Investments Background and Issues

1
Chapter 1

• Investments - Background and Issues

2
Investments Financial Assets

• Essential nature of investment
• Reduced current consumption
• Planned later consumption
• Real Assets
• Assets used to produce goods and services
• Financial Assets
• Claims on real assets or the income generated by
  them

3
Major Classes of Financial Assets

• Fixed-income securities pay a specified cash
  flow over a specific period
• Equity an ownership share in a corporation
• Derivative securities securities providing
  payoffs that depend on the value of other assets

4
The Investment Process

• Asset allocation
• Security selection
• Risk-return trade-off
• Market efficiency

5
The Investment Process

• Active Management
• Finding undervalued securities
• Timing the market
• Passive Management
• No attempt to find undervalued securities
• No attempt to time
• Holding an efficient portfolio

6
The Players

• Firms are net borrowers
• Households typically are net savers
• Governments can be borrowers or lenders
• Financial intermediaries

7
Financial Markets

• Primary market vs. secondary market
• Primary market new issues of securities are
  offered to the public
• Secondary market already existing securities are
  traded.
• Dealer markets vs. auction markets
• Dealer markets traders specializing in
  particular assets buy and sell for their own
  account.
• Auction markets all traders meet at one place to
  buy or sell on asset, such as the New York Stock
  Exchange (NYSE)

8
Recent Trends in Financial Markets

• Globalization The tendency toward a worldwide
  investment environment, and the integration of
  national capital markets.
• Domestic firms compete in global markets
• Many new investments opportunities
• Causes additional elements of risk

9
Recent Trends in Financial Markets

• Securitization Pooling loans into standardized
  securities backed by those loans, which can then
  be traded like any other security.
• Example of this type of investment is Federal
  Home Loan Mortgage Company Freddie

10
Recent Trends in Financial Markets

• Financial engineering The process of creating
  and designing securities with customer-tailored
  characteristics.
• Bundling and unbundling of cash flows
• Bundling combining more than one security into a
  composite security.
• Unbundling breaking up and allocating the cash
  flows from one security to create several new
  securities.

11
Recent Trends in Financial Markets

• Advances in computer network and communication
• Online trading
• Information more cheaply and widely available to
  the public
• Automated trading