Transcript CHP 1

CHAPTER 1
Investments - Background
and Issues
McGraw-Hill/Irwin
Copyright © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
1.1 REAL ASSETS VERSUS
FINANCIAL ASSETS
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Financial Versus Real Assets
Real Assets
– Assets used to produce goods and
services
Financial Assets
– Claims on real assets or the income
generated by them
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Real assets generate net income to the
economy.
Financial assets define the allocation of
income and wealth among investors.
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Table 1.1. Balance Sheet – U.S.
Households, 2006
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Table 1.2 Domestic Net Worth,
2006
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1.2 A TAXONOMY OF FINANCIAL ASSETS
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Major Classes of Financial Assets
or Securities
Fixed Income (Debt) Securities: Pay a specified
cash flow over a specific period.
– Money market instruments
Bank certificates of deposit
– Capital market instruments
Bonds
Equity: An ownership share in a corporation.
– Common stock
Derivative securities: Provide payoffs that
depend on the values of the other securities
– Futures, Options and etc.
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1.3 FINANCIAL MARKETS AND
THE ECONOMY
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Financial Markets
Informational Role of Financials Markets
Consumption Timing
Allocation of Risk
Separation of Ownership and
Management
– Agency Issues
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1.4 THE INVESTMENT PROCESS
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The Investor’s Portfolio
Asset allocation
– Choice among broad asset classes such as stocks,
bonds, bills, real estate and commodities.
Security selection
– Choice of which securities to hold within asset class.
– Top-down approach and Bottom-up approach
Security analysis: valuation of particular
securities that might be included in the portfolio.
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1.5 MARKETS ARE COMPETITIVE
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Risk-Return Trade-Off
Assets with higher expected returns have
greater risk.
Diversification means that many assets
are held in the portfolio so that the
exposure to any particular asset is limited.
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Efficient Markets Theory
Should be neither underpriced nor
overpriced securities
Security price should reflect all information
available to investors
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Active Versus Passive Management
Active Management
Finding undervalued securities
Timing the market
Passive Management
No attempt to find undervalued securities
No attempt to time
Holding an efficient portfolio
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1.6 THE PLAYERS
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The Players
Business Firms – net borrowers
Households – net savers
Governments – can be both borrowers
and savers
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Financial Institutions
Financial Intermediaries: Institutions that
“connect” borrowers and lenders by
accepting funds from lenders and loaning
funds to borrowers.
– Banks
– Investment companies: Firms manageing
funds for investors such as mutual funds.
– Insurance companies
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Investment Bankers: Firms specializing in
the sale of new securities to the public.
– Primary market: A market in which new issue
of securities are offered to the public.(IPOs:
Initial Public Offerings)
– Secondary market: Previously issued
securities are traded among investors.
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Table 1.3 Balance Sheet of
Commercial Banks
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Table 1.4 Balance Sheet of
Nonfinancial U.S. Business
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1.7 RECENT TRENDS
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Globalization
Tendency toward a worldwide investment
environment, and the integration of the
international capital markets.
US investors;
– Purchase foreign securities using ADRs
(American Depository Receipts).
– Purchase foreign securities that are offered
in dollars.
– Buy mutual funds that invest internationally.
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Figure 1.1 Global Debt Issue
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Securitization
Pooling loans into standartized securities
backed by those loans, which can then be
traded like any other security.
Asset- backed securities, Mortgage-backed
securities are called as Pass-through
securities: Pools of loans (such as home
mortgage loans) sold in one package.
Owners of them receive all the principal
and interest payments made by the
borrowers.
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Figure 1.2 Asset-backed Securities
Outstanding
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Financial Engineering
Creation of new securities by unbundlingbreaking up and allocating the cash flows
from one security to create several new
securities or by bundling- combining more
than one security into a composite security.
Examples: strips, principal/interest splits
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Figure 1.3 Building a Complex Security
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Unbundling – Mortgage Security
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Computer Networks
Online trading
Information made cheaply and widely
available
Direct trading among investors
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