2 - The Investment Environment (Part I)

The Investment Environment
Prof. Salvador Figueroa Nadal

“One of the funny things
Quote of the Day about the Stock Market is
that every time one person
buys, another sells, and both
think they are astute.”
- William Feather
El Entorno de Inversión 2
Real Assets vs Financial Assets
What is an Investment?
Any asset into which funds can be placed with the expectation to
generate positive income and to preserve or increase its value.
Return: The reward for owning an investment.
• Current Income: Interest or dividend.
• Capital Gain: Increase in value.
Real Assets vs. Financial Assets
Real Assets
• Determine the productive capacity and net income of the economy.
• Used to produce goods and services.
• e.g.: Land, buildings, machines, knowledge used to produce goods and
services, intellectual property.
Financial Assets
• Claims to the income generated by real assets or claims on income from the
government.
• Do not directly contribute to the productive capacity of the economy.
• e.g.: Stocks, bonds...
Real Assets vs. Financial Assets
Are the following assets Real or Financial?
a) Patents a) Real
b) Lease obligations b) Financial
c) Customer goodwill c) Real
d) College education d) Real
e) A $100 bill e) Financial
Types of Financial Assets
Fixed-income / Debt securities
• Promises either a fixed stream of income or a
stream of income determined by a specified
formula .
• e.g..: Corporate bond
• Money market debt: short term, highly

marketable, usually low credit risk.
• Capital market debt: long term bonds, can be safe
or risky
Equity
• Represents ownership share in a firm.
• Ej.: Acciones ordinarias
• Payments to stockholders are not fixed, but depend on
the success of the firm.
Derivative securities
• Payoff depends on the value of other financial
variables such as stock prices, interest rates, or
exchange rates.
• e.g.: Options, Future Contracts...
Other types of Financial Markets
Currency
• Marketplace where different currencies can be
bought and sold
• e.g.: EUR/USD, USD/JPY, GPD/USD...
Cryptocurrency
• Digital or virtual currency secured by
cryptography and based on a network that is
distributed across a large number of computers.
• e.g.: Bitcoin, Ethereum, Tether...
Other types of Financial Markets
Commodities
• Market for buying, selling, and trading raw
materials or primary products
• e.g.: Gold, Natural Gas, Corn, Wheat...
Financial Markets and the
Economy
Financial Markets and the Economy
• Information Role: Stock markets encourage allocation of

capital to those firms that appear at the time to have the best
prospects
• Consumption Timing: Use securities to store wealth and transfer

consumption to the future
• Allocation of Risk: Investors can select securities
consistent with their tastes for risk.
• Virtually all real assets involve some risk.
Q: what is your risk appetite?
• Separation of Ownership and Management
• agency problems
• how to mitigate?
• Corporate Governance and Corporate Ethics – Accounting
Scandals
o Examples – Enron, Rite Aid, HealthSouth
• Auditors – watchdogs of the firms (caveat)
• Analyst Scandals
o Arthur Andersen
• Sarbanes-Oxley Act (2002)

o Tighten the rules of corporate governance
o Personal liability, independent structures
Investment Process
The Investment Process
Portfolio: Collection of investment assets.
Asset Allocation
• Choice among broad asset classes (for example, stocks, bonds, real
estate, etc.)
• Primary determinant of a portfolio's return
• Percentage of fund in assets classes
Security Selection
• Choice of securities within each asset class
• Security analysis to value securities and determine investment
attractiveness
The Investment Process
Security Selection
“Top-Down” Approach
• Asset allocation followed by security analysis
• Determine the mix of asset classes and the determine the investment in
each class
“Bottom-up” approach
• Investment based on attractively priced securities without as much
concern for asset allocation
• Find perceived good investments with little acknowledgement of asset
class proportions
Markets are Competitive
Financial markets are highly competiitive
Risk-Return Trade-Off
• Higher-risk assets are priced to offer
higher expected returns tan lower-risk
assets
• Risk and expected neither underpriced
nor overpriced securities
• These are the important questions of

analysis?
• How do you measure risk?
• How much premium should risk pay?
Efficient Markets
• Efficient markets: price quickly
adjust to all relevant information
• There should be neither underpriced
nor overpriced securities
• The question is:

• How efficient is the market market?
• Are we able to find Nuggets of
information that provided an
advantage over other investors?
Passive Management
• Holding a highly diversified portfolio
• No attempt to find undervalued
securities
• No attempt to time the market
• Assumes a very efficient market
Active Management
• Finding mispriced securities
• Timing the market
• Assumes some inefficiencies
The Players
The Players
Firms
• Net demanders of capital
• Raise capital now to pay for investments in plant and
equipment
Households
• Typically, net suppliers of capital
• Purchase securities issued by firms that need to raise funds
Governments
• Can function as borrowers or lenders, depending on the
relationship between tax revenue and government
expenditures El Entorno de Inversión 26
The Players
Financial intermediaries
• Bring the suppliers of capital (investors) together with the

demanders of capital (primarily corporations and the federal
government)
Examples:
• Investment companies
• Banks
• Insurance companies
• Credit unions
The Players
Investment Bankers
• Specialize in the sale of new securities to the public, typically
by underwriting the issue
• Advise the issuing corporation on appropriate price,
interest rates, etc.
New issues of securities are offered to the public in the primary

market.
Investors trade previously issued securities amongst themselves

in the secondary market.
The Players
Universal Bank Activities
Investment Banking
• Underwrite new stock and bond issues
• Sell newly issued securities to public in the primary market
• Investors trade previously issued securities among
themselves in the secondary markets
Commercial Banking
• Take deposits and make loans
The Players
Venture capital (VC)
• Refers to money invested to finance a new, not yet publicly
traded firm
• VC investors commonly take an active role in the
management of a start-up firm
Private equity
• Refers to investments in companies whose shares are not
publicly traded in a stock market
THANK YOU!

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2 - The Investment Environment (Part I)

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The Investment Environment

Prof. Salvador Figueroa Nadal

Return: The reward for owning an investment.

• Current Income: Interest or dividend.

• Capital Gain: Increase in value.

b) Lease obligations b) Financial

c) Customer goodwill c) Real

d) College education d) Real

e) A $100 bill e) Financial

• Money market debt: short term, highly

• Information Role: Stock markets encourage allocation of

• Consumption Timing: Use securities to store wealth and transfer

Q: what is your risk appetite?

• Separation of Ownership and Management

• Auditors – watchdogs of the firms (caveat)

• Sarbanes-Oxley Act (2002)

Financial markets are highly competiitive

• These are the important questions of

• The question is:

• Bring the suppliers of capital (investors) together with the

New issues of securities are offered to the public in the primary

Investors trade previously issued securities amongst themselves

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