Chapter 1
Introduction
Types of Assets
Tangible Assets
Value is based on physical properties
Examples include buildings, land, machinery
Intangible Assets
Claim to future income
Examples include various types of financial
assets
Types of Financial Assets
Bank loans
Common stock
Government bonds Preferred stock
Corporate bonds
Foreign stock
Municipal bonds
Foreign bond
Debt vs. Equity
Debt Instruments
Fixed dollar payments
Examples include loans, bonds
Equity Claims
Dollar payment is based on earnings
Residual claims
Examples include common stock, partnership
share
Price of Financial Asset
and Risk
The price or value of a financial asset is
equal to the present value of all expected
future cash flows.
Expected rate of return
Risk of expected cash flow
Types of Investment Risks
Purchasing power risk or inflation risk
Default or credit risk
Exchange rate or currency risk
Role of Financial Assets
Transfer funds from surplus units to deficit
units.
Transfer funds so as to redistribute
unavoidable risk associated with cash
flows generated from both tangible and
intangible assets.
Role of Financial Markets
Determine price or required rate of return
of asset.
Provide liquidity.
Reduce transactions costs, which consists
of search costs and information costs.
Classification of Financial
Markets
Debt vs. equity markets
Money market vs. capital market
Primary vs. secondary market
Cash or spot vs. derivatives market
Auction vs. over-the-counter vs.
intermediated market
Financial Market
Participants
Households
Business units
Federal, state, and local governments
Government agencies
Supranationals
Regulators
Globalization of Financial
Markets
Deregulation or liberalization of financial
markets
Technological advances
Increased institutionalization
Classification of Global
Financial Markets
Internal Market
(also called national
market)
Domestic Market
External Market
(also called international
market, offshore market,
and Euromarket)
Foreign Market
Motivation for Using Foreign
Markets and Euromarkets
Limited fund availability in internal market
Reduced cost of funds
Diversifying funding sources
Derivatives Market
Futures/forward contracts are obligations
that must be fulfilled at maturity.
Options contracts are rights, not
obligations, to either buy (call) or sell (put
the underlying financial instrument.
Role of Derivative
Instruments
Protect against different types of
investment risks, such as purchasing
power risk, interest rate risk, exchange
rate risk.
Advantages:
Lower transactions costs
Faster to carry out transaction
Greater liquidity