fabozzi_fofmi4_ch01

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Introduction

Chapter 1


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Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall2

Types of Assets

y Tangible Assets

y Value is based on physical properties

y Examples include buildings, land, machinery

y

Intangible Assetsy Claim to future income

y Examples include various types of financial assets


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Types of Financial Assets

y Bank loans

y Government bonds

y

Corporate bonds

y Municipal bonds

y Foreign bond

y Common stock

y Preferred stock

y

Foreign stock


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Debt vs. Equity

y Debt Instruments

y Fixed dollar payments

y Examples include loans, bonds

y

Equity Claimsy Dollar payment is based on earnings

y Residual claims

y Examples include common stock, partnership share


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Price of Financial Asset and Risk

y The price or value ofa financial asset is equal to the present

value ofall expected future cash flows.

y Expected rate of return

y

Risk of expected cash flow


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Types of Investment Risks

y Purchasing power risk or inflation risk

y Default or credit risk

y Exchange rate or currency risk


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Role of Financial Assets

y Transfer funds from surplus units to deficit units.

y Transfer funds so as to redistribute unavoidable risk

associated with cash flows generated from both tangible and

intangible assets.


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KeyPoints You Should Understand

y Difference between tangible and financial assets

y Difference between debt and equity

y Cash flow ofa financial asset

y Three types of risks associated with financial assety Two principal economic functions of financial assets


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Role of Financial Markets

y Determine price or required rate of return ofasset.

y Provide liquidity.

y Reduce transactions costs, which consists of search costs and

information costs.


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Classification of Financial Markets

y Debt vs. equity markets

y Money market vs. capital market

y Primary vs. secondary market

y Cash or spot vs. derivatives markety Auction vs. over-the-counter vs. intermediated market


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Financial Market Participants

y Households

y Business units

y Federal, state, and local governments

y Government agenciesy Supranationals

y Regulators


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y Three economic functions of financial markets

y Ways that financial markets can be classified

y Market participants


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Globalization of Financial Markets

y Deregulation or liberalization of financial markets

y Technological advances

y Increased institutionalization


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Classification ofGlobal FinancialMarkets

Internal Market

(also called nationalmarket)

External Market

(also called internationalmarket, offshore market,

and Euromarket)

Domestic Market Foreign Market


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Motivation for Using Foreign Markets andEuromarkets

y Limited fund availability in internal market

y Reduced cost of funds

y Diversifying funding sources


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Derivatives Market

y Futures/forward contracts are obligations that must be

fulfilled at maturity.

y Options contracts are rights, not obligations, to either buy

(call) or sell (put the underlying financial instrument.


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Role ofDerivative Instruments

y Protect against different types of investment risks, such as

purchasing power risk, interest rate risk, exchange rate risk.

y Advantages:

y L

ower transactions costsy Faster to carry out transaction

y Greater liquidity


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y Three major factors that have integrated financial markets

y Institutionalization of financial markets

y Internal and external markets

y Motive to raise money outside of domestic markety Two basic types of derivatives

y Principal economic role of derivatives

y Potential uses of derivatives


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Types of Regulation

y Disclosure regulation

y Financial activity regulation

y Regulation of financial institution

y Regulation of foreign participation


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Regulation in the United States

y Reasons for regulation

y Stock market crash of 1929

y Great Depression of 1930s

y

Regulation primarily by SEC, CFTC,Treasury, and FederalReserve

y Blueprint for Regulatory Reform

y Split regulation by functions

y

Market stability regulatory Prudential regulator

y Business conduct regulator


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y Explanation for the existence of regulation

y Goals sought in regulation

y Major forms of regulation

y Blueprint for Regulatory Reform


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All rights reserved. No part of this publication may be reproduced,

stored in a retrieval system, or transmitted, in any form or by any means,

electronic, mechanical, photocopying, recording, or otherwise, withoutthe prior written permission of the publisher. Printed in the United States

of America.

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