LECTURE 1 Flashcards
What are real assets?
Determine the productive capacity and net income of the economy
What are financial assets?
Claims on real assets, this can be larger than real assets
What are three types of financial assets
- Fixed income or debt
- Common stock or equity
- Derivative Securities
What is fixed income?
Payments fixed or determined by a fomula
What are money market debt?
Short term, highly marketable, usually low credit risk
What are capital market debt?
Long term bonds, can be safe or risky
What is a common stock?
Equity or ownership in a corporation
What are the two types of rights of a common stock?
Voting rights and payments
What are derivatives
- Prices from other securities like stocks and bonds
- Used to transfer risk
What is information role?
Capital flows to companies with best prospects also facilitate price discovery
What is consumption timing?
Use securities to store wealth and transfer consumption to the future, this is preferable to more primitive forms of savings
What is allocation of risk?
Investors can select securities consistent with their tests for risks, allows investors to diversify risk
How does you separate of ownership and management
- Helps establish stability and allows for very large firms to exist
- With stability comes agency problems
- Conflict of interest between shareholders and managers, shareholders and debt holders and to lesser extent intra-creditor and intrashareholder conflicts
What is corporate governance
Corporate governance is the structure of rules, practices and processes used to direct and manage a company
Why are markets so competitive
- No free luck, risk-return trade off
- Efficient markets; active management, finding misplaced securities, timing the market
What is law of one price
- Equivalent investment opportunities trade in different competitive markets then they must trade for the same price in both markets
- An arbitrage opportunity
- Price of any security is the present value of the security flows
What is value additivity
- Price of an asset that consist of other assets must equal the sum of the prices of the other assets
- If security C has the same cash flow as securities A and B
What are the limits to arbitrage
- Fundamental risk
- Noise trader risk
- Transaction costs
What is fundamental risk
True arbitrage opportunity is riskless
What is noise trader risk
If the arbitrageur is a portfolio manager, naive investors may see negative returns, withdraw their funds, and force the arbitrageur to close the positions early
What is transaction costs
Commissions, bid ask spreads, price impact
