Investors generally have three broad concerns
when an investment is made. They care about how much money the investment
will earn over time, they care about how risky the investment is, and
they care about how liquid, or convertible, the asset is.
1) Rate of return  the percentage change in the value
of an asset over some period of time.
Investors purchase assets as a way of saving for the future. Anytime an asset is purchased
the purchaser is forgoing current consumption for future consumption. In order to make
such a transaction worthwhile the investors hopes (sometimes expects) to have more
money for future consumption than the amount they give up in the present. Thus
investors would like to have as high a rate of return on their investments as possible.
Example 1: Suppose a Picasso painting is purchased in 1996 for $500,000. One year later
the painting is resold for $600,000. The rate of return is calculated as,
Example 2: $1000 is placed is a savings account for 1 year at an annual interest rate of
10%. The interest earned after one year is $1000 x 0.10 = $100. Thus the value of the
account after 1 year is $1100. The rate of return is,
This means that the rate of return on a domestic interest bearing account is merely the
interest rate.
2) Risk
The second primary concern of an investor is the riskiness of the assets. Generally, the
greater the expected rate of return, the greater the risk. Invest in an oil wildcat endeavor
and you might get a 1000% return on your investment ... if you strike oil. The chances of
doing so are likely to be very low however. Thus, a key concern of investors is how to
manage the tradeoff between risk and return.
3) Liquidity
Liquidity essentially means the speed with which assets can be converted to cash.
Insurance companies need to have assets which are fairly liquid in the event that they need
to pay out a large number of claims. Banks have to stand ready to make payout to
depositors etc.
