Investment Analysis

Definition

Investment analysis is the process of evaluating potential investment opportunities to determine their viability and expected returns. This evaluation often involves calculating the expected value and variance, which help investors understand the potential risks and rewards associated with various investments. By analyzing these factors, investors can make informed decisions that align with their financial goals and risk tolerance.

5 Must Know Facts For Your Next Test

1. Investment analysis often uses expected value to quantify the average anticipated return on an investment, allowing investors to compare different options.
2. Variance provides insight into the risk associated with an investment by measuring how much returns may deviate from the expected value.
3. A higher variance indicates greater uncertainty in investment returns, which can influence an investor's decision-making process regarding risk tolerance.
4. Investment analysis typically involves qualitative assessments, like market trends and economic conditions, in addition to quantitative metrics like expected value and variance.
5. Successful investment analysis helps investors construct a diversified portfolio that balances risk and return according to their financial objectives.

Review Questions

• How do expected value and variance contribute to effective investment analysis?
  • Expected value provides a quantifiable measure of the average anticipated return from an investment, helping investors understand what they might earn over time. Variance complements this by showing how much individual returns may differ from this average, highlighting the risk involved. Together, these metrics allow investors to assess potential investments more comprehensively, weighing both their possible returns and associated risks.
• In what ways can an investor use variance in conjunction with expected value to make informed decisions about their portfolio?
  • Investors can use variance to evaluate how different assets within their portfolio might behave relative to their expected returns. If one investment has a high expected value but also high variance, it may carry more risk compared to another with a lower expected value but also lower variance. By analyzing both metrics, investors can better balance their portfolios, choosing assets that align with their individual risk tolerance and investment strategy.
• Evaluate the impact of external economic factors on investment analysis when considering expected value and variance.
  • External economic factors such as market trends, interest rates, and inflation can significantly affect both the expected value and variance of potential investments. For instance, a rising interest rate may decrease the expected returns on bonds while increasing volatility. When performing investment analysis, considering these external factors alongside expected values and variances allows investors to adapt their strategies in response to changing economic conditions, ultimately improving their decision-making process.

Related terms

Expected Value:

The anticipated value of a random variable, calculated as the sum of all possible values, each multiplied by its probability of occurrence.

Variance:

A statistical measure that represents the degree of spread or dispersion in a set of values, indicating the volatility or risk associated with an investment's returns.

Risk Assessment:

The process of identifying and analyzing potential risks that could negatively impact investment performance, enabling investors to mitigate those risks effectively.