Investment Management BusFin522 Course Overview and Investment Background
Course Outlines <ul><li>This course provides an overview of investment fields: </li></ul><ul><ul><li>Financial instruments...
Course Outlines <ul><li>Course materials </li></ul><ul><ul><li>Textbook: Bodie, Kane, and Marcus, Essentials of Investment...
Course Outlines <ul><li>Three exams </li></ul><ul><ul><li>Will be given in class hours as scheduled. </li></ul></ul><ul><u...
Chapter   1 Investments - Background and Issues
Investments <ul><li>What is an investment? </li></ul><ul><ul><li>Giving up consumption today and putting money into assets...
Financial Assets <ul><li>Fixed-income securities or bonds </li></ul><ul><ul><li>Provides a stream of income (interest or/a...
Financial Markets & Firm Financial markets facilitate allocation of risk of a firm, and  help separate ownership and manag...
Financial Market Participants <ul><li>Firms are net borrowers, and raise capital (bond or equity) to finance investments i...
Investment process <ul><li>Typical investors faces two steps of decisions: </li></ul><ul><li>Asset allocation </li></ul><u...
Principles of the markets <ul><li>No-free-lunch rule (or no arbitrage rule) </li></ul><ul><ul><li>Financial markets are co...
Active vs. Passive Management <ul><li>Active Management </li></ul><ul><ul><li>Attempt to select undervalued securities and...
Market structure : How securities are traded? <ul><li>Brokered markets </li></ul><ul><li>Dealer markets : quote-driven mar...
Investments and Innovation <ul><li>Technology </li></ul><ul><li>Advancements in computing power and internet technology </...
Key Trends (1) Globalization <ul><li>Global Markets Continue Developing </li></ul><ul><li>More opportunities of investing ...
Key Trends (2) Securitization <ul><li>Since 1970, mortgages can be traded like a security </li></ul><ul><ul><li>(EX) GNMA ...
Key Trends (3) Financial Engineering <ul><li>Repackaging cash flows of a security to be sold to other class of investors <...
The Future <ul><li>Globalization continues and offers more opportunities </li></ul><ul><li>Securitization continues to dev...
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  1. 1. Investment Management BusFin522 Course Overview and Investment Background
  2. 2. Course Outlines <ul><li>This course provides an overview of investment fields: </li></ul><ul><ul><li>Financial instruments and how they are traded </li></ul></ul><ul><ul><li>Mean-variance analysis and portfolio theory </li></ul></ul><ul><ul><li>Efficient markets and market anomalies </li></ul></ul><ul><ul><li>Pricing of stocks, bonds, options, and futures </li></ul></ul><ul><ul><li>Course contents are comparable to BusFin722 </li></ul></ul><ul><li>Prerequisites </li></ul><ul><ul><li>BusFin 620 </li></ul></ul><ul><ul><li>Accounting 201 or 212; Econ 200 & 400; Statistics 133 </li></ul></ul><ul><ul><ul><li>If you haven’t taken these, you should plan to take them at the same time in this quarter, and let me know. </li></ul></ul></ul><ul><ul><li>Basic concepts such as present values, future values, calculating returns, financial accounting statements, and basic statistics (means, variance, correlations, and random variables) </li></ul></ul>
  3. 3. Course Outlines <ul><li>Course materials </li></ul><ul><ul><li>Textbook: Bodie, Kane, and Marcus, Essentials of Investments, 5th ed. </li></ul></ul><ul><ul><li>Lecture note available at http://fisher.osu.edu/ ~kho_1/522.html </li></ul></ul><ul><ul><li>Financial (or scientific) calculator </li></ul></ul><ul><ul><li>Recommend to read regularly the financial newspapers such as Wall Street Journal, Financial Times, etc. </li></ul></ul><ul><li>Grading </li></ul><ul><ul><li>Three exams (non-cumulative) 300 points (100 pts each) </li></ul></ul><ul><ul><li>Three quizzes 60 points (20 pts each) </li></ul></ul><ul><ul><li>Team project 60 points </li></ul></ul><ul><ul><li>Class participation/Attendance 15 points (1 pts each) </li></ul></ul><ul><ul><li>(Seating chart) 435 points </li></ul></ul><ul><ul><li>Grading will be close to curves, but may vary depending on the outcome of exam scores. </li></ul></ul>
  4. 4. Course Outlines <ul><li>Three exams </li></ul><ul><ul><li>Will be given in class hours as scheduled. </li></ul></ul><ul><ul><ul><li>Midterm exam 1: 1/26/05 (Wed) in class </li></ul></ul></ul><ul><ul><ul><li>Midterm exam 2: 2/16/05 (Wed) in class </li></ul></ul></ul><ul><ul><ul><li>Final exam: 3/14/05 (Mon) in class </li></ul></ul></ul><ul><ul><li>No makeup exams except for serious cases. </li></ul></ul><ul><li>Homework </li></ul><ul><ul><li>You may work in groups on homework problems, but will not be collected for grade. </li></ul></ul><ul><ul><li>Part of the exams will be taken directly from or slightly modified from homework. </li></ul></ul><ul><li>Team project </li></ul><ul><ul><li>Form a group of 4~5 students </li></ul></ul><ul><ul><ul><li>Your team members must be notified to the instructor by 3rd class.. </li></ul></ul></ul><ul><ul><li>The assignment will include a report, and a Power Point presentation. </li></ul></ul>
  5. 5. Chapter 1 Investments - Background and Issues
  6. 6. Investments <ul><li>What is an investment? </li></ul><ul><ul><li>Giving up consumption today and putting money into assets that will bring greater wealth and consumption in the future </li></ul></ul><ul><ul><li>Compared to savings, investment involves higher risks, and thus, </li></ul></ul><ul><ul><li>one will want higher returns from investment </li></ul></ul><ul><li>Where to Invest? </li></ul><ul><ul><li>Real Assets: used to produce goods and services </li></ul></ul><ul><ul><li>(EX) Real estate, Auto plant, Cars, etc. </li></ul></ul><ul><ul><li>Financial Assets: claims on the income generated by real assets </li></ul></ul><ul><ul><li>(EX) Stocks, Bonds, Options, Futures, etc. </li></ul></ul><ul><ul><li>Balance sheet of U.S. households: Table 1.1 </li></ul></ul><ul><ul><li>National wealth: Table 1.2 </li></ul></ul><ul><li>We will mostly talk about investments in financial assets </li></ul>
  7. 7. Financial Assets <ul><li>Fixed-income securities or bonds </li></ul><ul><ul><li>Provides a stream of income (interest or/and principal) fixed or determined by a formula </li></ul></ul><ul><ul><li>Corporate bond, Treasury bond, Municipal bond, etc. </li></ul></ul><ul><ul><li>Fixed or Floating rate note </li></ul></ul><ul><ul><li>Money market securities: T-Bills, CDs, CPs, etc. </li></ul></ul><ul><li>Stocks or Equity </li></ul><ul><ul><li>Represents an ownership share of a company, and provides dividends and capital gains (or losses) </li></ul></ul><ul><ul><li>Value of equity is tied directly to the success of the firm, and thus, is riskier than investments in bonds </li></ul></ul><ul><ul><li>Common stocks vs. preferred stocks </li></ul></ul><ul><li>Derivatives </li></ul><ul><ul><li>Income streams are dependent on the value of underlying assets </li></ul></ul><ul><ul><li>Call options vs. put options </li></ul></ul><ul><ul><li>Futures </li></ul></ul>
  8. 8. Financial Markets & Firm Financial markets facilitate allocation of risk of a firm, and help separate ownership and management of a firm. Real Assets NPV>0 Firm Firm value max, or, SH wealth max Financial Markets Risk-Return tradeoff Retained earnings (Reinvest) Capital Structure Decision: Raise equity or bond Capital Budgeting Decision: Invest the proceeds Dividends, Interests Corporate taxes Govern-ment Operating Cash Flows Cost of capital
  9. 9. Financial Market Participants <ul><li>Firms are net borrowers, and raise capital (bond or equity) to finance investments in plant and equipment </li></ul><ul><li>Households are net savers, and purchase securities issued by firms </li></ul><ul><li>Government can be borrowers or lenders, depending on tax revenue and government expenditures </li></ul><ul><li>Financial intermediaries </li></ul><ul><ul><li>Banks take deposits and lend money to borrowers </li></ul></ul><ul><ul><li>Investment companies pool and manage funds for many investors </li></ul></ul><ul><ul><li>Investment banks specialize in selling (underwriting) securities to the public </li></ul></ul><ul><ul><li>Insurance companies, credit unions, mutual funds, pension funds, venture capital firms, etc. </li></ul></ul>
  10. 10. Investment process <ul><li>Typical investors faces two steps of decisions: </li></ul><ul><li>Asset allocation </li></ul><ul><ul><li>Choice among broad asset classes </li></ul></ul><ul><ul><li>(Ex) stocks, bonds, real estate, commodities, etc. </li></ul></ul><ul><ul><li>This requires “economic analysis” (boom or bust) or “industry analysis” </li></ul></ul><ul><li>Security selection </li></ul><ul><ul><li>Choice of particular securities within each asset class </li></ul></ul><ul><ul><li>(Ex) GM, IBM, etc. </li></ul></ul><ul><ul><li>This requires the valuation process of particular securities, so called, “security analysis” </li></ul></ul><ul><li>Therefore, investors face the following problems: </li></ul><ul><ul><li>Forecasting future returns (or cash flows) </li></ul></ul><ul><ul><li>Identifying sources of risk and measuring risk </li></ul></ul><ul><ul><li>Evaluating whether the expected return compensates for the risk </li></ul></ul><ul><ul><li>Investment decisions </li></ul></ul>
  11. 11. Principles of the markets <ul><li>No-free-lunch rule (or no arbitrage rule) </li></ul><ul><ul><li>Financial markets are competitive enough to rule out any profit opportunity from investing in obviously underpriced securities </li></ul></ul><ul><li>Risk-return trade-off </li></ul><ul><ul><li>Assets with higher expected returns have greater risk </li></ul></ul><ul><ul><li>Higher-risk assets should be priced lower to offer higher expected return than lower-risk assets </li></ul></ul><ul><ul><li>How to measure risk? </li></ul></ul><ul><li>Market efficiency hypothesis </li></ul><ul><ul><li>All relevant information is quickly and efficiently reflected in prices </li></ul></ul><ul><ul><li>In reality, however, we observe near-efficient markets where there may exist profit opportunities for diligent and creative investors </li></ul></ul><ul><ul><li>This provides an incentive for actively managing one’s investment portfolios </li></ul></ul>
  12. 12. Active vs. Passive Management <ul><li>Active Management </li></ul><ul><ul><li>Attempt to select undervalued securities and time the market </li></ul></ul><ul><ul><li>Adjust the portfolio weights according to a forecast of the market movements for next period </li></ul></ul><ul><ul><ul><li>Shift between stocks, bonds, etc. </li></ul></ul></ul><ul><li>Passive Management </li></ul><ul><ul><li>No attempt to select undervalued securities or time the market </li></ul></ul><ul><ul><li>Hold an efficient portfolio </li></ul></ul><ul><li>Balanced Management </li></ul><ul><ul><li>Active + Passive </li></ul></ul>
  13. 13. Market structure : How securities are traded? <ul><li>Brokered markets </li></ul><ul><li>Dealer markets : quote-driven market </li></ul><ul><li>Auction markets : order-driven market (electronic trade) </li></ul><ul><li>Primary markets </li></ul><ul><ul><li>New securities are issued to the public </li></ul></ul><ul><li>Secondary markets </li></ul><ul><ul><li>Subsequent trading occurs </li></ul></ul><ul><li>Types of orders </li></ul><ul><ul><li>Market vs. Limit orders </li></ul></ul><ul><ul><li>Costs of trading </li></ul></ul>
  14. 14. Investments and Innovation <ul><li>Technology </li></ul><ul><li>Advancements in computing power and internet technology </li></ul><ul><li>More complete and timely information delivery </li></ul><ul><li>Globalization </li></ul><ul><li>Domestic firms compete in global markets </li></ul><ul><li>Performance in regions depends on other regions </li></ul><ul><li>Causes additional elements of risk </li></ul>
  15. 15. Key Trends (1) Globalization <ul><li>Global Markets Continue Developing </li></ul><ul><li>More opportunities of investing abroad </li></ul><ul><ul><li>ADRs (American Depository Receipts) </li></ul></ul><ul><ul><li>Mutual funds like country funds or WEBS (World Equity Benchmark Shares) </li></ul></ul><ul><ul><li>Direct purchase of foreign securities </li></ul></ul><ul><li>Provides diversification benefits, but are exposed to foreign exchange risk </li></ul><ul><li>Global information and analysis skills improve </li></ul>
  16. 16. Key Trends (2) Securitization <ul><li>Since 1970, mortgages can be traded like a security </li></ul><ul><ul><li>(EX) GNMA pass-through security </li></ul></ul><ul><ul><li>Pools individual home mortgages, and sells them in one package </li></ul></ul><ul><ul><li>Owners receive prorated shares of the principal and interest payments made by the mortgage borrowers </li></ul></ul><ul><li>Funds are made available easily through securitization and credit enhancement </li></ul><ul><ul><li>(EX) Nonmortgage asset-backed securities since 1995 </li></ul></ul><ul><ul><li>Car loans, student loans, credit card loans, etc. (Figure 1.2) </li></ul></ul><ul><ul><li>Brady bonds traded in international markets </li></ul></ul>
  17. 17. Key Trends (3) Financial Engineering <ul><li>Repackaging cash flows of a security to be sold to other class of investors </li></ul><ul><ul><li>It creates new products that allow investors to manage their financial assets more efficiently </li></ul></ul><ul><li>Unbundling and bundling of cash flows creates a complex security </li></ul><ul><ul><li>Examples: Strips, CMOs, dual purpose funds, principal/interest splits (PO/IO) (Figure 1.3, 1.4) </li></ul></ul>
  18. 18. The Future <ul><li>Globalization continues and offers more opportunities </li></ul><ul><li>Securitization continues to develop </li></ul><ul><li>Derivatives and exotics continue to develop </li></ul><ul><li>Strong fundamental foundation is critical </li></ul><ul><li>Integration of investments & corporate finance </li></ul>

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