Chapter 1. IntroductionChapter 1. IntroductionChapter 1. IntroductionChapter 1. Introduction

• financial assets

• financial markets

• derivatives markets

• financial assets

• financial markets

• derivatives markets

I. Financial AssetsI. Financial AssetsI. Financial AssetsI. Financial Assets

• assets = anything with value– tangible = physical property– intangible = legal claim to

something of value

• assets = anything with value– tangible = physical property– intangible = legal claim to

something of value

financial assetsfinancial assetsfinancial assetsfinancial assets

• intangible assets

• claim to future cash flows– issuer pays cash flows– investor receives cash flows

• also called– financial instruments–securities

• intangible assets

• claim to future cash flows– issuer pays cash flows– investor receives cash flows

• also called– financial instruments–securities

• financial assets finance tangible assets• financial assets finance tangible

assets

debt vs. equitydebt vs. equitydebt vs. equitydebt vs. equity

• debt security–cash flows are fixed–bonds, loans

• equity security–cash flow variable, residual–common stock

• debt security–cash flows are fixed–bonds, loans

• equity security–cash flow variable, residual–common stock

Price & riskPrice & riskPrice & riskPrice & risk

• price of security =

PV of expected cash flows–use appropriate discount rate–are cash flows certain?

• price of security =

PV of expected cash flows–use appropriate discount rate–are cash flows certain?

RiskRiskRiskRisk

• degree of uncertainty about cash flows– inflation–default–exchange rates– liquidity–regulation

• degree of uncertainty about cash flows– inflation–default–exchange rates– liquidity–regulation

financial assetsfinancial assetsfinancial assetsfinancial assets

• transfer funds from savers to borrowers

• redistribute risk

• vehicle of financial intermediaries

• transfer funds from savers to borrowers

• redistribute risk

• vehicle of financial intermediaries

II. Financial MarketsII. Financial MarketsII. Financial MarketsII. Financial Markets

• Why have them?–determine price/value & allocate

resources–ease of buying and selling

securities–reduce transactions costs

• Why have them?–determine price/value & allocate

resources–ease of buying and selling

securities–reduce transactions costs

ClassificationClassificationClassificationClassification

• type of assets–debt market–equity market

• maturity of assets–money market (short-term debt)–capital market (long-term)

• type of assets–debt market–equity market

• maturity of assets–money market (short-term debt)–capital market (long-term)

• time of delivery of assets–cash/spot market

-- exchange immediately after trade

–derivative market

-- exchange in future even though trade today

• time of delivery of assets–cash/spot market

-- exchange immediately after trade

–derivative market

-- exchange in future even though trade today

• age of asset–primary market (newly issued)–secondary market (previously

issued)

• structure of market–exchange (physical location)–over-the-counter (dealers)

• age of asset–primary market (newly issued)–secondary market (previously

issued)

• structure of market–exchange (physical location)–over-the-counter (dealers)

GlobalizationGlobalizationGlobalizationGlobalization

• many financial markets in each country merging to an international market

• why?–advances in technology–deregulation–greater choice/lower cost funding–growth in institutional trading

• many financial markets in each country merging to an international market

• why?–advances in technology–deregulation–greater choice/lower cost funding–growth in institutional trading

III. Derivatives MarketsIII. Derivatives MarketsIII. Derivatives MarketsIII. Derivatives Markets

• what are derivatives?–contracts for future sale/purchase

of an asset–contract values DERIVED from

asset value– futures contracts, options

contracts

• what are derivatives?–contracts for future sale/purchase

of an asset–contract values DERIVED from

asset value– futures contracts, options

contracts

How are derivatives used?How are derivatives used?How are derivatives used?How are derivatives used?

• manage risk from changes in– interest rates–stock prices–exchange rates

• cheap way to manage risks

• manage risk from changes in– interest rates–stock prices–exchange rates

• cheap way to manage risks