ch1outline - Chapter 1 investments Background and Issues I...

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Chapter 1: investments: Background and Issues I. Real assets versus financial assets A. The material wealth of a society is ultimately determined by the productive capacity of its economy, that is, the goods and services its members can create 1. This capacity is a function of the real assets of the economy: the land, buildings, equipment, and knowledge that can be used to produce goods and services B. Financial assets , such as stocks and bonds, are no more than sheets of paper 1. These assets are the means by which individuals in well-developed economies hold their claims on real assets C. While real assets generate net income in the economy, financial assets simply define the allocation of income or wealth among investors D. However, these securities, which are financial assets of households, are liabilities of the issuers of the securities. 1. Your asset is GM’s liability 2. Therefore, when we aggregate overall balance sheets, these claims cancel out, leaving only real assets as the net wealth of the economy II. A taxonomy of financial assets A. It is common to distinguish among three broad types of financial assets: debt, equity, and derivatives B. Fixed income or debt securities promise either a fixed stream of income or a stream of income that is determined according to a specified formula C. The money market refers to fixed-income securities that are short term, highly marketable, and generally of very low risk 1. Examples of money market securities are U.S. Treasury bills or bank certificates of deposit(CDs) D. In contrast, the fixed-income capital market includes long term securities such as Treasury bonds, as well as bonds issued by federal agencies, state and local municipalities, and corporations 1. These bonds rand from very safe in terms of default risk to relatively risky 2. They also are designed with extremely diverse provisions regarding payments provided to the investor and protection against the bankruptcy of the issuer E. Common stock, or equity , in a firm represents an ownership share in the corporation 1. Equity holders are not promised any particular payment 2. They receive any dividends the firm may pay and have prorated ownership in the real assets of the firm 3. If the firm is successful, the value of equity will increase; if not, it will decrease 4. The performance of equity investments is tied directly to the success of the firm and its real assets
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5. Equity investments tend to be riskier than investments in debt securities F. Derivative securities - securities providing payoffs that depend on the values of other assets 1. Derivative securities such as options and futures contracts provide payoffs that are determined by the prices of other assets such as bond or stock prices 2. Named because their values derive from the prices of other assets 3. Other important derivative securities are futures and swap contracts 4. One use of derivatives, perhaps the primary use, is to hedge risks or transfer them to other parties
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This note was uploaded on 09/10/2010 for the course FIN 367 taught by Professor Han during the Fall '08 term at University of Texas.

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ch1outline - Chapter 1 investments Background and Issues I...

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