chapter 1; elements of investments

Question 1

Functions of financial assets and investments

Answer 1

• Reduced current consumption
• Planned later consumption
• Future economic advantages

Question 2

Real asset

Answer 2

• Production of goods and services
• Generation of net income to the economy

Example; land, building knowledge. anything can be used to produce goods and services.

Question 3

Financial asset

Answer 3

• Claims on real assets or the income generated by them
• No direct contribution to the productive capacity of the economy
• Definition of the allocation of income or wealth among investors

Example; securities, stock, bonds.

Question 4

Fixed income(debt)

Answer 4

Carrying either a fixed stream of income (or a stream of income determined according to a specified formula) over a specific period of time.

Question 5

Equities (hisse senedi)

Answer 5

Potential dividend

“Ownership in the corporation” (incl. voting right)

Question 6

Derivatives (sermaye piyasası türev araçları)

Answer 6

Derivatives such as options and futures are securities providing payoffs that depend on the values of other assets such as bond or stock prices. **A major use is to hedge risks or transfer them to other parties. **

example;Futures contracts, forward contracts, options and swaps are the most common types of derivatives

Question 7

Financial assets are useful;

Answer 7

1. Consumption timing (life cycle)
2. Allocation of risk
3. Separation of ownership and management

Advantage: stability

Problem: conflicts of interest between managers and shareholders => agency problem
13

Question 8

Agency Problem

Answer 8

The agency problem usually refers to a conflict of interest between a company’s management and **the company’s shareholders. **

Question 9

Sarbanes-Oxley Act (SOX)

Answer 9

Act passed by U.S. Congress in 2002 to protect investors from the possibility of fraudulent accounting activities by corporations.

Question 10

Risk/return trade off

Answer 10

• Effort to achieve a balance between the desire for the lowest possible risk and the highest possible return.
• A higher standard deviation means a higher risk and therefore a higher possible return.

Question 11

Efficient Market Theory, Hypothesis

(EMH)

Answer 11

Efficient Markets would imply that prices are always fair. impossible to “beat the market”

=> Passive asset management without attempting to identify undervalued securities.

Active investment management does not make sense if we assume markets are fully efficient.

Question 12

Active management

and

Passive management

Answer 12

Active Management

• Attempting to identify under- valued securities or to forecast broad market trends
• Timing the performance of broad asset classes
Passive Management

• No attempts to identify undervalued securities
• Market timing plays no role
• Buy/Hold of an a diversified portfolio without attempting to identify undervalued securities

Question 13

Financial intermediaries

Answer 13

(connectors borrowers/len- ders)

• Pensions funds
• Investment funds
• Insurances
• Banks

Question 14

Duties of financial intermediaries

Answer 14

• Coordination of demand and supply of capital
• Contracts: set-up / support / control
• information flows

Question 15

Latest Trends are ;

• Globalization
• Securitization and Financial Engineering

Answer 15

Globalization

Development of global markets
• FX-management and integration • Diversification and improvement of the performance
Instruments and investment forms are continuously being developed Example: credit default swaps

Question 16

Securitization

Answer 16

An issuer creates a financial instrument by combining other financial assets and then marketing different tiers of the repackaged instruments to investors.

Loans of a given type such as mortgages are placed into a ‘pool’. New securities are issued that use the loan payments as collateral(teminat). The securities are marketable and are purchased by many institutions (“shadow banking system”).

End result: more investment opportunities for purchasers; spreading loan credit risks among more institutions.Liquidity to market

Question 17

Financial Engineering

Answer 17

Repackaging cash flows of a security to enhance marketability; bundling and unbundling of cash flows. Bundling: combining more than one asset into a composite security, for example securities sold backed by a pool of mortgages.

Question 18

Types of structered products

Answer 18

Certificates: Participating in ups and downs of a basket or of an index

Products with minimum return: Capital protection, but lower return

Products with maximum return: No capital protection, but higher return

Question 19

What reforms to the financial system might reduce its exposure to systematic risk?

Answer 19

• Removal of the favourable treatment of sovereign bonds (devlet tahvilleri) by the regulator in the balance sheets of the banks.
• Mutual recognition of the regulation of derivatives markets.
• Risk assesments and increasing volatility in financial markets should be taken into consideration.

Question 20

Wallstreet firms have traditionally compensated their traders with a share of their trading profits that they generated. How might this practice have affected traders’ willingness to assume risk? What is the agency problem this practice engendered?

Answer 20

**Increased risk tolerance **(yatırımcıların kişisel olarak risk almaya ne kadar yatkın oldukları),which might not have been in the interest of shareholders.

Question 21

Discuss the advantages and disadvantages of the following forms of managerial compensation in terms of mitigating agency problems, that is, potential conflicts of interest:

a) A fixed salary
b) Stock in the firm that must be held for five years
c) A salary linked to the firm’s profits.

Answer 21

a) Advantages is improved predictability and safety;transparency for shareholders.

Disadvantage is; This salary structure does not tie the manager’s immediate compensation to the success of the firm. However, the manager might view this as the safest compensation structure and therefore value it more highly.

b)Adtantage;Medium term commitment to the firm results in continuity and efficiency which should be positive for management and shareholders.

Disadvantage; If stock compensation is overdone, however, the manager might view it as overly risky since the manager’s career is already linked to the firm, and this undiversified exposure would be exacerbated(daha beter edilmis) with a large stock position in the firm.

c)Disadvantage; short-term way of thinking,less transparency, credibility and predictability

Question 22

The average rate of return on investments in a diversified portfolio of stocks from around the world has outpaced(geçmek, geride bırakmak) that on Treasury bills by over 7% since 1926. Why, then, does anyone invest in Treasury bills?

Answer 22

Treasury bills are low risk investment. The lower leverage rate of return compared to stocks is the price investors pay for predictability of investment performance and portfolio value.

Question 23

Give an example of three financial intermediaries and explain how they act as a bridge between small investors and large capital markets or corporations.

Answer 23

Mutual funds accept funds from small investors and invest, on behalf of these investors, in the national and international securities markets.

Pension funds accept funds and then invest, on behalf of current and future retirees, thereby channeling funds from one sector of the economy to another.

Venture capital firms pool the funds of private investors and invest in start-up firms.

Banks accept deposits from customers and loan those funds to businesses, or use the funds to buy securities of large corporations.