Chapter 1 the Investment Environment

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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,
usually 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



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Payments to stockholders are not fixed, but
depend on the success of the firm
Value derives from prices 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:



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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)



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Portfolio strategies
 Top-down: starts from asset allocation
 Bottom-up: starts from individual
securities

1.5.Markets are Competitive
(page 37-39)



Implications from “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



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Finding mispriced securities
Timing the market

1.6.The Players
(page 39-42)







Business Firms– net borrowers
Households – net savers
Governments – can be both borrowers and savers
Financial Intermediaries: Pool and invest funds
 Investment Companies
 Banks
 Insurance companies
 Credit unions

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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

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