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note01 (1) - Investments Financial Assets Essential nature...

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1 Investments & Financial Assets Essential nature of investment Reduced current consumption Planned later consumption Consumption Timing Allocation of Risk Two main themes of investments Modern Portfolio theory (MPT): Risk-return trade off in the securities markets Efficient diversification Capital asset pricing and valuation Efficient Market Hypothesis (EMH): security price reflects all the information available to investors concerning the value of the securities Real Assets Assets used to produce goods and services Financial Assets Claims on real assets
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2 Major Classes of Financial Assets or Securities Debt Money market instruments Bonds Equity Common stock Preferred stock Derivative securities
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3 Agency Issues and Crisis in Corporate Governance Accounting Scandals Examples – Enron and WorldCom Analyst Scandals Example – Citigroup’s Salomon Smith Barney Initial Public Offerings Credit Swiss First Boston
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4 The Agency Problem Agency relationship Principal hires an agent to represent their interest Stockholders (principals) hire managers (agents) to run the company Two conditions of agency problem: 1. Conflict of interest between principal and agent 2. Asymmetric information Management goals and agency costs
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5 The Investment Process A Top-Down Analysis of Portfolio Construction the Capital Allocation decision Choice of safe but low-return money market securities, or risky but higher-return securities (e.g., stocks) the Asset Allocation decision the distribution of risky investments across broad asset classes like stocks, bonds, real estates, foreign assets, and so on. the Security Selection decision the choice of which particular securities to hold within each asset class security analysis involves the valuation of particular securities: must forecast dividends and earnings fundamental/ technical analysis Market efficiency
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6 Active vs. Passive Management Active Management Finding undervalued securities Timing the market Passive Management No attempt to find undervalued securities No attempt to time Holding an efficient portfolio
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7 Major Financial Markets and Assets or Securities Money market Treasury bills, Certificates of deposits, Commercial Paper, Bankers Acceptances, Eurodollars, Repurchase Agreements (RPs) and Reverse RPs, Brokers’ Calls, Federal Funds, etc. Treasury bills most marketable; highly liquid; discount bond maturities: 28, 91, 182 days minimum denomination: $1,000 Issued weekly
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8 Costs of Trading Commission : fee paid to broker for making the transaction Spread : cost of trading with dealer Bid : price dealer will buy from you Ask : price dealer will sell to you Spread : ask - bid Combination : on some trades both are paid
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9 Figure 2.2 Treasury Bills
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10 T-bill T.B yields are quoted as the “ bank discount yield r BD = 10,000 - P x 360 10,000 n where P = the bond price; n = the maturity in days; r BD = the bank discount yield; $10,000 = par value.
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