Investments Midterm
Chapter 1 and Chapter 2:
Investment – Commitment of money or other current resources with the expectation of deriving greater benefits in the
future.
– Education, time, money
– The goal of investing is to generate wealth and gather assets.
Real Assets vs. Financial Assets:
– Real assets determine the productive wealth of the society
– Financial assets determine the wealth of the individuals or firms holding them
Real Assets:
– Land
– Building
– Machinery
– Furniture
– Knowledge
Financial asset determines the means by which individuals hold their claims on real assets.
Real assets appear only on the asset side of the balance sheet
Financial assets appear both on the asset and liability side
– When we aggregate overall balance sheet, financial asset will cancel out, leaving only the sum of real assets
as net wealth of aggregate economy.
Real assets are destroyed only by accident or by wearing out over time
Financial assets are created and destroyed during the ordinary course of business
Marketable Assets:
– Equity Shares
– Money Market Instruments
– Bonds
– Mutual Funds
Non-marketable Assets:
– Bank deposits
– Post office saving deposit
– Company deposits
– Provident fund deposits
– Life Insurance
Marketable Securities:
Money Market Securities:
– Treasury bills
– Euro Dollars
– Commercial papers
– Negotiable Certificates
– Banker’s Acceptance
– Purchase Agreement
Capital Market Securities:
– Fixed income securities
– Bonds
– Treasury notes and bonds
– Federal agencies securities
– Municipal bonds
– Corporate bonds
– Common stocks
– Preferred stocks
Derivatives:
– Options
– Futures
– Rights and Warrants
– Forwards
– Swaps
–
Indirect Investments:
– Unit trusts
– Investment trusts
– Hedge funds
Why financial assets?
– Consumption timing: to shift consumption needs across time
– Allocation of risk: real asset too risky
– Separation of ownership and management
Investment Process:
– Asset allocation – Allocation of an investment portfolio across broad asset classes (equity, bond,
commodities, cash)
– Security selection – Choice of securities within each asset class
– Security analysis – Analysis of the value of securities that might be included in portfolio
Major Players in Financial Markets:
– Firms are net demanders of capital (investments in plant and equipment)
– Households are supplies of capital
– Governments can be borrowers/lenders
– Financial intermediaries are institutions that connect borrows and lenders, accept funds from lenders and
loaning funds to borrowers (investment companies, insurance companies, credit unions)
– Investment banks, firms that specialize in the sale of new securities to the public by underwriting the issue.
New issues are offered to the primary market.
– Venture capital
– Private equity
Indexes:
– Dow Jones averages
– Standard & Poor’s indexes
– Bond market indicators
– International indexes
Chapter 3 and Chapter 4:
– Money Markets – The market where short-term securities are bought and sold
– Capital Market – The market where long-term securities such as stocks and bonds are bought and sold
– Primary Market – The market in which new issues of securities are sold to the public
– Secondary Market – The market in which securities are traded after they have been issued
o Role of Secondary Markets
▪ Provides liquidity to security purchasers
▪ Provides continuous pricing mechanism
o Securities Exchanges – Forums where buyers and sellers of securities are brought together to
execute trades
o Nasdaq Market – Employs all-electronic trading platform to execute trades
o Over-the-counter (OTC) Market – Involves trading in smaller, unlisted securities
– Publicly traded securities is that they can be sold later in the public secondary market
Types of Secondary Markets for Equity:
– Secondary Equity Market
o Can be organized and an exchange or as an over-the-counter market
o An exchange is a physical location where buyers and sellers came together to buy and sell securities
o An over-the-counter market in contrast, allow buyers and sellers to transact without meeting at one
physical place
▪ The National Association for Security Dealers Automated Quotation System
Underwriting syndicate: Issuing firm – Lead underwriter – Investment banker A, B, C, D – Investors
Types of Markets:
– Direct search markets
o Buyers and sellers locate one another on their own
– Brokered markets
o 3rd party assistance in location buyer or seller
– Dealer markets
o 3rd party acts as intermediate buyer/seller
– Auction markets
o Brokers and dealers trade in one location, trading is more or less continuous
Trading Order Types:
Market order – Buy/sell at best available price, no price control
Limit order – Buy/sell at a specified price or better, full price control
Stop-Loss order – Buy/sell when price reaches a specified point, one stop price is triggered, no price control
Stop-Loss Limit order – Limit order activated at predetermined price, full price control
Characteristics of an Exchange:
– Place where securities are purchased and sold
– Association of persons whether incorporated or not
– Trading in stock exchange is strictly regulated and rules are prescribed for various transactions
– Both genuine investors and speculators buy or sell shares
– Securities of corporations, trusts, governments, municipal corporations etc. are allowed to be dealt at stock
exchange
Specialist:
Member of stock exchange whose role is to:
– Makes markets on one or more firms (5-10), facilitates trading
– Maintains a fair and orderly market (will deal with own capital if necessary)
– Prohibited from trading ahead of investors who have placed orders to buy or sell securities
Percentage Margin – The ratio of the net worth or the “equity value,” of the account to the market value of the
securities.
Ex. Investor paid $6,000 toward purchase of $10,000 worth of stock, borrowing remaining $4,000 from broker
Assets:
Value of Stock $10,000
Liabilities and Owner’s Equity:
Loan from broker $4,000
Equity $6,000
Percentage Margin = Equity in Account
Value of Stock
$6,000 = .60 or 60%
$10,000
Investment companies are financial intermediaries that invest the funds of individuals or institutions in securities or
other assets.
The advantages/benefits of hiring an investment company:
1. Record keeping and administration (track cap gains, dividends, investments, reinvestment of dividends/interest
income)
