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CHAPTER 1
McGraw-Hill/Irwin
Investments Background and
Issues
© 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.
Investments & Financial Assets
Essential nature of investment
– Reduced current consumption
– Planned later consumption
Real Assets
– Assets used to produce goods and
services
Financial Assets
– Claims on real assets
1-2
Balance Sheet – U.S. Households
1-3
Domestic Net Worth
1-4
Major Classes of Financial Assets
or Securities
Debt
– Money market instruments
– Bonds
Common stock
Preferred stock
Derivative securities
1-5
Financial Markets and the Economy
Consumption Timing
Allocation of Risk
Separation of Ownership and
Management
– Agency Issues
1-6
Large Option Exercises
1-7
Crisis in Corporate Governance
Accounting Scandals
– Examples – Enron and WorldCom
Analyst Scandals
– Example – Citigroup’s Salomon Smith Barney
Initial Public Offerings
– Credit Swiss First Boston
1-8
The Investment Process
Asset allocation
Security selection
Risk-return trade-off
Market efficiency
Active vs. passive management
1-9
Active vs. 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
1-10
Players in the Financial Markets
Business Firms – net borrowers
Households – net savers
Governments – can be both borrowers
and savers
Investment Bankers
1-11
Key Trends - Globalization
International and Global Markets Continue
Developing
Managing foreign exchange
Diversification to improve performance
Instruments and vehicles continue to
develop (WEBs)
Information and analysis improves
1-12
Global Debt Issue
1-13
Key Trends - Securitization
Securitization & Credit Enhancement
Offers opportunities for investors and
originators
Changes in financial institutions and
regulation
Improvement in information capabilities
Credit enhancement and its role
1-14
Asset-backed Securities
1-15
Key Trends Financial Engineering
Repackaging Services of Financial
Intermediaries
Bundling and unbundling of cash flows
Slicing and dicing of cash flows
Examples: strips, CMOs, dual purpose funds,
principal/interest splits
1-16
Building a Complex Security
1-17
Unbundling – Mortgage Security
1-18