Chapter 1

Introduction

Types of Assets
Tangible Assets
Value is based on physical properties Examples include buildings, land, machinery

Intangible Assets
Claim to future income Examples include various types of financial assets

Types of Financial Assets

Bank loans Government bonds Corporate bonds Municipal bonds Foreign bond Common stock Preferred stock Foreign stock

Debt vs. Equity

Debt Instruments
Fixed dollar payments Examples include loans, bonds

Equity Claims
Dollar payment is based on earnings Residual claims Examples include common stock, partnership share

Price of Financial Asset and Risk

The price or value of a financial asset is equal to the present value of all expected future cash flows.
Expected rate of return Risk of expected cash flow

Types of Investment Risks

Purchasing power risk or inflation risk Default or credit risk Exchange rate or currency risk

Role of Financial Assets

Transfer funds from surplus units to deficit units. Transfer funds so as to redistribute unavoidable risk associated with cash flows generated from both tangible and intangible assets.

Role of Financial Markets

Determine price or required rate of return of asset. Provide liquidity. Reduce transactions costs, which consists of search costs and information costs.

Classification of Financial Markets

Debt vs. equity markets Money market vs. capital market Primary vs. secondary market Cash or spot vs. derivatives market Auction vs. over-the-counter vs. intermediated market

Financial Market Participants

Households Business units Federal, state, and local governments Government agencies Supranationals Regulators

Globalization of Financial Markets

Deregulation or liberalization of financial markets Technological advances Increased institutionalization

Classification of Global Financial Markets

Internal Market (also called national market) External Market (also called international market, offshore market, and Euromarket)

Domestic Market

Foreign Market

Motivation for Using Foreign Markets and Euromarkets

Limited fund availability in internal market Reduced cost of funds Diversifying funding sources

Derivatives Market
Futures/forward contracts are obligations that must be fulfilled at maturity. Options contracts are rights, not obligations, to either buy (call) or sell (put the underlying financial instrument.

Role of Derivative Instruments

Protect against different types of investment risks, such as purchasing power risk, interest rate risk, exchange rate risk. Advantages:
Lower transactions costs Faster to carry out transaction Greater liquidity