chapters 1 & 2
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Chapters 1 & 2. Investments - Background and Issues Financial Markets and Instruments. Investments & Financial Assets. Essential nature of investment Reduced current consumption Planned later consumption Real Assets Assets used to produce goods and services Financial Assets - PowerPoint PPT PresentationTRANSCRIPT
Essentials of Investments
© 2001 The McGraw-Hill Companies, Inc. All rights reserved.
Fourth Edition
Irwin / McGraw-Hill
Bodie • Kane • Marcus1
Chapters 1 & 2
Investments - Background and Issues
Financial Markets and Instruments
Essentials of Investments
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Fourth Edition
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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
Essentials of Investments
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The Investment Process
• Asset allocation
• Security selection
• Risk-return trade-off
• Market efficiency
• Active vs. passive management
Essentials of Investments
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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
Essentials of Investments
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Investments and Innovation
Technology and Delivery of Service• Computer advancements• More complete and timely informationGlobalization• Domestic firms compete in global
markets• Performance in regions depends on
other regions• Causes additional elements of risk
Essentials of Investments
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Key Trends - Globalization
International and Global Markets Continue Developing• Managing foreign exchange• Diversification to improve
performance• Instruments and vehicles continue
to develop• Information and analysis improves
Essentials of Investments
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Key Trends - Securitization
Securitization & Credit Enhancement• Offers opportunities for investors and
originators• Changes in financial institutions and
regulation• Improvement in information
capabilities• Credit enhancement and its role
Essentials of Investments
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Key Trends - Financial Engineering
Repackaging Services of Financial Intermediaries
• Bundling and unbundling of cash flows
• Slicing and dicing of cash flows
• Examples: CMOs, principal/interest splits
Essentials of Investments
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The Future
• Globalization continues and offers more opportunities
• Securitization continues to develop
• Continued development of derivatives and exotics
• Strong fundamental foundation is critical• Integration of investments & corporate
finance
Essentials of Investments
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Major Classes of Financial Assets or Securities
• Debt– Money market instruments– Bonds
• Common stock
• Preferred stock
• Derivative securities
Essentials of Investments
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Markets and Instruments
• Money Market– Debt Instruments– Derivatives
• Capital Market– Bonds– Equity– Derivatives
Essentials of Investments
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Money Market Instruments
• Treasury bills
• Certificates of deposit
• Commercial Paper
• Bankers Acceptances
• Eurodollars
• Repurchase Agreements (RPs) and Reverse RPs
• Federal Funds
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Money Market Instrument Yields
• Yields on Money Market Instruments are not always directly comparable
Factors influencing yields
• Par value vs. investment value
• 360 vs. 365 days assumed in a year (366 leap year)
• Bond equivalent yield
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Bank Discount Rate (T-Bills)
rrBDBD = bank discount rate= bank discount rate
PP = market price of the T-bill= market price of the T-bill
nn = number of days to maturity= number of days to maturity
rrBDBD == 10,00010,000 -- PP10,00010,000
xx 360360nn
90-day T-bill, P = $9,87590-day T-bill, P = $9,875
rrBDBD == 10,00010,000 -- 9,8759,875
10,00010,000 x x
360360
9090== 5%5%
ExampleExample
Essentials of Investments
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Bond Equivalent Yield
• Can’t compare T-bill directly to bond– 360 vs 365 days – Return is figured on par vs. price paid
• Adjust the bank discounted rate to make it comparable
Essentials of Investments
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Bond Equivalent Yield
P = price of the T-billP = price of the T-bill
n = number of days to maturityn = number of days to maturity
rr BEYBEY == 10,00010,000 -- PP
PP xx 365365
nn
rrBEYBEY == 10,00010,000 -- 9,8759,875
9,8759,875 x x 365365
9090rrBEYBEY = .0127 x 4.0556 = .0513 = 5.13% = .0127 x 4.0556 = .0513 = 5.13%
Example Using Sample T-BillExample Using Sample T-Bill
Essentials of Investments
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Effective Annual Rate of Return
• Similar to the bond equivalent yield • However, the annualized rate is compounded.
r = 10,000-9,875 = 0.0127
9,875
EAR = (1.0127)4 - 1 = 0.0518
= 5.18%
Essentials of Investments
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Capital Market - Fixed Income Instruments
Publicly Issued Instruments• US Treasury Bonds and Notes• Agency Issues (Fed Gov)
– Example FHLB, FNMA
• Municipal Bonds– General obligation or revenue
Privately Issued Instruments• Corporate Bonds• Mortgage-Backed Securities
Essentials of Investments
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Capital Market - Equity
• Common stock– Residual claim– Limited liability
• Preferred stock– Fixed dividends - limited– Priority over common– Tax treatment
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Uses
• Track average returns
• Comparing performance of managers
• Base of derivatives
Factors in constructing or using an Index
• Representative?
• Broad or narrow?
• How is it constructed?
Stock Indexes
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Examples of Indexes - Domestic
• Dow Jones Industrial Average (30 Stocks)
• Standard & Poor’s 500 Composite
• NASDAQ Composite
• NYSE Composite
• Wilshire 5000
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Examples of Indexes - Int’l
• Nikkei 225 & Nikkei 300
• FTSE (Financial Times of London)
• Dax
• Region and Country Indexes– EAFE– Far East– United Kingdom
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Construction of Indexes
• How are stocks weighted?– Price weighted (DJIA)– Market-value weighted (S&P500,
NASDAQ)– Equally weighted (Value Line Index)
Essentials of Investments
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Fourth Edition
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Derivatives Securities
Options• Basic Positions
– Call (Buy)– Put (Sell)
• Terms– Exercise Price– Expiration Date– Assets
Futures • Basic Positions
– Long (Buy)– Short (Sell)
• Terms– Delivery Date– Assets