Fin 322 Investments Chapter Outlines

Fin 322 Investments Chapter Outlines - Chapter 1 Real Asset...

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Chapter 1 Real Asset – the land, building, knowledge, and machines that are used to produce goods and the workers whose skills are necessary to use those resources Financial Asset – items such as stocks and bonds. Financial assets contribute to the productive capacity of the economy indirectly because they allow for separation of ownership and management of the firm and facilitate the transfer of funds to enterprises with attractive investment opportunities. Financial assets are claims to the income generated by real assets or claims on income from the government. Separation of ownership and management lead to agency problems. Mechanisms to prevent this include stock options, board of director regulatory control, outside investors monitoring company management, and the threat of takeover. Clients of the Financial System: - Government Sector – governments cannot sell equity shares and are restricted to borrowing to raise funds. They can also print money. Their taxing power makes their bonds very creditworthy and therefore are able to borrow at the lowest rate. - Household Sector – Taxes lead to varying asset demands because people are in different tax brackets. For example high tax bracket investors will seek securities that are exempt form state and local taxes. Risk considerations also create demand for a diverse set of investment alternatives. - Business Sector – Whereas household financial decisions are concerned with how to invest money, business typically need to raise money to finance their investments in real assets. Primitive Securities – offers returns based only on the status of the issuer. Derivative Securities – yield returns that depend on additional factors pertaining to the prices of other assets. For example, the payoff to stock options depends on the price of the underlying stock. Much of the innovation in security design may be viewed as the continual creation of new types of derivative securities from the available set of primitive ones. The primary use of derivatives is to hedge risk. Types of Markets: - Direct Search Market – buyers and sellers seek each other out directly. The least organized market. - Brokered Market – brokers offer search services to buyers and sellers. Good for products where trading is sufficiently active. - Dealer Market – dealers specialize in various assets, purchasing them for their own inventory and selling them for a profit from their inventory. Typical if a high volume of trading occurs for a particular asset. Dealers, unlike brokers, trade assets for their own accounts. - Auction Market – all transactions of a good converge at one place to bid on or offer a good. It is the most integrated market.
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Financial Engineering – the process of bundling and unbundling; the creation and design of securities with custom tailored characteristics, often regarding exposure to various sources of risk.
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