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