.
3
, Risk: change/ probability that the realised return is different from the expected return.
ð If the risk is higher, you have a higher possibility of a higher return.
ð Range of possible returns is much higher if you invest in the stock market.
MCQ:
In securities markets, there should be a risk-return trade-off with higher-risk assets having _____ expected
returns than lower-risk assets.
A. higher
B. lower
C. the same
D. The answer cannot be determined from the information given.
Explanation: if markets are functioning well, people will only take higher risk, if they expect a higher return.
2. Trade-off between risk & return
Why do investors earn a return?
ð Financial markets are competitive → no free lunch
o Suppose the interest rate on your savings account is 10%, this is a free lunch → you’re not taking
any risk and get a little return.
o If markets are competitive, then a free lunch isn’t possible.
o Yields will go down until it is a fair compensation for the risk youre taking.
ð To earn more than the risk-free rate, you must take risk.
Key principles:
1) Investors are risk averse:
a. They dislike risk unless compensated with higher expected returns.
2) Investors only take risk if they expect a reward for doing so.
Investment decisions:
ð Always a trade-off between expected return and risk.
ð How much risk to take depends on:
Investment - Is only one year.
horizon - You can invest today, but next year I need to have my money (ex. Buy a house).
- Then you don’t want to take too much risk.
- Can also play a role.
- If you have a investment horizon of 20 years, then you have more potential to take risk.
- If there is a stock crash, then it isn’t a problem, because the stock market will probably recover
and you have a lot of time.
- If you need you’re money within the year back you will not take to much risk because you do
not want to take the risk of losing it.
Risk tolerance - Depends on your level of risk aversion (ó is risk tolerance).
- Risk is a positive trade-off.
4
Introduction – some recent trends
What factors explain the sharp global stock market
decline in Feb–Mar 2025?
Trump with his tariffs, this created a lot of
uncertainty, and investors don’t like this.
ð In march the price recovered, people saw
that the tariffs weren’t as bad it seemed.
ð Less uncertainty
ð If you wait the markets will recover
MCQ:
From a European investor’s perspective, did the US stock market perform well last year?
A. Yes, because the return was positive in USD.
B. No, because after converting to EUR the return was negative.
C. It depends, both A and B are correct.
D. I don’t know.
Explanation:
If you want to look at the return as an European investor, then you will need to express it in €.
ð Look at the green on the previous dia.
ð Which should be a negative return.
ð Look at the returns in your own currency.
Exchange rates: At the bottom you can see the depreciation of the US
dollar by 11%.
This explains why we have negative returns when
investing in the US market expressed in €.
If you invest outside of Europe, then you have to take
into account the currency risk.
The € has become more valuable, appreciated for a
lot of countries → is a disadvantage for european
investors.
1
,Government bond yields: You buy them and hold them for 10 years.
ð There are some fluctuations.
ð Intrest rate in the US is typically higher than
in Europe.
ð Growth is higher in the US, than in Europe.
ð In the US they have a lot of debt; the higher
the debt of the country, the higher the
interest rates you have to pay on your debt.
Bitcoins: Depends on when you buy & on when you sell.
Þ Difficult to explain why it’s going up or
down → with stock markets it’s easier to
explain why they are fluctua-ting.
Þ Not clear what the clear value of the bitcoin
is.
Þ Not advised to buy bitcoins.
Þ If you combine it with some assets in your
portfolio, then you can “control” your
fluctuations.
Introduction – historical perspective
We see that investing in individual stocks has big
potential to go up (Apple).
ð You take a lot of risk
ð Putting all your money in 1 specific asset has
a lot of risk = the reason why you should
diversify
During a crisis, the stock market will go down, but in
the end you will have made a lot of money.
You need to wait until it recovers (if you have a LT
perspective), this will give you trouble if you need
money on short term.
Trade-off between risk & return.
2
,For highly creditworthy countries, government bond interest rates are negative (as of 2016):
ð Investors are therefore willing to accept a loss in order to park their money safely.
ð Why?
o Security: investors want certainty that they will get their money back and are willing to pay a
price for that.
o Falling interest rate expectations: they expect interest rates to decline further, which would push
up the prices of existing bonds (since bond prices and interest rates move in opposite
directions).
§ This situation changes in the event of deflation.
o Exchange rate risk: for example, suppose you invest in a Japanese bond.
§ If the JPY appreciates, this will create a foreign exchange gain.
o Institutional investors: some investors, such as pension funds, are required to invest a certain
amount in government bonds, and thus must accept negative interest rates.
Stylized facts:
Individual stocks - Can fluctuate a lot
- Great potential for high gains, but also high risk of losing money
Stock indices - Do fluctuate less in general than individual stocks
- Less potential for high gains, but also less risk of losing money
- Diversification potential
Bond indices - Do fluctuate less in general than stock indices
- Less potential for high gains, but also less risk of losing money
2 basic concepts – return & risk
1. Return & risk
Return: what you earn on your investment.
ð Why invest? People want to invest, because they want a return.
ð ó of return = no investment, keeping your money at home (holding cash), you have the opportunity
cost of losing purchasing power (money decreases in value) & not earning a return.
Expected return - = the anticipated return for a future period.
- Something you estimate.
- Return you expect to have over x years.
- We will learn how to calculate and estimate this.
Realized return - = the annual return over a past period.
- What you really realize.
- The return you actually have from your investment.
ó Expected return ≠ realized return → this is where risk comes in.
3
, Risk: change/ probability that the realised return is different from the expected return.
ð If the risk is higher, you have a higher possibility of a higher return.
ð Range of possible returns is much higher if you invest in the stock market.
MCQ:
In securities markets, there should be a risk-return trade-off with higher-risk assets having _____ expected
returns than lower-risk assets.
A. higher
B. lower
C. the same
D. The answer cannot be determined from the information given.
Explanation: if markets are functioning well, people will only take higher risk, if they expect a higher return.
2. Trade-off between risk & return
Why do investors earn a return?
ð Financial markets are competitive → no free lunch
o Suppose the interest rate on your savings account is 10%, this is a free lunch → you’re not taking
any risk and get a little return.
o If markets are competitive, then a free lunch isn’t possible.
o Yields will go down until it is a fair compensation for the risk youre taking.
ð To earn more than the risk-free rate, you must take risk.
Key principles:
1) Investors are risk averse:
a. They dislike risk unless compensated with higher expected returns.
2) Investors only take risk if they expect a reward for doing so.
Investment decisions:
ð Always a trade-off between expected return and risk.
ð How much risk to take depends on:
Investment - Is only one year.
horizon - You can invest today, but next year I need to have my money (ex. Buy a house).
- Then you don’t want to take too much risk.
- Can also play a role.
- If you have a investment horizon of 20 years, then you have more potential to take risk.
- If there is a stock crash, then it isn’t a problem, because the stock market will probably recover
and you have a lot of time.
- If you need you’re money within the year back you will not take to much risk because you do
not want to take the risk of losing it.
Risk tolerance - Depends on your level of risk aversion (ó is risk tolerance).
- Risk is a positive trade-off.
4
