CHAPTER 1 Mc GrawHillIrwin Investments Background and Issues

CHAPTER 1 Mc. Graw-Hill/Irwin Investments Background and Issues © 2007 The Mc. Graw-Hill Companies, Inc. , All Rights Reserved.

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 1 -2

Balance Sheet – U. S. Households 1 -3

Domestic Net Worth 1 -4

Major Classes of Financial Assets or Securities Debt – – Money market instruments Bonds Common stock Preferred stock Derivative securities 1 -5

Financial Markets and the Economy Consumption Timing Allocation of Risk Separation of Ownership and Management – Agency Issues 1 -6

Large Option Exercises 1 -7

Crisis in Corporate Governance Accounting Scandals – Examples – Enron and World. Com Analyst Scandals – Example – Citigroup’s Salomon Smith Barney Initial Public Offerings – Credit Swiss First Boston 1 -8

The Investment Process Asset allocation Security selection Risk-return trade-off Market efficiency Active vs. passive management 1 -9

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 1 -10

Players in the Financial Markets Business Firms – net borrowers Households – net savers Governments – can be both borrowers and savers Investment Bankers 1 -11

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 1 -12

Global Debt Issue 1 -13

Key Trends - Securitization & Credit Enhancement Offers opportunities for investors and originators Changes in financial institutions and regulation Improvement in information capabilities Credit enhancement and its role 1 -14

Asset-backed Securities 1 -15

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 1 -16

Building a Complex Security 1 -17

Unbundling – Mortgage Security 1 -18