L1- Introducing and measuring returns Flashcards
What are real assets?
Assets used to produce goods and services- Land, buildings, equipment
What are financial assets?
Claims on real assets or the income generated by them- stocks, bonds.
What do real assets determine?
Real assets determine an economy’s productive capacity, the fundamental source of material wealth.
They generate net income, which forms the economic output available for consumption or reinvestment.
What do financial assets facilitate?
Financial assets facilitate the allocation of income and wealth among individuals and entities.
They enable the transfer of funds from savers (who purchase financial assets) to firms or governments (who issue them to finance real assets).
Describe the relationship between real and financial assets.
Financial assets are not productive on their own. Instead they serve as a tool to mobilise and allocate resources for investing in real assets.
What are some further characteristics of financial and real assets?
Investments in real assets enhance productivity and economic growth.
Financial assets play a supporting role by ensuring efficient resource allocation.
Financial assets allow individuals to share the risks and rewards of real asset investment.
What is a fixed income security?
A borrower agrees to pay a specified cash flow (interest payments) to the investor (lender) over a specified time period.
These securities have a specified life span, ranging from short term e.g. Treasury bills to long term e.g. corporate bonds.
What is equity?
Equity represents an ownership share in a corporation.
What are derivative securities?
Financial instruments whose value is dervived from the performance of other underlying assets such as stocks, bonds, commodities, interest rates, or market indicies.
Derivatives allow investors to control large positions with relatively small amounts of capital.
When would companies use fixed-income securities?
When funding operations or projects with lower-risk financing. Equity is issued to raise payment capital and absorb risk.
How do derivative securities help financial markets?
Derivatives enhance the functionality of financial markets by providing tools for risk management.
They depend on and interact with both fixed-income and equity markets for pricing and hedging.
What are the roles of financial markets?
They play a critical role in developed economies by facilitating the efficient allocation of resources and enabling the economy to maximise the productive potential of its real assets.
Explain the informational role of financial markets- Stocks as signals
- Stocks as signals
Stock prices reflect the collective assessment of investors by regarding a firms current performance and future growth potential.
Rising stock prices indicate optimism and make it easier for firms to raise capital by issuing new shares or bonds, which can be used in productive projects, fostering economic growth.
Explain the informational role of financial markets- Allocation of capital
Financial markets direct resources toward firms and industries perceived to have the greatest potential for productivity and innovation.
Explain the informational role of financial markets- Efficient Market Hypothesis
Stock prices incorporate all available information, reflecting the collective wisdom of investors.
However, markets can experience misallocations due to bubbles and irrational events e.g. dot.com bubble 1995-2000
What is consumption timing?
The ability of individuals to adjust their consumption patterns over their lifetimes to better align with their financial resources and preferences for satisfaction.
By utilizing financial markets, individuals can store excess earnings during high-income periods and access these savings during low-income periods (retirement)
