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Investments CHAPTER - 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
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
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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
Debt
Money market instruments
Bank certificates of deposit
Capital market instruments
Bonds
Common stock Preferred stock Derivative securities
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1.3 FINANCIAL MARKETS AND THE ECONOMY
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Financial Markets
Informational Role of Financials Markets
The Google effect
Consumption Timing Allocation of Risk Separation of Ownership and Management
Agency Issues
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Corporate Governance and Ethics
Accounting Scandals
Examples Enron and WorldCom
Misleading research reports Auditors watchdogs or consultants
Example Arthur Andersen and Enron
Sarbanes-Oxley Act
Tighten the rules of corporate governance
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1.4 THE INVESTMENT PROCESS
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The Investors Portfolio
Asset allocation
Choice among broad asset classes
Security selection
Choice of which securities to hold within asset class
Security selection
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1.5 MARKETS ARE COMPETITIVE
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Risk-Return Trade-Off
How should one measure risk Assets with higher expected returns have greater risk What role does diversification play
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Efficient Markets be Theory
Should 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 Financial Intermediaries
Banks Investment companies Insurance companies Credit unions
Investment Bankers
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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
Managing foreign exchange Diversification to improve performance Instruments and vehicles continue to develop (WEBs) Information and analysis improves
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Figure 1.1 Global Debt Issue
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Securitization
Offers opportunities for investors and originators Changes in financial institutions and regulation Improvement in information capabilities Credit enhancement and its role
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Figure 1.2 Asset-backed Securities Outstanding
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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
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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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