4751 - Financial Economics
Summer 2011
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©2011 The McGraw-Hill Companies
4751 - Financial Economics
• My Name: Rene Schwengber
• Today:
– Syllabus
– Introduction
• BKM chapter 1
INVESTMENTS | BODIE, KANE, MARCUS
©2011 The McGraw-Hill Companies
Syllabus
• Grade from 3 sources (each worth 1/3)
• average homework
• First exam (July 1st, in class)
• Second exam (July 22nd, in class)
• Homework’s typed and stapled
• otherwise cap maximum grade at 75%
• I will not accept emailed homeworks.
• If you can’t submit homework in due date in class,
talk to me first.
INVESTMENTS | BODIE, KANE, MARCUS
©2011 The McGraw-Hill Companies
Webpage and other content
• Our webpage is http:www.econ.umn.edu/~schwe227
(click on teaching)
• Our required book is BKM.
– We will also use other books for content that
required more depth.
INVESTMENTS | BODIE, KANE, MARCUS
©2011 The McGraw-Hill Companies
Other
• Office Hours:
– TBA, and by appointment.
INVESTMENTS | BODIE, KANE, MARCUS
©2011 The McGraw-Hill Companies
Intro
• Investment (noun) current commitment of money
or other resources in the expectation of reaping
future benefits
– Intertemporal allocation of resources
• Time (for “risk-free” investments)
• Uncertainty (Risky)
• Examples of risky investment?
– (list examples)
• Example of risk-free investment?
– (list examples)
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©2011 The McGraw-Hill Companies
Real Assets Versus Financial Assets
• Real Assets
>____________<
– Examples: Land, buildings, machines,
knowledge used to produce goods and
services
• Financial Assets
>____________<
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Financial Assets
• Three types:
1. Fixed income or debt
>____________<
2. Common stock or equity
>____________<
3. Derivative securities
>____________<
INVESTMENTS | BODIE, KANE, MARCUS
©2011 The McGraw-Hill Companies
Financial Assets vs. Real Assets
polling
•
Which type of assets do you think is most
important in an economy?
•
Real assets.
•
How important do you think financial assets
are in a modern well functioning economy?
–
Very ______ Not that much ______
INVESTMENTS | BODIE, KANE, MARCUS
©2011 The McGraw-Hill Companies
Class vote
•
How important financial assets are in a
modern well functioning economy?
____ “Very” vs. ____ “Not that much”
Let’s hear this 4minutes clip.
http://hhei.umn.edu/videos/video3.html
•
•
•
About in 3’40’’ to 5’30”
INVESTMENTS | BODIE, KANE, MARCUS
©2011 The McGraw-Hill Companies
Example: Dutch East India Company
• As mentioned in the video. Financial assets are
important in a well functioning economy since they
provide some means on how to best allocate resources
at any given time.
• Consider the Dutch East India Company example.
– Chartered company
– Founded in 17th century defunct almost in 19th century
– Fist company to issue Stock (financial asset)
INVESTMENTS | BODIE, KANE, MARCUS
©2011 The McGraw-Hill Companies
Example: Dutch East India Company
•
•
•
•
Consider the Dutch East India Company
What is a stock?
Stock or equity is a claim of ownership on a firm.
Payoff of exploration was potentially very big (high gains)
but so was its risk (e.g. loss ship)
• Idea: Spread risk by financing more than one expedition
at once.
• Many claim this was one of the major force behind the
Dutch growth in maritime power in that period (and
believe, the growth and power of this mega-coroporation
was every big)
INVESTMENTS | BODIE, KANE, MARCUS
©2011 The McGraw-Hill Companies
Investment Example
• The goal of investing in simple:
– Maximize (today and future) utility while allocating current
resources into real and financial assets.
• Assume agents value streams of daily consumption.
– (c1, c2, c3, c4) (a vector) gives Utility U(c1, c2, c3, c4) (a
number)
• E.g.: Stream 1: (1,1,1,97) vs. Stream 2 (25,25,25,25)
– Which would you rank higher?
• Most would prefer the 2nd stream of consumption
• This type of question is studied under the label “Theory
of Choice (under uncertainty)”. We will spend some time
talking about it
INVESTMENTS | BODIE, KANE, MARCUS
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Financial Markets and the Economy
• Information Role: >____________<
• Consumption Timing: >____________<
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Financial Markets and the
Economy (Ctd.)
• Allocation of Risk: >____________<
• Separation of Ownership and Management:
>____________<
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General problem
• A well-developed economy with financial
markets provides:
– intertemporal allocation of resources
– Insurance
• against bad shocks
• decreasing volatility
• You can think of a financial assets as the means of
decreasing the friction on resource allocation in the
economy
INVESTMENTS | BODIE, KANE, MARCUS
©2011 The McGraw-Hill Companies
The Investment Process
• Asset allocation
– Choice among broad asset classes
• Security selection
– Choice of which securities to hold within
asset class
– Security analysis to value securities and
determine investment attractiveness
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Markets are Competitive
• Risk-Return Trade-Off
– The will always be risk associated to
investments.
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Markets are Competitive (Ctd.)
• Efficient Markets
– Passive Management
• No attempt to find undervalued securities
• No attempt to time the market
• Holding a highly diversified portfolio
– Active Management
• Finding mispriced securities
• Timing the market
INVESTMENTS | BODIE, KANE, MARCUS
©2011 The McGraw-Hill Companies
Last Announcement
• Read Chapter 1 from BKM (focus on 1.1 to
1.5)
• Read Chapter 2 of Theory of Value (link in
class webpage)
• We will review basic concepts from basic
probability theory.
• What time Office Hours works for most?
INVESTMENTS | BODIE, KANE, MARCUS
©2011 The McGraw-Hill Companies