Chapter 1
Background and Issues
Definition
An investment is the commitment of
current resources in the expectation of
future benefits.
1.1 Real vs Financial Assets
Real
Assets
Financial Assets:
Claims on Real Assets or Real
Asset Income
Productive
Capacity
Property, plants
and equipment,
human capital,
etc.
1.1 Real vs Financial Assets
Table 1.1 Balance Sheet, U.S. Households, 2014
Assets
Real assets
Real estate
Consumer durables
Other
Total real assets
Financial assets
Deposits
Life insurance reserves
Pension reserves
Corporate equity
Equity in noncorp. business
Mutual fund shares
Debt securities
Other
Total financial assets
TOTAL
$ Billion
% Total
$22,820
5,041
468
$28,330
23.9%
5.3%
0.5%
29.6%
8,038
1,298
13,419
8,792
11.2%
1.8%
18.7%
12.2%
6,585
5,050
4,129
1,536
48,847
71,932
9.2%
7.0%
5.7%
2.1%
67.9%
100.0%
Liabilities and Net Worth
$ Billion
% Total
Mortgages
Consumer credit
Bank and other loans
Security credit
Other
Total liabilities
$9,551
3,104
493
352
286
$13,785
13.3%
4.3%
0.7%
0.5%
0.4%
19.2%
Net worth
58,147
$71,932
80.8%
100.0%
1.2 Financial Assets
Common Stock
Ownership stake in entity,
residual cash flow
Asset
Classes
Derivative Securities
Fixed Income Securities
Contract, value derived
from underlying market
condition
Money market
instruments,
Bonds, Preferred stock
1.3 Financial Markets and the Economy
• The Informational Role of Financial Markets
• Consumption timing
• Allocation of risk
• Separation of ownership and management
1.4 The Investment Process
• Asset allocation
• Security selection
“Top-down” vs. “bottom-up”
1.5 Markets are Competitive
• Risk-return trade-off
• Efficient Markets
– Passive management
– Active management
1.6 The Players
• Firms, Households, Government
‒ Financial Intermediaries
‒ Investment Bankers
‒ Venture Capital and Private Equity
FTSE/JSE ALSI vs DJIA
(Trading Economics, 2015)
1.7 The Financial Crisis of 2008
1.7 The Financial Crisis of 2008
Antecedents of the Crisis:
• Low interest rates
• A stable economy
• Housing market boom
• A search for higher-yield investments
1.7 The Financial Crisis of 2008
Changes in Housing Finance
• 1970s: Fannie Mae and Freddie Mac bundle
mortgage loans into tradable pools (securitization)
• Subprime loans: Loans above 80% of home value,
no underwriting criteria, higher default risk
1.7 The Financial Crisis of 2008
Mortgage Derivatives
• CDO
• CDS
1.7 The Financial Crisis of 2008
The Shoe Drops
Dodd-Frank Reform Act
• Stricter rules for bank capital, liquidity, risk
management
• Mandated increased transparency
• Clarified regulatory system