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Chap 001
Chap 001
Investments: Background
and Issues
McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
1.1 Real Versus Financial
Assets
1-2
Real Versus Financial Assets
• Essential nature of investment
• Reduce current consumption in hopes of greater
future consumption
• Real Assets
• Used to produce goods and services: Property,
plant & equipment, human capital, etc.
• Financial Assets
• Claims on real assets or claims on asset income
Table 1.1. Balance Sheet –
U.S. Households, 2008
Real versus Financial Assets
• All financial assets (owner of the claim) are offset by
a financial liability (issuer of the claim).
• When we aggregate over all balance sheets, only
real assets remain.
• Hence the net wealth of an economy is the sum of its
real assets.
Table 1.2 Domestic Net Worth, 2008
1.2 A Taxonomy of
Financial Assets
Major Classes of Financial Assets or
Securities
• Debt
o Money market instruments
• Bank certificates of deposit, T-bills, commercial
paper, etc.
o Bonds
o Preferred stock
• Common stock
o Ownership stake in the entity, residual cash flow
• Derivative securities
o A contract whose value is derived from some
underlying market condition.
1.3 Financial Markets and
the Economy
Financial Markets
• Informational Role of Financial Markets
o Do market prices equal the fair value estimate of a
security’s expected future risky cash flows?
o Can we rely on markets to allocate capital to the
best uses?
• What other mechanism could we use to
allocate capital?
• What would be the advantages and
disadvantages of another system?
Consumption Timing
o People tend to smooth consumption over time.
o Primary market:
• A market where newly issued securities are offered to
the public.
• The investment banker typically ‘underwrites’ the issue.
o Secondary market
• A market where pre-existing securities are traded among
investors.
Investment Bankers
• Investment Bankers
o Commercial and investment banks’ functions and
organizations were separated by law from 1933 to 1999.
• Securitization
• Financial Engineering