1 / 44

Chapter 1

Chapter 1. Investments - Background and Issues. Investments & 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. The Investment Process.

Anita
Download Presentation

Chapter 1

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript


  1. Chapter1 Investments - Background and Issues

  2. Investments & 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

  3. The Investment Process • Asset allocation • Security selection • Risk-return trade-off • Market efficiency • Active vs. passive management

  4. 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

  5. Major Classes of Financial Assets or Securities • Debt • Money market instruments • Bonds • Common stock • Preferred stock • Derivative securities

  6. Investments and Innovation Technology and Delivery of Service • Computer advancements • More complete and timely information Globalization • Domestic firms compete in global markets • Performance in regions depends on other regions • Causes additional elements of risk

  7. Key Trends - Globalization International and Global Markets Continue Developing • Managing foreign exchange • Diversification to improve performance • Instruments and vehicles continue to develop • Information and analysis improves

  8. Key Trends - Securitization Securitization & Credit Enhancement • Offers opportunities for investors and originators • Changes in financial institutions and regulation • Improvement in information capabilities • Credit enhancement and its role

  9. Key Trends - Financial Engineering Repackaging Services of Financial Intermediaries • Bundling and unbundling of cash flows • Slicing and dicing of cash flows • Examples: strips, CMOs, dual purpose funds, principal/interest splits

  10. The Future • Globalization continues and offers more opportunities • Securitization continues to develop • Continued development of derivatives and exotics • Strong fundamental foundation is critical • Integration of investments & corporate finance

  11. Chapter2 Financial Markets and Instruments

  12. Major Classes of Financial Assets or Securities • Debt • Money market instruments • Bonds • Common stock • Preferred stock • Derivative securities

  13. Markets and Instruments • Money Market • Debt Instruments • Derivatives • Capital Market • Bonds • Equity • Derivatives

  14. Money Market Instruments • Treasury bills • Certificates of deposit • Commercial Paper • Bankers Acceptances • Eurodollars • Repurchase Agreements (RPs) and Reverse RPs • Federal Funds

  15. Money Market Instrument Yields • Yields on Money Market Instruments are not always directly comparable Factors influencing yields • Par value vs. investment value • 360 vs. 365 days assumed in a year (366 leap year) • Bond equivalent yield

  16. Interest rates that arise in connection with money market securities .Bank discount rate (rBD ) .This is a rate that is used solely for determining the price of a MM security for trading purposes. .Bond equivalent yield (rBEY ) .In general, a yield is an interest rate that (under very specific, sometimes unrealistic, assumptions) represents a rate of return. .rBEY is such a rate of return. It is an annual percentage rate (APR) .For comparing different MM instruments, we often use the effective annual rate (EAR) of the rBEY .

  17. - P 10,000 360 x r = BD n 10,000 - 10,000 9,875 360 x r = = 5% BD 90 10,000 Bank Discount Rate (T-Bills) rBD = bank discount rate P = market price of the T-bill n = number of days to maturity Example 90-day T-bill, P = $9,875

  18. Bond Equivalent Yield • Can’t compare T-bill directly to bond • 360 vs 365 days • Return is figured on par vs. price paid • Adjust the bank discounted rate to make it comparable

  19. P 10,000 - 365 x r = BEY n P 10,000 - 9,875 365 x r = BEY 9,875 90 Bond Equivalent Yield P = price of the T-bill n = number of days to maturity Example Using Sample T-Bill rBEY = .0127 x 4.0556 = .0513 = 5.13%

  20. Capital Market - Fixed Income Instruments Publicly Issued Instruments • US Treasury Bonds and Notes • Agency Issues (Fed Gov) • Municipal Bonds Privately Issued Instruments • Corporate Bonds • Mortgage-Backed Securities

  21. Capital Market - Equity • Common stock • Residual claim • Limited liability • Preferred stock • Fixed dividends - limited • Priority over common • Tax treatment

  22. Stock Indexes Uses • Track average returns • Comparing performance of managers • Base of derivatives Factors in constructing or using an Index • Representative? • Broad or narrow? • How is it constructed?

  23. Examples of Indexes - Domestic • Dow Jones Industrial Average (30 Stocks) • Standard & Poor’s 500 Composite • NASDAQ Composite • NYSE Composite • Wilshire 5000

  24. Examples of Indexes - Int’l • Nikkei 225 & Nikkei 300 • FTSE (Financial Times of London) • Dax • Region and Country Indexes • EAFE • Far East • United Kingdom

  25. Construction of Indexes • How are stocks weighted? • Price weighted (DJIA) • Market-value weighted (S&P500, NASDAQ) • Equally weighted (Value Line Index)

  26. Example .Suppose we have two stocks #Shares Stock Pr 9/19/01 Pr 9/20/01 Return Outstand A 100 120 20% 10M B 10 9 –10% 500M .Computation of a price-weighted index (like the Dow) .Index on 9/19/01 (100+10)/2 = 55 Index on 9/20/01 (120+9)/2 = 64.5 Return on index 17.27% .This is called a price-weighted index because the index return is the price-weighted average of the component (100/110) x 20% + (10/110) x –10% = 17.27% .Portfolio: one share in each stock.

  27. Market-value weighted index .A market-value weighted average (like the S&P). .Index on 9/19/01 = “100” (an arbitary base level) .Market value of A = $100 x 10M = $1,000M Market value of B = $10 x 500M = $5,000M .Return on index is (1,000/6,000) x 20% + (5,000/6000) x –10% = –5% .Index on 9/20/01 = 100 x (1–5%) = 95 .Portfolio: 1/6 in A; 5/6 in B .An equally-weighted index (like the Wilshire 5000) .Index on 9/19/01 = “100” (an arbitary base level) .Return on index is (20% + –10%)/2 = +5% .Index on 9/20/01 = 100 x (1+5%) = 105 .Portfolio: equal amounts in A and B

  28. Chapter3 How Securities are Traded

  29. Primary vs. Secondary Security Sales • Primary • New issue • Key factor: issuer receives the proceeds from the sale • Secondary • Existing owner sells to another party • Issuing firm doesn’t receive proceeds and is not directly involved

  30. Investment Banking Arrangements • Underwritten vs. “Best Efforts” • Underwritten: firm commitment on proceeds to the issuing firm • Best Efforts: no firm commitment • Negotiated vs. Competitive Bid • Negotiated: issuing firm negotiates terms with investment banker • Competitive bid: issuer structures the offering and secures bids

  31. Public Offerings • Public offerings: registered with the SEC and sale is made to the investing public • Shelf registration (Rule 415, since 1982) • Initial Public Offerings (IPOs) • Evidence of underpricing • Performance

  32. Private Placements Private placement: sale to a limited number of sophisticated investors not requiring the protection of registration • Dominated by institutions • Very active market for debt securities • Not active for stock offerings

  33. Organization of Secondary Markets • Organized exchanges • OTC market • Third market • Fourth market

  34. Organized Exchanges • Auction markets with centralized order flow • Dealership function: can be competitive or assigned by the exchange (Specialists) • Securities: stock, futures contracts, options, and to a lesser extent, bonds • Examples: NYSE, AMEX, Regionals, CBOE

  35. Types of Orders Instructions to the brokers on how to complete the order • Market • Limit • Stop loss

  36. Margin Trading • Using only a portion of the proceeds for an investment • Borrow remaining component • Margin arrangements differ for stocks and futures

  37. Stock Margin Trading • Maximum margin is currently 50%; you can borrow up to 50% of the stock value • Set by the Fed • Maintenance margin: minimum amount equity in trading can be before additional funds must be put into the account • Margin call: notification from broker you must put up additional funds

  38. Margin Trading - Initial Conditions X Corp $70 50% Initial Margin 40% Maintenance Margin 1000 Shares Purchased Initial Position Stock $70,000 Borrowed $35,000 Equity 35,000

  39. Margin Trading - Maintenance Margin Stock price falls to $60 per share New Position Stock $60,000 Borrowed $35,000 Equity 25,000 Margin% = $25,000/$60,000 = 41.67%

  40. Margin Trading - Margin Call How far can the stock price fall before amargin call? (1000P - $35,000)* / 1000P = 40% P = $58.33 * 1000P - Amt Borrowed = Equity

  41. Short Sales Purpose: to profit from a decline in the price of a stock or security Mechanics • Borrow stock through a dealer • Sell it and deposit proceeds and margin in an account • Closing out the position: buy the stock and return to the party from which is was borrowed

  42. Short Sale - Initial Conditions Z Corp 100 Shares 50% Initial Margin 30% Maintenance Margin $100 Initial Price Sale Proceeds $10,000 Margin & Equity 5,000 Stock Owed 10,000

  43. Short Sale - Maintenance Margin Stock Price Rises to $110 Sale Proceeds $10,000 Initial Margin 5,000 Stock Owed 11,000 Net Equity 4,000 Margin % (4000/11000) 36%

  44. Short Sale - Margin Call How much can the stock price rise before a margin call? ($15,000* - 100P) / (100P) = 30% P = $115.38 * Initial margin plus sale proceeds

More Related