Professional Documents
Culture Documents
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Finance
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Areas of Finance
Financial Management
Financial Economics
Investments
Security analysis
Portfolio theory
Market Analysis
Behavioral Finance
Personal Finance
Public Finance
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What is “Behavioral Finance”?
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Investments
Real Assets = Hard assets
Real estate, commodities
(Gold, silver, oil etc)
Suppliers of capital:
Individuals and institutions with “excess funds”. These groups are
saving money and looking for a rate of return on their investment.
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How is capital transferred between savers and
borrowers?
Direct transfers ($ go directly from saver to borrower)
Example:
Your small business borrows money from a wealthy individual in exchange
for a part ownership
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Transfer of capital
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What is a market?
Options exchanges
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How important are financial markets?
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Summary of Classification of
Financial Markets
Classification by nature of claim.
Debt market; Equity market
Classification by maturity of claim.
Money market; Capital market
Classification by seasoning of claim.
Primary market; Secondary market
Classification by immediate delivery or future
delivery
Cash or spot market; Derivative market
Classification by organizational structure
Auction market; Over-the-counter market; Intermediated market
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Financial Instruments and
Markets
Primary Markets
Market for issuing a new security and distributing to
saver-lenders.
Investment Banks—Information and marketing
specialists for newly issued securities.
Secondary Markets
Market where existing securities can be exchanged
New York Stock Exchange
American Stock Exchange
Over-the-counter (OTC) markets
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Stock Market Transactions
Apple Computer decides to issue stock for the first time with the
assistance of its investment banker. An investor purchases some of
the newly issued shares. Is this a primary market transaction or a
secondary market transaction?
Since new shares of stock are being issued, this is a primary market
transaction.
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What is an IPO?
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Stock Represents Ownership
Stockholders
Owns part of the corporation and receives
dividends from the issuer.
Capital Gains
Difference between price initially paid and amount
received when stock is sold.
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Types of Corporate Stock
Preferred Stock
Fixed dividends, priority over common stock
Common Stock
Variable dividends, based on company’s profits.
Convertible
Preferred stock that can be converted into
common stock at a stated price
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Common stock
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Preferred Stock
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Measures of Trends in Common
Stock Prices
Standard & Poor’s 500 Stock Index
Based on prices of 500 individual stocks
NASDAQ Composite Index
Based on all stocks listed in NASDAQ
Dow Jones Industrial Average
Based on price of 30 “blue-chip” stocks
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S&P 500 Index, Total Returns: Dividend Yield +
Capital Gain or Loss, 1968-2007
What was the total return for 2008? - 57%
What was the total return for 2009? + 26%
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Where can you find a stock quote, and what does
one look like?
Stock quotes can be found in a variety of print sources (Wall
Street Journal or the local newspaper) and online sources
(Yahoo!Finance, CNNMoney, or MSN MoneyCentral).
This one is from finance.yahoo.com
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What is “Market Efficiency”?
This means, for example, if you hear in the news that a medical research
company received FDA approval for one of its products. By the time you
hear the news, this information probably will already have been
incorporated into the company’s stock price. So, it’s probably too late to
take advantage of this information by purchasing the stock.
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What is “Market Efficiency”? (continued)
A small investor has been reading about a “hot” IPO that is scheduled to
go public later this week. She wants to buy as many shares as she can get
her hands on, and is planning on buying a lot of shares the first day once
the stock begins trading. Would you advise her to do this?
Probably not. The long-run track record of hot IPOs is not that great,
unless you are able to get in on the ground floor and receive an
allocation of shares before the stock begins trading. It is usually hard
for small investors to receive shares of hot IPOs before the stock
begins trading.
The “hot” IPOs usually go to big institutional traders (hedge fund
managers, investment banks, and mutual fund managers).
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What is the Efficient Market Hypothesis
(EMH)?
Securities are normally in equilibrium and are “fairly priced.”
Investors cannot “beat the market” except through good luck or
better information.
Efficiency continuum
Highly Highly
Inefficient Efficient
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Bonds Represent Borrowing
Agreement by issuer to pay interest on specified
dates and redeem the bond upon maturity.
Consol
Bond with no maturity date, pay interest forever
Coupon Securities
Make interest payments – usually semiannually.
Zero-coupon
Make no interest payments.
Sold at price well below face value.
Tax Exempt
Interest earned is not taxed.
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Bond
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Both stocks and bonds represent a claim
to a stream of payments in the future.
Bonds—Interest payment and face value at
maturity
Stocks—Dividends and sales price when sold
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Mortgages
Debt incurred in order to buy land or building
Amortized—principal and interest is gradually
repaid over the life of loan
Fixed Rate—Rate of interest is fixed
Variable-Rate—Rate of interest varies
depending on financial environment
Cash flow for lender is uncertain
Interest payments may vary - variable rate mortgages
Home owner may prepay
Refinance a fixed mortgage if interest rates decline
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Mortgages
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What are derivatives?
How can they be used to reduce or increase risk?
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Options and Futures Contracts
Contractual agreement between two parties to
exchange an asset in the future at a stated price
Derivative financial instruments
Derive value from underlying assets
Long
Buyer of the contract, receive commodity in the future
Short
Seller of the contract, provide commodity in the future
Speculators
Gamble on price fluctuations and hope to profit
Hedgers
Eliminate the risk of price fluctuations
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The Money Market
Exchange of short-term instruments—less than one
year
Highly liquid, minimal risk
Use of a temporary surplus of funds by banks or
businesses
U.S. Treasury bills—short-term debts of US government
Bank Certificates of Deposits—liabilities of issuing bank,
interest bearing to corporations that hold them
Commercial paper—short-term liabilities of prime business firms
and finance companies
Federal Funds—Exchange of excess/deficient reserves between
banks on an overnight basis.
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Pakistani MM T-Bills
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The Capital Market
Exchange of long-term securities—in excess
of one year
Generally used to secure long-term financing for
capital investment
Stock market—Largest part of capital market and
held by private and institutional investors
Corporate bond market—Held by insurance
companies, pension and retirement funds
Local and state government bonds—Primarily held
for tax-exempt feature
Government securities—Held by commercial banks,
the Fed, individual Americans/foreigners, and dealers
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Role of Financial Intermediaries
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Types of financial Institutions
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Types of financial Institutions
Deposit-taking institutions that accept and manage
deposits and make loans, including banks, building
societies, credit unions, trust companies, and mortgage
loan companies.
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Types of financial institutions
Commercial banks
Investment banks
Financial services corporations
Credit unions
Pension funds
Life insurance companies
Mutual funds
Hedge funds
Private equity companies
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Commercial Banks
Most prominent financial institution
Range in size from huge (BankAmerica) to small (local
banks)
Major sources of funds
used to be demand deposits of public
now rely more on “other liabilities”
also accept savings and time deposits
Uses of funds
short-term government securities
long-term business loans
home mortgages
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Commercial Banks in Pakistan
Commercial banks
Allied Bank Limited Allied Bank of Pakistan
Bank Alfalah Limited
Habib Bank Limited
Bank Al-Habib Limited
Standard Chartered Bank Limited
City Bank Limited
United Bank Limited
Askari Bank Limited.
MCB Bank Limited.
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Investment Banks
In the primary market, investment banks assist a
business in selling a new issue to the public.
Investment banks underwrite new securities,
meaning that they buy the new issue from the
business and sell it to the public.
Investment banks charge fees for this service,
along with any profits from reselling the issue at a
higher price.
Underwriting is big business. The largest
underwriters of new equity securities include Merril
Lynch, Salomon Smith Barney, and Goldman
Sachs.
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Investment banks in Pakistan
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Life Insurance Companies
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Pension and Retirement Funds
(Superannuation Funds)
Concerned with long run
Receive funds from working
individuals building “nest-egg”
Accurate prediction of future use of
funds
Invest mainly in long-term corporate
bonds and high-grade stock
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Mutual Funds
minimize risk
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Money Market Mutual Funds
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Savings and Loan Associations
(S&L’s)
Traditionally acquired funds through savings
deposits
Used funds to make home mortgage loans
Now perform same functions as commercial
banks
issue checking accounts
make consumer and business loans
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Commercial and Consumer Finance
Companies
Acquire funds primarily by selling short term
loans (commercial paper)
Lend money for consumer purchases or
business firms to finance inventories
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Property and Casualty Insurance
Companies
Insure homeowners and businesses against
losses
Receive premiums
Need to be fairly liquid due to uncertainty of
claims
Purchase a variety of securities
high-grade stocks and bonds
short-term money market instruments for liquidity
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Credit Unions
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Hedge funds
Hedge funds—financial institutions that pool funds from a limited number
(e.g., less than 100) of wealthy (e.g., annual incomes of more than
$200,000 or net worth exceeding $1 million) individuals and other investors
(e.g., commercial banks) and invest these funds on their behalf, usually
keeping a large proportion (commonly 20 percent) of any upside return and
charging a fee (2%) on the amount invested.
Unregulated ( with few regulations. They can do whatever they want
Hedge funds managers are smarter
Exotic instrument = having special feature/common
Very rare instrument
High risk
High return
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Private Equity firms
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The End
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