CHAPTER 1 The Investment

Environment

Investments, 8th edition

Bodie, Kane and Marcus

Slides by Susan Hine

McGraw-Hill/Irwin Copyright © 2009 by The McGraw-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

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Table 1.1 Balance Sheet of U.S.
Households, 2007

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Table 1.2 Domestic Net Worth

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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

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Financial Markets and the Economy

• Information Role
– The Google effect
• Consumption Timing
• Allocation of Risk
• Separation of Ownership and
Management
– Agency Issues

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

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 The Investment Process

• Asset allocation
– Choice among broad asset classes
• Security selection
– Choice of which securities to hold within
asset class
• Security analysis

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 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
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 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

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 The Players Continued

• Investment Bankers
– Perform specialized services for
businesses
– Markets in the primary market

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Table 1.3 Balance Sheet of
Commercial Banks, 2007

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Table 1.4 Balance Sheet of Nonfinancial
U.S. Business, 2007

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 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)

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Figure 1.1 Globalization: A Debt Issue
Denominated in Euros

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 Recent Trends—Securitization

• Mortgage pass-through securities

• Other pass-through arrangements
– Car, student, home equity, credit card
loans
• Offers opportunities for investors and
originators

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Figure 1.2 Asset-backed Securities
Outstanding

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Recent Trends—Financial Engineering

• Use of mathematical models and computer-

based trading technology to synthesize new
financial products
• Bundling and unbundling of cash flows

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Figure 1.3 Building Creates a Complex
Security

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Figure 1.4 Unbundling of Mortgages into
Principal- and Interest-Only Securities

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Recent Trends—Computer Networks

• Online information dissemination

• Information is made cheaply and widely
available to the public
• Automated trade crossing
– Direct trading among investors

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