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55 Cards in this Set
- Front
- Back
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Real assets
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Determine the productive capacity and net income of the economy.
Examples: Land, buildings, machines, knowledge used to produce goods and services |
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Finansial assets
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Claims on real assets.
Examples: Stocks, bonds |
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Finansial assets: Fixed-income securities
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The income stream that the owner is entitled to is known in advance.
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Finansial assets: Stocks
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The income stream is linked to the sucess of the firm. Dividends and price increases are the source of income.
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Finansial assets: Derivatives
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These securities entitle their owner to a stream of income that depends on the price of another financial asset.
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The role of the financial market
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Information: Capital flows to companies with 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. Separation of Ownership and Management: Most companies cannot be owned by their manager |
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The Investment Process. Asset allocation
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Choice among broad asset classes: stocks, bonds, real estate, …
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The Investment Process. Security selection
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Choice of which securities to hold within asset class
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The Investment Process. Top-down:
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first asset allocation and then security selection
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The Investment Process. Bottom-up:
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first security selection and then asset allocation
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Markets are competitive
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No arbitrage, Risk-return Trade off, Efficient market hypothesis
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The players
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Business Firms– net borrowers.
Households – net savers. Governments – can be both borrowers and savers |
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Financial markets:
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Money Markets: Short-term and highly liquid financial instruments
Capital Markets: Everything else |
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The Money Market
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Treasury Bills: short-term government debt.
Certificates of Deposit: short-term deposits with a bank. Commercial Paper: short-term debt issued by a firm. Repurchase agreements: overnight debt which uses a government security as collateral |
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The LIBOR Market
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The London Interbank Offered Rate (LIBOR): the rate at which the banks lend money to each other in London
Important reference rates –LIBOR is based on interest rates reported by large banks |
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The Bond Market. Long-term government borrowing:
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–Treasury Notes: Longer term (up to 10 years) –Treasury Bonds: Even longer term (from 10 to 30 years)
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The Bond Market Nongovernment debt:
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higher default risk
–Corporate bonds: Issued by private firms. Special corporate bonds–Callable–Convertible –Mortgage-backed securities: Mortgage lenders pooled their loans into securities which are sold off. The homeowners payments are then transferred to the holders of these securities |
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Equity Securities: Common Stock
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–Residual claim–Limited liability
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Equity Securities: Preferred Stock
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–Features of a bond: it promises a fixed amount of dividends per year
–Features of a stock: these dividends may be unpaid at discretion although if so they are cumulative |
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Stock Market Indexes – 3 types
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Price-weighted indexes:–The weight of each company in the index is proportional to its share price–Example:Dow Jones Industrial Average (DJIA).
Market-valued-weighted indexes:–The weight of each company is proportional to its market value–Examples: S&P 500, OMX Stockholm 30. Equally-weighted indexes.–The weights of all companies is identical –Example:S&P 500 Equal Weight |
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Derivative Marktes. Futures contract:
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The delivery of an asset or its cash value is agreed at a specified price and time
–The buyer commits to purchase the underlying–The seller commits to sell it –The contract is entered at no cost –Who gains when? |
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Derivatives Markets. Options:
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–Calls: they give the right to buy an asset or its cash value at a specified price and time
–Puts: they give the right to sell an asset or its cash value at a specified price and time –The buyer pays a premium to the seller or writer –Two main types: European and American |
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How Firms Issue Securities 1
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Primary Market:–Firms get funding–Investors get new securities.
Secondary Market:–Investors trade previously issued securities among themselves. Private Placement |
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How Firms Issue Securities 2
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Stocks:–IPO–Seasoned offering–Private Placement. Bonds:–Public offering–Private placement
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Initial Public Offerings (IPO´s)
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–Mediated by investment bankers–Publicity (Road Shows)–Bookbuilding. Determining demand for the issue
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How Securities are traded: Types of markets
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Brokered markets:–Brokers offer intermediary services to both buyers and sellers–Example: real estate market.
Dealer markets:–Dealers (the intermediaries) who buy and sell assets have inventories–They need to do pricing work and bear risk and they are compensated with the bid-ask spread–Example: Nasdaq. Auction markets:–Market participants are buying and selling to one another–Auction: the highest bidding price will be matched with the lowest asking price–Example: NYSE |
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Bid and Asked Prices
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Bid Price: Represent offers to buy The price at which the dealer is willing to buy and Investors can sell.
Ask Price:Represent offers to sell. The price at which the dealer is willing to sell and investors can buy |
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How Securities are traded: Types of orders
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Market orders:–Executed immediately: at best bid or best ask prices
Limit orders: They are executed when a stipulated price is reached. The compilation of all active limit orders is known as the limit order book Stop orders:The trade is not to be executed unless a stipulated price is reached |
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Market Making
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Bid-Ask spread is the profit for making a market in a security–Market makers (dealers) provide liquidity and receive the profit from the spread as a compensation–Investors can buy and sell securities but bid-ask spread is considered as part of their cost. Automated trading
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Trading Mechanisms: Dealer markets
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Dealers markets used to involve broker-dealer negotiation–It is still the case in over the counter (OTC) trades
Electronic markets–Participants post market and limit orders over computer networks–Direct crossing of trades without using a broker-dealer system |
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Trading Costs
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Brokerage Commission: fee paid to broker for making the transaction–Explicit cost of trading–Full Service vs. Discount brokerage
Spread: Difference between the bid and asked prices–Implicit cost of trading |
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Buying on Margin
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Borrowing part of the total purchase price of a position using a loan from a broker. Investor contributes the remaining portion. Margin refers to the percentage or amount contributed by the investor.
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Buying on Margin: Maintenance Margin
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The stock value may fall below the loan value. The broker sets a maintenance margin to prevent this possibility. The investor is forced to put down additional cash whenever the value falls below it–He/she receives a margin call–If no reaction, broker sells
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Buying on Margin: The upside and downside
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Upside: Leverage, to gain upside potential and earn more on a positive growth. Downside: Higher risk, losses becomes proportionally larger
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Short Sales
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Purpose: to profit from a expected decline in the price of a stock or security.
Mechanics:–Borrow stock from a broker–Sell it and deposit proceeds and margin in an account–Closing out the position: buy the stock and return it (plus dividends) |
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Insider Trading Regulation
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Officers, directors, major stockholders must report all transactions in firm’s stock. There seems to be evidence suggesting that insiders do exploit their knowledge
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Insider Trading Regulation: Sweden
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Senior executives cannot trade the stock of their own company following inside information. They must report these trades to Finansinspektionen. Finansinspektionen:–Publishes daily these trades in its website–Suspicious operations are investigated
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U.S. and Global Securities Markets
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U.S. securities markets have the most significant role–Many foreign companies list their shares in the USA–The New York Stock Exchange (NYSE) is the largest stock exchange in the world–The NASDAQ OMX Group is the largest exchange company
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Investment Companies
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Pool funds of individual investors and invest in a wide range of securities or other assets. Services provided:–Administration & record keeping–Diversification & divisibility–Professional management–Reduced transaction costs
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Net Asset Value Calculation:
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(Market Value of Assets – Liabilities) / Shares Outstanding
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Managed Investment Companies–Open-End
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Fund issues new shares when investors buy in and redeems shares when investors cash out. Priced at Net Asset Value (NAV)
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Managed Investment Companies–Closed-End
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no change in shares outstanding; old investors cash out by selling to new investors. Priced at premium or discount to NAV.
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Other investment organizations
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–Commingled funds–Real Estate Investment Trusts–Hedge Funds
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Mutual Funds AKA open-end investment companies
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They are categorized by their investment policy–Money Market Funds–Equity Funds–Sector Funds–Balanced Funds–Flexible/Asset Allocation Funds–Index Funds. Their shares can only be bought or sold at the end of the session when NAV is calculated
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Mutual Funds- Index Funds
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–The fund manager follows the benchmark index–Low Costs–Low portfolio turnover
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Mutual Funds - Active Funds
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–The fund manager aims to beat a benchmark index–Higher costs–High portfolio turnover
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Mutual Fund Fees - Four types of fees:
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–Operating expenses
–12 b-1 charge (commissions paid to the brokers)–Front-end load–Back-end load - Fees must be disclosed in the prospectus. |
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Taxation of Mutual Funds
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Investors in mutual funds lose the ability to manage their taxes
–The more the fund trades the more tax inefficiencies for the investor. The trading activity of the fund is measured by its turnover |
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Exchange Traded Funds (ETFs)
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Funds which allow the investor to trade an index. Trade continuously like stocks and closed-end funds. Can be sold short or purchased on margin. Low costs
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Real and Nominal Interest Rates
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Nominal interest rate, R – Growth rate of your money.
Real interest rate, r– Growth rate of your purchasing power |
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Taxes and the Real Rate of Interest
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Investors suffer an inflation penalty equal to the tax rate times the inflation rate. The after-tax real rate of return has a negative relation to the inflation rate – The size of the penalty increases with inflation
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Determination of the Equilibrium Real Rate of Interest
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Supply (households)
Demand (businesses) Government/central bank actions. Expected rate of inflation |
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The Fisher Equation
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Investors demand higher nominal rates of return when the inflation rate increases.
Nominal rate = real rate + inflation forecast |
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Bills and Inflation, 1926-2009
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Moderate inflation can offset most of the nominal gains on low-risk investments. A dollar invested in T-bills from1926–2009 grew to $20.52 in nominal terms, but the corresponding real value was only $1.69.
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Holding Period Return (HPR):
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(P1-P0 + D1) / P0
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