Professional Documents
Culture Documents
McGraw-Hill/Irwin
1-3
1-4
1-5
Financial Markets
Informational Role of Financial Markets
o Information conveyed by financial markets play an important role in determining the future of corporations.
o The stock price of a corporation reflects the collective judgment of market analysts.
1-7
Consumption Timing
o People tend to smooth consumption over time.
o If one has more than enough cash to meet their basic needs in the current time period one might shift consumption through time by investing the surplus.
1-8
Allocation of Risk
o Allocation of Risk
Bonds versus stock of a given company
Which is riskier?
1-9
Example 1.1
In February 2008, Microsoft offered to buy Yahoo at $31 per share when Yahoo was trading at $19.18.
1-12
1-13
o Security Selection
Choosing specific securities within an asset class
o Security Analysis
oValuation of specific securities that may be considered for a portfolio
1-15
1-16
A stock portfolio can be expected to lose money about 1 out of every 4 years.
o Bonds have a much lower average rate of return (under 6%) and have not lost more than 13% of their value in any one year.
1-17
Efficient Markets
o Market efficiency: o Securities should be neither underpriced nor
overpriced on average
o Security prices should reflect all information
available to investors
o Whether we believe markets are efficient
1-18
The Players
Business Firms net borrowers Households net savers Governments can be both borrowers and savers Financial Intermediaries Connectors of borrowers and lenders
o Commercial Banks
Traditional line of business: Make loans funded by deposits
o o o o
o Secondary market
A market where pre-existing securities are traded among investors.
1-21
Investment Bankers
Investment Bankers o Commercial and investment banks functions and organizations were separated by law from 1933 to 1999.
o Post 1999 large investment banks, collectively known as Wall Street, operated independently from commercial banks, although many of the large commercial banks increased their investment banking activities, pressuring profit margins of investment banks.
o In September 2008 major investment banks either went bankrupt, reorganized as commercial banks or were purchased by commercial banks as a result of the collapse of the mortgage markets. 1-22
Investment Bankers
o Some investment banks chose to become commercial banks to obtain deposit funding and government assistance o All of the major investment banks are now under the much stricter commercial bank regulations.
What are the implications for innovation and capital issuance resulting from these changes?
1-23
1-24
1-25
Recent Trends
Globalization Securitization Financial Engineering Information and Computer Networks
1-26
Globalization
Domestic firms compete in global markets Performance in one country or region depends on other regions Opportunities for better returns & implications for risk o Managing foreign exchange o International diversification reduces risk o Instruments and vehicles continue to develop (ADRs and WEBs) o Information and analysis improves
1-27
Securitization
Loans of a given type such as mortgages are placed into a pool and new securities are issued that use the loan payments as collateral. The securities are marketable and are purchased by many institutions. Shadow banking system End result is more investment opportunities for purchasers, and spreading loan credit risk among more institutions
1-28
Securitization
Securitization has grown rapidly due to Changes in financial institutions and regulation permitting its growth, particularly lower capital requirements on securitized loans, Improvement in information capabilities, Credit enhancement provided by pool issuers has improved marketability.
1-29
1-30
Financial Engineering
Repackaging cash flows of a security to enhance marketability Bundling and unbundling of cash flows o Bundling: Combining more than one asset into a composite security, for example securities sold backed by a pool of mortgages. o Unbundling Selling separate claims to the cash flows of one security, for example a CMO
1-31
1-32
1-33
Computer Networks
Online low cost trading Information made cheaply and widely available Direct trading among investors via electronic communication networks What have been the effects on Wall Street firms profit margins? o How has Wall Street responded?
1-34
The Future
Globalization will continue and investors will have far more investment opportunities than in the past Securitization will continue to grow after the crisis Continued development of derivatives and exotics, more regulation for over the counter derivatives Strong fundamental foundation of understanding is critical Understanding corporate finance requires understanding investments
1-35