Chapter 1 the Investment Environment

Chapter 1 The Investment Environment 1. 1. Real Assets versus Financial Assets (Page 30) ? Real Assets ? Determine the productive capacity and net income of the economy ? Examples: Land, buildings, machines, and knowledge used to produce goods and services ? Financial Assets ? Claims on real assets 1-2 1. 2. Financial Assets (Page 32) ? Three types: 1. Fixed income or debt Common stock or equity Derivative securities 2. 3. 1-3 Fixed Income ? ? ? ? 1-4 Payments fixed or determined by a formula Money market debt: short term, highly marketable, sually low credit risk (T-bills, certificates of deposits etc) Capital market debt: long term bonds, can be safe or risky (Treasury bonds, municipal bonds, corporate bonds, etc) Bond ratings: in terms of default risk, from very safe to junk Common Stock and Derivatives ? Common Stock is equity or ownership in a corporation. ? ? Derivatives ? ? 1-5 Payments to stockholders are not fixed, but depend on the success of the firm Value derives from pri ces of other securities such as stocks and bonds Used to transfer risk (hedge) 1. 3.Financial Markets and the Economy (page 33-36) ? ? ? ? ? 1-6 Information Role: Capital flows to companies with best prospects Consumption Timing: Use securities to store wealth and transfer consumption to the future Allocation of Risk: Investors can select securities consistent with their tastes for risk Separation of Ownership and Management: minimize the famous agency costs and maximize firm value Corporate Governance and Corporate Ethics How to reduce the agency problems (Page 34-35) ? ? ? ? 1-7 Compensation plans: bonus, stock options, etc.The power of the board of directors Outsiders’ monitor Threat of takeover: proxy contest, mergers, etc. 1. 4. The Investment Process (page 36) ? When constructing a portfolio, investors need to decide: ? ? 1-8 Asset allocation ? Choice among broad asset classes Security selection ? Choice of which securities to hold within asset class ? Security analysis to value securities and determine investment attractiveness 1. 4. The Investment Process (page 37) ? 1-9 Portfolio strategies ? Top-down: starts from asset allocation Bottom-up: starts from individual securities 1. 5. Markets are Competitive (page 37-39) ? Implications from â€Å"no-free-lunch† proposition: ? ? Risk-Return Trade-Off Efficient Markets (security prices have reflected all information) (Chapter 11-12): ? Passive management ? No attempt to find undervalued securities ? No ? attempt to time the market ? Holding a highly diversified portfolio Active Management ? ? 1-10 Finding mispriced securities Timing the market 1. 6. The Players (page 39-42) ? ? ? ? Business Firms– net borrowersHouseholds – net savers Governments – can be both borrowers and savers Financial Intermediaries: Pool and invest funds ? Investment Companies ? Banks ? Insurance companies ? Credit unions 1-11 Universal Bank Activities Investment Banking †¢ Underwrite new stock and bond issues †¢ Sell newly issued securities to public in the primary market †¢ Investors trade previously issued securities among themselves in the secondary markets Commercial Banking †¢ Take deposits and make loans †¢ †¢ 1-12 1. 7. Financial Crisis of 2008 Reading (page 42-51) 1-13