CHAPTER 1 The Investment Environment Investments 8 th

CHAPTER 1 The Investment Environment Investments, 8 th edition Bodie, Kane and Marcus Slides by Susan Hine Mc. Graw-Hill/Irwin Copyright © 2009 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

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 1 -2

Table 1. 1 Balance Sheet of U. S. Households, 2007 1 -3

Table 1. 2 Domestic Net Worth 1 -4

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 1 -5

Financial Markets and the Economy • Information Role – The Google effect • Consumption Timing • Allocation of Risk • Separation of Ownership and Management – Agency Issues 1 -6

Financial Markets and the Economy Continued • Corporate Governance and Corporate Ethics – Accounting Scandals • Examples – Enron, Rite Aid, Health. South – Auditors—watchdogs of the firms – Analyst Scandals • Arthur Andersen – Sarbanes-Oxley Act • Tighten the rules of corporate governance 1 -7

The Investment Process • Asset allocation – Choice among broad asset classes • Security selection – Choice of which securities to hold within asset class • Security analysis 1 -8

Markets are Competitive • Risk-Return Trade-Off • Efficient Markets – 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 1 -9

The Players • Business Firms– net borrowers • Households – net savers • Governments – can be both borrowers and savers • Financial Intermediaries – Investment Companies – Banks – Insurance companies – Credit unions 1 -10

The Players Continued • Investment Bankers – Perform specialized services for businesses – Markets in the primary market 1 -11

Table 1. 3 Balance Sheet of Commercial Banks, 2007 1 -12

Table 1. 4 Balance Sheet of Nonfinancial U. S. Business, 2007 1 -13

Recent Trends—Globalization • • American Depository Receipts (ADRs) Foreign securities offered in dollars Mutual funds that invest internationally Instruments and vehicles continue to develop (WEBs) • Exchange Traded Funds (ETFs) 1 -14

Figure 1. 1 Globalization: A Debt Issue Denominated in Euros 1 -15

Recent Trends—Securitization • Mortgage pass-through securities • Other pass-through arrangements – Car, student, home equity, credit card loans • Offers opportunities for investors and originators 1 -16

Figure 1. 2 Asset-backed Securities Outstanding 1 -17

Recent Trends—Financial Engineering • Use of mathematical models and computerbased trading technology to synthesize new financial products • Bundling and unbundling of cash flows 1 -18

Figure 1. 3 Building Creates a Complex Security 1 -19

Figure 1. 4 Unbundling of Mortgages into Principal- and Interest-Only Securities 1 -20

Recent Trends—Computer Networks • Online information dissemination • Information is made cheaply and widely available to the public • Automated trade crossing – Direct trading among investors 1 -21