Econ173A_topic1

Econ173A_topic1 - Earnings ory Institutions banks Secondary...

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Secondary Financial Markets Flow of Funds $ $ Financial Intermediaries Primary Financial Markets Bonds Deposits, Shares Stocks, Bonds Stocks, Bonds Loans, Promissory Notes banks ent Companies s) ent nce nies ges dity Ec 173A INTRO FINANCE/INVESTING p. 1 Ec 173A – FINANCIAL MARKETS LECTURE NOTES Foster, UCSD 13:14:31 A. Introduction to Investment 1. Definitions: a) Finance -- the art and science of managing money. 1) Personal finance -- managing one's own money (individual investor). 2) Professional finance -- managing other people's money (institutional investor). b) Financing -- raising money (financial capital). 1) Debt financing -- borrowing money. 2) Equity financing -- selling ownership shares in corporation or partnership. c) Financial instruments or securities -- contracts associated with debt or equity financing. 1) Equity instruments ( e.g. , corporate stocks) -- ownership shares in a business or piece of real property. Holders receive a dividend or share of profit from issuer. 2) Debt instruments ( e.g. , bonds, notes) -- promises to repay borrowed money. Holder receives interest from issuer (the borrower). 3) Derivative securities (options, futures and forward contracts) – option or obligation to buy/sell some other asset. Value derived from performance of underlying assets. d) Portfolio -- collection of assets (items of monetary value). 1) Financial assets -- stocks, bonds, savings accounts, cash balances, derivatives. 2) Real property -- land, buildings and things permanently on the land. 3) Tangible personal property -- gold, art, equipment owned by firms, etc. e) Investment -- any placement of funds with the expectation of some rate of return. 1) Physical capital investment -- purchase new equipment to enhance expected π. 2) Financial investment -- purchase securities or property with expectation of income (dividends, interest) and/or capital gains. 2. Two Basic Investment Strategies: a) Passive (buy-and-hold) -- Buy diversified portfolio of securities and hold for a long time. 1) Can include assets with low liquidity and long holding periods. With proper diver- sification, it can also include some volatile, high risk securities. 2) Objective -- moderate, steady cash income of dividends and interest at low overall risk, with negligible capital gains. 3) Transactions and information costs -- low because portfolio does not require constant monitoring and adjustment by investor or financial adviser. b) Active -- buy stocks and or bonds to try to outperform the market on a regular basis.
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Ec 173A INTRO FINANCE/INVESTING p. 2 1) Market timing (“asset allocation”) approach -- buy stocks just before stock market rises, and move back into T-bills and safer bonds just before the stock market drops. Requires superior forecasting ability. 2) Security selection approach
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Econ173A_topic1 - Earnings ory Institutions banks Secondary...

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