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Investments - Introduction. Riccardo Colacito. Assets. Real Assets Assets used to produce goods and services Financial Assets Claims on real assets. Balance Sheet – U.S. Households. Major Classes of Financial Assets or Securities. Fixed Income or Debt

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Investments - Introduction

Riccardo Colacito


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Assets

  • Real Assets

    • Assets used to produce goods and services

  • Financial Assets

    • Claims on real assets



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Major Classes of Financial Assets or Securities

  • Fixed Income or Debt

    • Money market (e.g.T-Bills): low risk

    • Capital market: variety of risks

  • Equity

    • Ownership share in the corporation

  • Derivative securities

    • Call or Put options

    • Futures


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Why do we invest?

  • Essential nature of investment

    • Reduced current consumption

    • Planned later consumption

  • Consumption Timing

  • Allocation of Risk


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Ownership and Management

  • Separation of Ownership and Management

    • Agency Issues: managers may wish to pursue their own interests

    • Stock option compensations

  • Does this system work well?


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Crisis in Corporate Governance

  • Accounting Scandals

    • Examples – Enron and WorldCom

  • Analyst Scandals

    • Example – Citigroup’s Salomon Smith Barney

  • Initial Public Offerings

    • Credit Swiss First Boston


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The Investment Process

  • Asset allocation

    • Choice among broad asset classes

  • Security selection

    • Choice of particular securities within each class

  • Security analysis

    • Analysis of the value of securities


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Competitive Markets

  • No free lunches!

  • Risk-return trade-off

  • Market efficiency


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Active vs. Passive Management

Active Management

  • Finding undervalued securities

  • Timing the market

    Passive Management

  • No attempt to find undervalued securities

  • No attempt to time

  • Holding an efficient portfolio


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Players in the Financial Markets

  • Business Firms – net borrowers

  • Households – net savers

  • Governments – can be both borrowers and savers

  • Financial Intermediaries

  • Investment Companies


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Key Trends

  • Globalization

  • Securitization

  • Financial Engineering


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Key Trends - Globalization

International and Global Markets Continue Developing

  • Diversification to improve performance

  • Managing foreign exchange

  • Instruments and vehicles continue to develop (WEBs)

  • Exchange rate risk


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Key Trends - Securitization

  • Mortgages can be traded like other securities

  • Pass-through securities

  • Majority of home mortgages pooled into mortgage-backed securities




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Key Trends - Financial Engineering

  • Repackaging Services of Financial Intermediaries

  • Bundling and unbundling of cash flows

  • Slicing and dicing of cash flows


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