Bodie

Kane

Marcus

INVESTMENTS
Irwin/McGraw-Hill

Chapter 1
The
Investment
Environment

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1-1

Investments
AN INVESTMENT IS the current commitment

of money or other resources in the

expectation of reaping future benefits.
For example, an individual might purchase
shares of stock anticipating that the future
proceeds from the shares will justify both the
time that her money is tied up as well as the
risk of the investment.
The time you will spend studying this text
(not to mention its cost) also is an
investment.

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1-2

Investment and Financial Assets

Essential nature of investment
Reduced current consumption
Planned later consumption
Real Assets
Assets used to produce goods and services
Financial Assets
Claims on real assets

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Role of Financial Assets and

Markets in the Economy
Informational role of financial markets: prices

of stocks reflect investors collective

assessment of firms performance
Consumption Timing: shifting purchasing
power from high-earnings periods to lowearnings periods of life
Allocation of Risk
Separation of Ownership

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1-3

Financial System Clients and

Their Needs
Household Sector
Primary Need: Invest Funds
Business Sector
Primary Need: Raise Funds
Government Sector
Primary Need: Raise Funds

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1-4

How the Financial System Meets

the Needs of Participants
Financial Intermediation
Investment Banking
Financial Innovation & Derivatives
Responding to Regulation & Taxes

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1-5

Major Classes of Financial

Assets
or Securities
Debt
Money market instruments
Bonds
Common stock
Preferred stock
Derivative securities

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Markets and Instruments

Money Market
Debt Instruments
Derivatives
Capital Market
Bonds
Equity
Derivatives

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Money Market
Instruments
Treasury bills
Certificates of deposit- a time deposit with

a bank
Commercial Paper- unsecured debt notes
issued by well-known companies rather
than borrow directly from banks
Bankers Acceptances
Repurchase Agreements (RPs) and Reverse
RPs
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Money Market Instrument Yields

Yields on Money Market Instruments are not

always directly comparable

Factors influencing yields
Par value vs. investment value
360 vs. 365 days assumed in a year (366 leap
year)
Bond equivalent yield

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Bank Discount Rate (TBills)

360
10,000 - P
x
rBD = 10,000
n
rBD = bank discount rate
P

= market price of the T-bill

= number of days to maturity

Example
90-day T-bill, P = $9,800
10,000 - 9,800
rBD =
10,000
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360

90

= 8%

Bond Equivalent Yield

Cant compare T-bill directly to bond
360 vs 365 days
Return is figured on par vs. price paid
Adjust the bank discounted rate to make it

comparable

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Bond Equivalent Yield

r BEY

10,000
=
P

-P

P = price of the T-bill

365
x n

n = number of days to maturity

Example Using Sample T-Bill

10,000 - 9,800
365
rBEY =
x
9,800
90
rBEY = .0204 x 4.0556 = .0828 = 8.28%
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Capital Market Fixed Income Instruments

Publicly Issued Instruments
Treasury Bonds and Notes
Municipal Bonds
Privately Issued Instruments
Corporate Bonds
Mortgage-Backed Securities

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Capital Market - Equity

Common stock
Residual claim
Limited liability
Preferred stock
Fixed dividends - limited
Priority over common
Tax treatment

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