Chapter 1 Flashcards
What are REAL assets?
assets used to produce goods and services
What are FINANCIAL assets?
claims on real assets or the income generated by them
What is equity?
an ownership share in a corporation
What is fixed-income (debt) securities?
pay a specified cash flow over a specific period
for example a bond
what are Derivative securities?
securities providing payoffs that depend on the values of other assets
How is the material wealth of society determined?
the economy’s productive capacity, which is a function of the economy’s REAL ASSETS
Equityholders are ______ and can get _________
owners , dividends
What are Equityholders NOT promised?
any particular payment
The success of common stock investments depends on ……
the success of the firm and its real assets
Debt securities do not promise ….
a share in the profits of the issuing entity
Debt securities promise …
either a fixed stream of income or a stream of income that is determined according to a specific formula
Money market securities are characterized by:
- Maturity less than 1 year
- Safety of the principal investment
- Low rates of return
example: treasury bill
The value of a derivative security depends on ….
the value of another related security
What are examples of a derivative security?
an option (put or call) and a futures contract
What is an important use of derivatives?
to hedge risks or transfer them to other parties
What happens when the market is more optimistic about a firm?
the share price will increase
the company will need to issue fewer shares to raise funds that are needed
In a market economy, _______ _________ are primarily allocated by _________ _______
capital resources , financial markets
Who does the stock market encourage allocation of capital to?
the firms that appear AT THE TIME to have the best prospects
Market signal will help to allocate capital efficiently only if …
investors are acting on accurate information
In security markets, there should be ….
a risk-return trade-off
higher-risk assets have higher expected returns than lower-risk assets
Financial markets allow for _____ __________ through time from higher-income periods to lower
shift consumption
How do financial markets price securities?
according to their riskiness
An investor who is considering one of two investment that are identical in all respects except for risk, anticipates …
a fair return for the risk of the security she invests in, she can expect to pay less for the security that has a higher risk.
Commodity and derivative markets allow firms to ….
adjust their exposure to various business risks
What is the purpose of derivative markets?
to transfer risk from one party to another
What is the Agency Problem?
conflicts of interest between mangers and stockholders
What are examples of Agency Problems?
managers protecting their jobs by avoiding risky projects
managers over consuming luxuries like corporate jets
What is an example of a Breakdown in Corporate Governance?
when shareholders cannot influence the decisions of managers, despite overwhelming shareholder support
What are some methods of encouraging managers to act in shareholders’ best interest?
tying managers’ compensation to stock price performance
threat of takeover
Why is it good that there is active trading in markets and competition among security analysts?
- security price approach informational efficiency
- riskier securities are priced to offer higher potential returns
- investors are unlikely to consistently find under or overvalued securities
What is Asset Allocation?
the allocation of the investment portfolio across broad asset classes
example: an investor decides to place 30% of their funds in equities and 70% in bonds
What does top-down portfolio construction start with?
asset allocation
What is Security Selection?
choosing specific securities within each asset class
What does Bottom-up Portfolio Construction start with?
selecting attractively priced securities
What is Security Analysis?
the analysis of the value of securities (an investor finding out that some particular stock is over or under priced)
To whom are hedge funds usually open to?
institutional investors and wealthy individuals
What are Venture Capital supplied with?
venture capital funds and individuals to start-up companies
If you want higher expected returns, you will ….
hav to pay a price in terms of accepting higher investment risk
What is Passive Management?
Investing in a wide variety of assets without trying to analyze individual stocks or make strategic changes to boost returns
What is Active Management?
the attempt to improve performance either by identifying mispriced securities or by timing the performance of broad asset classes
If the efficient market hypothesis were taken to the extreme, there would be no point in ______ _______ ________
active security analysis
Financial Intermediaries exist because small investors cannot efficiently:
- diversify their portfolios
- gather information
- assess and monitor the credit risk of borrowers
What is an Investment Company?
an intermediary that pools and manages funds for many investors
Investment Banks specialize in …
- helping companies raise capital by selling securities to the public
assisting corporations in primary market transactions
Why would individuals find it more advantageous to purchase claims from a financial intermediary rather than directly purchasing claims in capital markets?
- intermediaries are better diversified than most individuals
- intermediaries can exploit economies of scale in investing that individuals investors cannot
What investment banking firm was involved in the 2008 largest corporate bankruptcy in U.S. history?
Lehman Brothers
What is a major cause of the mortgage market meltdown in 2007 and 2008?
securitization
What is the difference between LIBOR and the Treasury-bill rate?
- called TED spread
- measures credit risk in the banking sector
- was very low just before the 2008 financial crisis
