Investments, 8th edition

Bodie, Kane and Marcus

Slides by Susan HineSlides by Susan Hine

McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

CHAPTER 1CHAPTER 1 The Investment The Investment EnvironmentEnvironment

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Real Assets Versus 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

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Table 1.1 Balance Sheet of U.S. Households, 2007

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Table 1.2 Domestic Net Worth

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A Taxonomy of Financial Assets

• Fixed income or debt

– Money market instruments

• Bank certificates of deposit

– Capital market instruments

• Bonds

• Common stock or equity

• Derivative securities

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Financial Markets and the Economy

• Information Role

– The Google effect

• Consumption Timing

• Allocation of Risk

• Separation of Ownership and Management

– Agency Issues

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Financial Markets and the Economy Continued

• Corporate Governance and Corporate Ethics

– Accounting Scandals

• Examples – Enron, Rite Aid, HealthSouth

– Auditors—watchdogs of the firms

– Analyst Scandals

• Arthur Andersen

– Sarbanes-Oxley Act

• Tighten the rules of corporate governance

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The Investment Process

• Asset allocation

– Choice among broad asset classes like stocks, bonds, real estate, commodities

• Security selection

– Choice of which securities to hold within asset class

• Security analysis

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Markets are Competitive• Risk-Return Trade-Off (no free lunch)

• Efficient Markets: price reflects all info.

– Active Management

• Finding mispriced securities

• Timing the market

– Passive Management

• No attempt to find undervalued securities

• No attempt to time the market

• Holding a highly diversified portfolio

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The Players

• Business Firms– net borrowers

• Households – net savers

• Governments – can be both borrowers and savers

• Financial Intermediaries

– Investment Companies; invests mainly in securities

– Banks

– Insurance companies

– Credit unions

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The Players Continued

• Investment Bankers:Goldman Sachs, Citigroup, J.P.Morgan

– Perform specialized services for businesses such as issuing securities for firms

– Markets in the primary market

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Table 1.3 Balance Sheet of Commercial Banks, 2007

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Table 1.4 Balance Sheet of Nonfinancial U.S. Business, 2007

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Recent Trends—Globalization

• American Depository Receipts (ADRs)

claim in shares of a foreign company

• Foreign securities offered in dollars

• Mutual funds that invest internationally

• Variant of ADR: Exchange Traded Funds (ETFs) ,diversified investment in foreign shares, e.g. iSHAREs, WEBS

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Figure 1.1 Globalization: A Debt Issue Denominated in Euros

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Recent Trends—Securitization

• Mortgage pass-through securities

• Other pass-through arrangements

– Car, student, home equity, credit card loans

• Offers opportunities for investors and originators

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Figure 1.2 Asset-backed Securities Outstanding

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Recent Trends—Financial Engineering

• Use of mathematical models and computer-based trading technology to synthesize new financial products

• Bundling and unbundling of cash flows

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Figure 1.3 Building Creates a Complex Security

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Figure 1.4 Unbundling of Mortgages into Principal- and Interest-Only Securities

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Recent Trends—Computer Networks

• Online information dissemination

customer's direct access to an on-line broker

• Information is made cheaply and widely available to the public

• Automated trade crossing

– Direct trading among investors