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Unformatted text preview: Investments Mid-Term Review Ch. 1-7 • 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. 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. • Financial assets such as stocks and bonds. Such securities are no more than sheets of paper or, more likely, computer entries and do not contribute directly to the productive capacity of the economy. • Financial assets are claims to the income generated by real assets or claims on income from the government. • Real Assets generate net income to the economy and Financial Assets define the allocation of income or wealth among investors. • Fixed I ncome (Debt) Securities pay a specified cash flow over a specific period. o Money Market- short term highly marketable and generally very low risk TBill and CD’s o Capital Markets- long term range of risk TBonds, Bonds (Federal, State, Local,Corporate) • Common Stock (Equity)- represents an ownership share in the corporation. The performance of equity investments is tied directly to the success of the firm and its real assets. Equity investments tend to be riskier than investments in debt securities. • Derivatives commonly used to hedge r isk and for speculative purposes. • Capital Markets allow the risk that is inherent to all investments to be borne by the investors willing to bear the risk (ex. Bonds have fixed stream payments whereas stocks rely on performance of the company) • Once a portfolio is established it must be rebalanced by selling existing securities and using the proceeds to buy new securities, by investing additional funds to increase the value of the portfolio, or by selling securities to decrease the size of the portfolio. • Investors must decide on Asset allocation and Security Selection when composing a portfolio. A Security analysis involves the valuation of particular securities that might be included in the portfolio. • Top down portfolio construction starts with asset allocation; bottom up only reviews security selection. • Risk-Return T rade-off- assets with higher expected returns entail greater risk. • Diversification- many assets are held in the portfolio so that the exposure to any particular asset is limited. • The expected rate of return is not the return investors believe they will necessarily earn. I t is actually an average rate of return across possible economic scenarios. • Passive Management- buying and holding a diversified portfolio w/o attempting to identify mispriced securities. • Active Management- attempting to identify mispriced securities or to forecast broad market trends....
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- Spring '11
- Modern portfolio theory