Investment Analysis & Portfolio Management

Chapter 1

The Investment Environment

FIN 435 (Instructor- Saif Rahman)

Investments & Financial Assets

Essential nature of investment

Reduced current consumption Planned later consumption

Real Assets

Productive capacity is a function of the real assets of the economy: the land, buildings, knowledge and machines that are used to produce goods and the workers whose skills are necessary to use those resources So, Real assets are used to produce goods and services Financial assets are claims on real assets The money a firm receives when it issues securities (sells them to investors) is used to purchase real assets. Ultimately, then, the returns on a financial asset come from the income produced by the real assets that are financed by the issuance of the security.
FIN 435 (Instructor- Saif Rahman)

Financial Assets

Classification of Financial Assets

Fixed

income or debt

Money market instruments

Bank

certificates of deposit

Capital market instruments

Bonds

Common

stock or equity securities

FIN 435 (Instructor- Saif Rahman)

Derivative

The Investment Process

Asset

allocation Choice among broad asset classes Security selection Choice of which securities to hold within asset class Security analysis

DIVERSIFICATION KEY TO ASSET ALLOCATION

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Investment Psychology
Risk-Return

Trade-Off Efficient Markets Active Management Finding mispriced securities Timing the market Passive Management No attempt to find undervalued securities No attempt to time the market Holding a highly diversified portfolio
FIN 435 (Instructor- Saif Rahman)

The Players
Business Firms net borrowers Households net savers Governments can be both borrowers and savers Non-residents: Specifically for a remittance dependent country such as Bangladesh Financial Intermediaries Investment Companies Banks Insurance companies Credit unions Investment Bankers FIN 435 (Instructor- Saif Rahman)

The Financial System

FIN 435 (Instructor- Saif Rahman)

Financial Markets

Primary Market

Markets that involve the issue of new securities by the borrower in return for cash from investors (Capital formation occurs)

Secondary Market

Markets that involve buyers and sellers of existing securities. Funds flow from buyer to seller. Seller becomes the new owner of the security. (No capital formation occurs)
FIN 435 (Instructor- Saif Rahman)

The Agency Problem

Agency

relationship

Principal hires an agent to represent their interest Stockholders (principals) hire managers (agents) to run the company

Agency

problem

Conflict of interest between principal and agent

Management
8

goals and agency costs

FIN 435 (Instructor- Saif Rahman)

Managing Managers
Managerial

compensation

Incentives can be used to align management and stockholder interests

The incentives need to be structured carefully to make sure that they achieve their goal

Corporate

control

The threat of a takeover may result in better management

Other
9

stakeholders

FIN 435 (Instructor- Saif Rahman)

Recent Trends TrendsGlobalization

American Depository Receipts (ADRs) Foreign securities offered in dollars Mutual funds that invest internationally Instruments and vehicles continue to develop (WEBs) Exchange Traded Funds (ETFs)

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Recent Trends TrendsSecuritization

Mortgage Other

pass-through securities

pass-through arrangements student, home equity, credit card loans opportunities for investors and originators

Car, Offers

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Recent Trends TrendsFinancial Engineering

Use

of mathematical models and computer-based

trading technology to synthesize new financial products

Bundling

and unbundling of cash flows

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Recent Trends TrendsComputer Networks

Online

information dissemination is made cheaply and widely available

Information

to the public
Automated Direct

trade crossing

trading among investors

FIN 435 (Instructor- Saif Rahman)