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quiz 1 - Investment 1 Expect of deriving greater resources...

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Investment: 1. Expect of deriving greater resources in the future. 2 Time and risk components in investment. (financial assets &financial markets)Players .)- Investment process: top down vs. bottom up • Principle : risk return tradeoff. ESSENTIAL NATURE OF INVEST: reduce current consumption in hopes of greater future. Assets: all financial assets (owner of the claim) are offset by a financial liability (issuer of the claim)/ only real assets remain in balance sheet/ net wealth of an economy is the sum of its real assets/Financial Assets do not determine the wealth of the economy. Classes of Financial Assets or Securities : Debt (fixed- income) security: Money market instruments( Generally short-term, highly marketable, low risk, Bank certificates of deposit, T- bills, commercial paper, etc., Bonds: longer term, risk varies from Treasury bonds to high yield bonds, Preferred stock: a fixed dividend but no principal repayment) Common stock: Ownership stake in the entity, uncertain residual cash flow. Derivative securities: A contract whose value is derived from some underlying market condition. E.g. Options, futures Financial Markets : Market prices reflect the fair value estimate of a security’s expected future risky cash flows. Financial markets help allocate capital resources to the best uses. Consumption Timing: People tend to smooth consumption over time (safe net). If one has more than enough cash to meet their basic needs in the current time period one might shift consumption through time by investing the surplus. Investors can choose a desired risk level: Bonds versus stock of a given company/ Bank CD versus company bond/Tradeoff between risk and return? Separation of Ownership: Large size of firms requires Separation of ownership and management (In 08 GE had over $800 billion in assets and over 650,000 stockholders / Owners (principals) ≠ Managers (agents) / Agency costs: Owners’ interests may not align with managers’ interests / Mitigating factors: Performance based compensation / Boards of Directors may fire managers / Threat of takeovers Corporate Gov. Vs Ethics: Business and market require trust to operate efficiently (Without trust additional laws and regulations are required/ All laws and regulations are costly). Governance and ethics failures have cost our economy billions if not trillions of dollars (Eroding public support and confidence in market). Sarbanes-Oxley Act: a. Increases the number of independent directors on company boards. b. Require the CFO to personally verify the financial statement. c. Create a new oversight board for the accounting/ audit industry. d. Charged the board with maintaining a culture of high ethical standards (CFO can be suited for wrong info) Accounting Scandals : Enron, WorldCom, RiteAid, HealthSouth, Global Crossing, Qwest / Misleading Research Reports: Citicorp, Merrill Lynch / Auditors: Watchdogs or Consultants? Arthur Andersen and Enron The investment Process: Asset allocation: choosing the percentage of funds across asset classes. Ex: 50% in stocks, 30% in bond. Security selections and security analysis:
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