Investments Background and Issues

1
Chapter 1

• Investments - Background and Issues

2
Investment

• Essential nature of investment
• Consumption smoothing
• Life-Cycle Theory of Consumption and Saving
  Individuals save/invest in order to provide for
  consumption in old age.
• Risk sharing

3
Financial Assets

• Real/Tangible Assets
• Assets used to produce goods and services
• Machines, land, and structures owned by
  corporations and the consumer durables (cars,
  washing machines, appliances) owned by
  households.
• Financial Assets
• Money, bonds, stocks
• Claims on real assets

4
The Investment Process

• Asset allocation
• Security selection
• Risk-return trade-off
• Market efficiency
• Active vs. passive management

5
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

6
Major Classes of Financial Assets or Securities

• Debt
• Money market instruments
• Bonds
• Equity Common and Preferred Stock
• Derivatives Options, Forwards, Futures

7
Financial Intermediaries

• Financial Intermediaries include banks, insurance
  companies, and investment companies.
• Bring lenders and borrowers together.
• Well suited to deal with the uncertainty and
  dishonesty found in the real world.

8
Investments and Innovation

• Technology and Delivery of Service
• Computer advancements
• More complete and timely information
• Globalization
• Domestic firms compete in global markets
• Performance in regions depends on other regions
• Causes additional elements of risk

9
Key Trends - Globalization

• International and Global Markets Continue
  Developing
• Managing foreign exchange
• Diversification to improve performance
• Instruments and vehicles continue to develop
  (WEBS)
• Information and analysis improves

10
Key Trends - Securitization

• Securitization Credit Enhancement
• Offers opportunities for investors and
  originators
• Changes in financial institutions and regulation
• Improvement in information capabilities
• Credit enhancement and its role

11
Key Trends - Financial Engineering

• Repackaging Services of Financial Intermediaries
• Bundling and unbundling of cash flows
• Slicing and dicing of cash flows
• Examples strips, CMOs, dual purpose funds,
  principal/interest splits