Investments
Lecture 1. (Chapter 1.1-1.6 ; 2.1-2.3 ; 4.1-4.4)
Chapter 1
Real vs Financial assets. Real = land, buildings, machines, knowledge,… ;
Financial = stocks, bonds, obligations,…
Three main broad types of financial assets:
- Fixed-income or debt securities = often bonds promising a fixed stream
of income at different maturities, yields, and risks
- Equity = share in corporation, value is tied to success of the firm, no fixed
payment, only when firm pays out dividends.
- Derivative securities = options, futures contracts,… payoff determined
by price of other financial assets such as stocks and bonds
The informational role of financial markets: stock prices reflect investors’
assessment of a firm’s performance and future prospects, however markets don’t
always channel resources to the most efficient use (dot-com bubble). We need to
be careful, no one knows with certainty which ventures will succeed and which
will fail.
Consumption timing: financial markets allow to spread consumption over time
by investing in financial assets in high-earnings periods and selling these assets
in low-earnings periods. Allowing to shift purchasing power/consumption over
time.
Allocation of Risk: financial markets allow investors to take on as much risk as
they want, getting higher returns for more risk. (risk-return trade-off)
Separation of Ownership and Management: large firms worth billions of
dollars are owned by tens of thousands of shareholders, these firms cant be
managed by one or all these shareholders so they select a board of directors that
manage the firm for them hoping they act in the best interest of all the
shareholders and thus maximizing value of the firm.
Critics say that management should consider stakeholder interests
(employees, customers, suppliers, community)
If managers pursue their own interests instead of shareholders we call this
agency problems.
To battle this CEO compensation is often tied to stock performance,
although this creates other problems (more later)
Since the board of directors can also act on their own interests, there is a rising
case of proxy contests where funds buy stakes into the company forcing change
of management and demanding change of the company’s actions. Aside from
this the real threat is from other firms, underperforming firms can be acquired by
other firms forcing a change in management with its own team. This should be
reflected in a rise in stock prices as prospects improve.
,Corporate ethics: financial markets will only allocate capital efficiently if
investors are acting on accurate information. Markets need to be transparent for
investors, otherwise much can go wrong.
The investment process: investors face 2 types of decisions when constructing
their portfolios: The asset allocation decision (allocate wealth to diff assets), and
the security selection decision (which particular securities to hold within each
asset class) -> Security analysis allows to valuate those that might be included in
the portfolio.
Markets are competitive: allowing no arbitrage opportunities -> there is a risk-
return trade-off in markets. To decrease risk one can diversify his portfolio, so
that the exposure to one single asset is limited.
Efficient markets: following the no arbitrage position. There should rarely be
bargains in security markets, security prices should reflect all the information
available to investors -> as new information comes out, prices adjust accordingly.
This is the EMH.
Implication of this concerns the passive vs active management strategies.
Passive = holding highly diversified portfolios. Active = actively searching
for mispriced assets to improve performance
EMH suggests that maybe we should only do passive management, and
there is no need for security analysis. However, if there is no security
analysis prices might deviate from their correct values creating incentives
for investors. This suggests that markets may only be near-efficient and
profit opportunities exist.
3 major players:
1) Firms: net demanders of capital, which they raise now to pay for
investments. Income generated by these investments provides investors
who purchased securities, returns.
2) Households: net suppliers of capital, they purchase the securities.
3) Governments: can be borrowers or lenders, depending on the tax revenue
and government expenditures
To bring 1) and 2) more together, financial intermediaries such as banks,
investment companies, insurance companies,… exist. Pooling resources of many
small investors to lend considerable amounts to large borrowers.
Other players:
- Investment bankers: offer specialized services to corporations such as:
support issuance of new securities = underwriting (advice on appropriate
pricing and marketing in primary market), give advice on strategic financial
decisions (eg M&A, restructuring), offer risk management and cash
management solutions, and offer specialized investment products to other
financial intermediaries
- Private equity: investment in equity of non-listed firms: young start-ups
(venture capital), and mature companies (growthcapital or buy-outs). -> PE
partner often being active in the management of the company
, - Fintech: application of technology to financial markets -> led to financial
disintermediation (DeFi), eg peer-to-peer lending, robo advice, blockchains,
crypto, digital token,…
Chapter 2.1 – 2.3
Explains money markets and capital markets, the 2nd divided into LT bond
markets, equity markets, and derivative markets for options and futures.
Not yet looking at derivate markets in this part.
The money market: short term, low risk debt securities -> allow us to ‘save’
=> treasury bills, CD, CP, Banker’s acceptance, repo, interbank loans, CB
deposits & loans, Call loans.
Most money market instruments are low risk, but not risk-free! In general
T-bills have the lowest risk, both in terms of credit risk, as well as liquidity
risk
The capital market – The bond market: longer term debt instruments with
wide range of maturities and various credit qualities. Liquidity varies from very
high to almost zero. Often in smaller denominations and traded over the counter
(OTC) instead of on the exchange. Typically pay a coupon interest. Performance
measurement: hpr or ytm
Treasury notes, treasury bonds, treasury inflation-protected securities,
federal agency/municipal bonds, corporate bonds, asset backed debt
The capital market – equity/stocks: are issued by corporations and represent
ownership in a firm, equity represents a residual claim you only receive a
payout if all other claims are met. Equity has limited liability -> minimum share
price is zero. Performance measurement: return
Preferred shares posses common equity features but also bond features:
share of ownership, no voting power, promise of fixed dividend
Chapter 4.1 – 4.4
Investment funds:
retail investors do not trade individual securities directly, but invest in a fund that
allows them to pool assets in which they share ownership (realize economies of
scale):
- Diversification and divisibility
- Lower transaction costs
- Professional management
- Record keeping and administration
Investors buy shares and ownership is proportional to the # of shares purchased,
the value of each share is called the net asset value (NAV).
Market value of assets−Liabilities
NAV =
Shares outstanding
, When the composition of the fund is changed, we compute the turnover rate as:
Market value of assets sold
Turnover rate=
Market value of assets
Funds with higher turnover incur higher transaction costs
Types of Investment funds:
Open-end fund (Mutual fund): managed fund with specified investment policy
that issues new shares when investors buy in and redeem shares when investors
cash out. They are priced at NAV.
Closed-end fund: managed fund with specified investment policy and fixed
number of shares, do not redeem or issue shares, investors who wish to cash out
must sell their shares to other investors. Trade intra-day on an organized
exchange at market determined prices.
Unit trust: collective investment establish under a trust deed with investors being
the beneficiaries
Exchange traded fund (ETF): hybrid format, legally structured as open-end, but
traded intra-day very close to NAV on an organized exchange.
Other types of investment organizations: not formally organized or
regulated as investment funds but have similar purpose
Commingled funds: partnerships of investments for large investors and not
regulated as a mutual fund, typically retirement or trust accounts with very large
portfolios but still too small to manage on a separate basis.
Real estate investment trust (REIT): an investment vehicle to invest in real estate
either as equity REIT (own real estate directly) or mortgage REIT (invest in
mortgage loans).
Hedge funds: private partnerships of investments with limited regulation allowing
managers to pursue strategies typically not open to mutual fund managers.
Mutual funds:
Parties involved: Sponsors (set up the fund), Fund (manages fund operations),
board of directors (oversees management in the interest of SH), Shareholders
(entitled to financial proceeds and have voting power), Advisors (manage the
fund’s portfolio in line with investment policy)
Even more… : Administrator (handles back-off administration), Principal
underwriter/distributor (acts as a sales agreement agent btwn fund and broker-
dealers/ distributes the fund), Transfer agent (maintains records of SH’s
accounts), Custodian (safe keeps the assets & assesses conduct of fund and
quality of information it receives), Auditor (certifies fund’s statements)
As many external parties are involved, this has implications for the costs of
investing in a mutual fund eg operating expenses and management fees are
reflected in the expense ratio
Lecture 1. (Chapter 1.1-1.6 ; 2.1-2.3 ; 4.1-4.4)
Chapter 1
Real vs Financial assets. Real = land, buildings, machines, knowledge,… ;
Financial = stocks, bonds, obligations,…
Three main broad types of financial assets:
- Fixed-income or debt securities = often bonds promising a fixed stream
of income at different maturities, yields, and risks
- Equity = share in corporation, value is tied to success of the firm, no fixed
payment, only when firm pays out dividends.
- Derivative securities = options, futures contracts,… payoff determined
by price of other financial assets such as stocks and bonds
The informational role of financial markets: stock prices reflect investors’
assessment of a firm’s performance and future prospects, however markets don’t
always channel resources to the most efficient use (dot-com bubble). We need to
be careful, no one knows with certainty which ventures will succeed and which
will fail.
Consumption timing: financial markets allow to spread consumption over time
by investing in financial assets in high-earnings periods and selling these assets
in low-earnings periods. Allowing to shift purchasing power/consumption over
time.
Allocation of Risk: financial markets allow investors to take on as much risk as
they want, getting higher returns for more risk. (risk-return trade-off)
Separation of Ownership and Management: large firms worth billions of
dollars are owned by tens of thousands of shareholders, these firms cant be
managed by one or all these shareholders so they select a board of directors that
manage the firm for them hoping they act in the best interest of all the
shareholders and thus maximizing value of the firm.
Critics say that management should consider stakeholder interests
(employees, customers, suppliers, community)
If managers pursue their own interests instead of shareholders we call this
agency problems.
To battle this CEO compensation is often tied to stock performance,
although this creates other problems (more later)
Since the board of directors can also act on their own interests, there is a rising
case of proxy contests where funds buy stakes into the company forcing change
of management and demanding change of the company’s actions. Aside from
this the real threat is from other firms, underperforming firms can be acquired by
other firms forcing a change in management with its own team. This should be
reflected in a rise in stock prices as prospects improve.
,Corporate ethics: financial markets will only allocate capital efficiently if
investors are acting on accurate information. Markets need to be transparent for
investors, otherwise much can go wrong.
The investment process: investors face 2 types of decisions when constructing
their portfolios: The asset allocation decision (allocate wealth to diff assets), and
the security selection decision (which particular securities to hold within each
asset class) -> Security analysis allows to valuate those that might be included in
the portfolio.
Markets are competitive: allowing no arbitrage opportunities -> there is a risk-
return trade-off in markets. To decrease risk one can diversify his portfolio, so
that the exposure to one single asset is limited.
Efficient markets: following the no arbitrage position. There should rarely be
bargains in security markets, security prices should reflect all the information
available to investors -> as new information comes out, prices adjust accordingly.
This is the EMH.
Implication of this concerns the passive vs active management strategies.
Passive = holding highly diversified portfolios. Active = actively searching
for mispriced assets to improve performance
EMH suggests that maybe we should only do passive management, and
there is no need for security analysis. However, if there is no security
analysis prices might deviate from their correct values creating incentives
for investors. This suggests that markets may only be near-efficient and
profit opportunities exist.
3 major players:
1) Firms: net demanders of capital, which they raise now to pay for
investments. Income generated by these investments provides investors
who purchased securities, returns.
2) Households: net suppliers of capital, they purchase the securities.
3) Governments: can be borrowers or lenders, depending on the tax revenue
and government expenditures
To bring 1) and 2) more together, financial intermediaries such as banks,
investment companies, insurance companies,… exist. Pooling resources of many
small investors to lend considerable amounts to large borrowers.
Other players:
- Investment bankers: offer specialized services to corporations such as:
support issuance of new securities = underwriting (advice on appropriate
pricing and marketing in primary market), give advice on strategic financial
decisions (eg M&A, restructuring), offer risk management and cash
management solutions, and offer specialized investment products to other
financial intermediaries
- Private equity: investment in equity of non-listed firms: young start-ups
(venture capital), and mature companies (growthcapital or buy-outs). -> PE
partner often being active in the management of the company
, - Fintech: application of technology to financial markets -> led to financial
disintermediation (DeFi), eg peer-to-peer lending, robo advice, blockchains,
crypto, digital token,…
Chapter 2.1 – 2.3
Explains money markets and capital markets, the 2nd divided into LT bond
markets, equity markets, and derivative markets for options and futures.
Not yet looking at derivate markets in this part.
The money market: short term, low risk debt securities -> allow us to ‘save’
=> treasury bills, CD, CP, Banker’s acceptance, repo, interbank loans, CB
deposits & loans, Call loans.
Most money market instruments are low risk, but not risk-free! In general
T-bills have the lowest risk, both in terms of credit risk, as well as liquidity
risk
The capital market – The bond market: longer term debt instruments with
wide range of maturities and various credit qualities. Liquidity varies from very
high to almost zero. Often in smaller denominations and traded over the counter
(OTC) instead of on the exchange. Typically pay a coupon interest. Performance
measurement: hpr or ytm
Treasury notes, treasury bonds, treasury inflation-protected securities,
federal agency/municipal bonds, corporate bonds, asset backed debt
The capital market – equity/stocks: are issued by corporations and represent
ownership in a firm, equity represents a residual claim you only receive a
payout if all other claims are met. Equity has limited liability -> minimum share
price is zero. Performance measurement: return
Preferred shares posses common equity features but also bond features:
share of ownership, no voting power, promise of fixed dividend
Chapter 4.1 – 4.4
Investment funds:
retail investors do not trade individual securities directly, but invest in a fund that
allows them to pool assets in which they share ownership (realize economies of
scale):
- Diversification and divisibility
- Lower transaction costs
- Professional management
- Record keeping and administration
Investors buy shares and ownership is proportional to the # of shares purchased,
the value of each share is called the net asset value (NAV).
Market value of assets−Liabilities
NAV =
Shares outstanding
, When the composition of the fund is changed, we compute the turnover rate as:
Market value of assets sold
Turnover rate=
Market value of assets
Funds with higher turnover incur higher transaction costs
Types of Investment funds:
Open-end fund (Mutual fund): managed fund with specified investment policy
that issues new shares when investors buy in and redeem shares when investors
cash out. They are priced at NAV.
Closed-end fund: managed fund with specified investment policy and fixed
number of shares, do not redeem or issue shares, investors who wish to cash out
must sell their shares to other investors. Trade intra-day on an organized
exchange at market determined prices.
Unit trust: collective investment establish under a trust deed with investors being
the beneficiaries
Exchange traded fund (ETF): hybrid format, legally structured as open-end, but
traded intra-day very close to NAV on an organized exchange.
Other types of investment organizations: not formally organized or
regulated as investment funds but have similar purpose
Commingled funds: partnerships of investments for large investors and not
regulated as a mutual fund, typically retirement or trust accounts with very large
portfolios but still too small to manage on a separate basis.
Real estate investment trust (REIT): an investment vehicle to invest in real estate
either as equity REIT (own real estate directly) or mortgage REIT (invest in
mortgage loans).
Hedge funds: private partnerships of investments with limited regulation allowing
managers to pursue strategies typically not open to mutual fund managers.
Mutual funds:
Parties involved: Sponsors (set up the fund), Fund (manages fund operations),
board of directors (oversees management in the interest of SH), Shareholders
(entitled to financial proceeds and have voting power), Advisors (manage the
fund’s portfolio in line with investment policy)
Even more… : Administrator (handles back-off administration), Principal
underwriter/distributor (acts as a sales agreement agent btwn fund and broker-
dealers/ distributes the fund), Transfer agent (maintains records of SH’s
accounts), Custodian (safe keeps the assets & assesses conduct of fund and
quality of information it receives), Auditor (certifies fund’s statements)
As many external parties are involved, this has implications for the costs of
investing in a mutual fund eg operating expenses and management fees are
reflected in the expense ratio
