Exam 1 Notes - Chapter 1 1 Real Assets land buildings...

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Chapter 1: 1. Real Assets: land, buildings, equipment, and knowledge that can be used to produce goods and services. 2. Financial Assets: the means by which individuals in well-developed economies hold their claims on real assets. 3. While real assets generate net income to the economy, financial assets simply define the allocation of income or wealth among investors. a. When aggregated over all balance sheets, these claims cancel out, leaving only real assets as the net wealth of the economy. 4. A Taxonomy of Financial Assets a. Fixed income or debt securities promise either a fixed stream of income or a stream of income that is determined according ot a specified formula. i. Investment performance is least closely tied to the financial condition of the issuer b. Money Market: refers to fixed-income securities that are short term, highly marketable, and generally of very low risk. i. US Treasury bills or bank certificates of deposit (CDs) c. Capital Market: includes long term securities such as Treasury bonds, as well as bonds issued by federal agencies, state and local municipalities, and corporations. Range from very safe in terms of default risk to relatively risky. d. Equity: equity holders are not promised any particular payment. They receive any dividends the firm may pay and have prorated ownership in the real assets of the firm. i. Tend to be riskier than investments in debt securities. e. 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. i. The primary use is to hedge risks or transfer them to other parties. ii. Can also be used to take highly speculative positions. 5. Financial Markets and the Economy a. If Toyota raises the funds to build its auto plant by selling both stocks and bonds to the public, the more optimistic or risk-tolerant investors can buy shares of stock in Toyota, while the more conservative ones can buy Toyota bonds. Because the bonds
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promise ot promise a fixed payment, the stockholders bear most of the business risk but reap potentially higher rewards. 6. Agency problems: managers, who are hired as agents of the shareholders, may pursue their own interests instead. a. Compensation plans that tie the income of managers to the success of the firm (without being overused or abused) b. Boards of Directors can force out management teams that are underperforming c. Outsiders, such as analysts, can make poor performers at least uncomfortable d. Proxy contest: shareholders seek to obtain enough proxies (rights to vote the shares of other shareholders) to take control of the firm and vote in another board. e. The real takeover threat by another firm 7. The Investment Process a. Asset Allocation: the choice among broad asset classes b. Security Selection: the choice of which particular securities to hold within each asset class. c.
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This note was uploaded on 09/02/2011 for the course FIN 357 taught by Professor Hadaway during the Spring '06 term at University of Texas.

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Exam 1 Notes - Chapter 1 1 Real Assets land buildings...

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