Bodie, Kane, Marcus Study Guide

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Essentials of Investments,
by

Bodie, Kane and Marcus
8th Edition,

Teaching Notes

Chapter 01 - Investments: Background and Issues

CHAPTER ONE INVESTMENTS: BACKGROUND AND ISSUES
CHAPTER OVERVIEW
The purpose of this book is to a) help students in their own investing and b) pursue a career in the investments industry. To help accomplish these goals Part 1 of the text (Chapters 1through 4) introduces students to the different investment types, the markets in which the securities trade and to investment companies. In this chapter the student is introduced to the general concept of investing, which is to forego consumption today so that future consumption can be preserved and hopefully increased in the future. Real assets are differentiated from financial assets, and the major categories of financial assets are defined. The risk/return tradeoff, the concept of efficient markets and current trends in the markets are introduced. The role of financial intermediaries and in particular, investment bankers is discussed, including some of the recent changes due to the financial crisis of 2007-2008.

LEARNING OBJECTIVES
After studying this chapter, students should have an understanding of the overall investment process and the key elements involved in the investment process such as asset allocation and security selection. They should have a basic understanding of debt, equity and derivatives securities. Students should understand differences in the nature of financial and real assets, be able to identify the major players in the markets, differentiate between primary and secondary market activity, and describe some of the features of securitization and globalization of markets.

CHAPTER OUTLINE
1. Investing and Real versus Financial Assets

PPT 1-2 through PPT 1-6
Investing involves sacrifice. One gives up some current consumption to be able to consumer more in the future (or to be able to consumer at all in the future if the goal is simply capital preservation.) Financial assets provide a ready vehicle to transfer consumption through time. They may be more appropriate investments than real assets for many investors. The distinctions between real and financial assets (see below) can be used to discuss key differences in their nature and in their appropriateness as investment vehicles. For instance, financial assets are more liquid and often have more transparent pricing since they are traded in well functioning markets. However, real asset investment generates growth in the capital stock and this allows a society to become wealthier over time. The material wealth of a society will be a function of the inputs to production, including quality and quantity of its capital stock, the education, innovativeness and skill level of its people, the efficiency of its production, the rule of law, and so called ‘Providential’ factors such as location on a global trade route. The quantity and quality of its real assets will be a major determinant of that wealth. Real assets include land, buildings, equipment, human capital, knowledge, etc. Real assets are used to produce goods and services. Financial assets are basically pieces of paper that represent claims on real assets or the income produced by real assets. Real assets are used to generate wealth for the economy. Financial assets are used to allocate the wealth among different investors and to shift consumption through time. Financial assets of households comprise about 62% of total assets in 2008, up from 60% in 2006. 1-1

Chapter 01 - Investments: Background and Issues

Interestingly, domestic net worth fell between September 2006 and June 2008 from $45,199 billion to $40,925 billion in 2008. This is due to the financial crisis and is due to the drop in real estate values. It is worth thinking about the implications of the wealth drop for consumer spending. The discussion of real and financial assets can be used to discuss key differences in the assets and their...
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