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

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Types of Financial Assets

Bank loans

Common stock

Government

Preferred stock

bonds
Corporate bonds
Municipal bonds
Foreign bond

Foreign stock

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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

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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

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Types of Investment Risks

Purchasing power risk or inflation risk
Default or credit risk
Exchange rate or currency risk

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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.

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Key Points You Should

Understand
Difference between tangible and financial assets
Difference between debt and equity
Cash flow of a financial asset

Three types of risks associated with financial

asset
Two principal economic functions of financial
assets

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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.

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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

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Financial Market Participants

Households
Business units
Federal, state, and local governments

Government agencies
Supranationals
Regulators

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Key Points You Should

Understand
Three economic functions of financial markets
Ways that financial markets can be classified
Market participants

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Globalization of Financial
Markets
Deregulation or liberalization of financial markets
Technological advances
Increased institutionalization

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Classification of Global Financial

Markets
Internal Market
(also called national
market)

Domestic Market

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External Market
(also called international
market, offshore market,
and Euromarket)

Foreign Market

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Motivation for Using Foreign Markets

and Euromarkets
Limited fund availability in internal market
Reduced cost of funds
Diversifying funding sources

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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.

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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

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Key Points You Should

Understand
Three major factors that have integrated financial

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markets
Institutionalization of financial markets
Internal and external markets
Motive to raise money outside of domestic market
Two basic types of derivatives
Principal economic role of derivatives
Potential uses of derivatives

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