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Chapter 1

Investments- Background and Issues

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Investments

Essential nature of investment: Reduced current consumption Planned later consumptionThat is,

________________________________________________________________________________________________________________________________________________________________

Investment is the current commitment of money or other resources in the expectation of reaping future benefits

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1.1 Real Assets Versus Financial Assets

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1.1 Real Assets Versus Financial Assets (cont.) Real Assets:

Assets used to produce goods and servicesFor example,

______________________________________. Financial Assets:

Claims on real assets or the income generated by them

For example,_______________________________________.

land, buildings, machines, and intellectual assets

stocks, bonds, and derivatives

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1.2 A Taxonomy of Financial Assets Fixed-Income Securities

Securities that promise either ______________or ____________________________________________________________________________.For example,-A corporate bond typically would promise that the

bond holders will receive ________________________________________________________.-Floating-rate bonds promise payments that ___________________________________________.

a fixed stream of incomea stream of income that is determined according to a specified formula

a fixed amount of interest each year

depend on current interest rates

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1.2 A Taxonomy of Financial Assets Equity (or_____________)

It represents an ___________________ in a corporation.

Derivative Securities It provides the payoffs that depend on __________________________________________.

For example, a call option on a share of IBM stock might turn out to be ________ if IBM’s share price is below an “exercise” price such as $40, but it can be _______ if the price rises above that level.

common stockownership share

the values of other assets

worthless

valuable

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1.4 The Investment Process

Asset Allocation (Chapter 5, 6) The choice among _________________,

such as ________________________________________________________.

Security Selection (Chapter 7, 10, 11, 13) The choice of which ________________

to hold within each asset class.

broad asset classes

stocks, bonds, real estate, commodities, etc.

particular securities

Top-down portfolio construction

Bottom

-up portfolio construction

Top-Down VS. Bottom-Up In the “bottom-up” strategy, the portfolio is

constructed from the securities that seem attractively priced without as much concern for the resultant asset allocation

Consequence: “bottom-up” technique can result in unintended bets on one or another sector of the economy.

Unintended bets in the sense that you invest just in the “hot” sector so you have exposure to just one source of uncertainty

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1.5 Markets are Competitive Thousands of intelligent and well-backed analysts

constantly scour the securities markets searching for the best buys. This competition means that it is very hard to find “___________” securities that are so underpriced that they represent obvious bargains.

Implications The Risk-Return Trade-Off

Assets w/higher expected returns have ________ risk

Efficient Market (chapter 8): we should rarely expect to find ________ in the security markets. That is, it is hard to find underpriced and overpriced security.

free lunches

higher

bargains

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1.5 Markets are Competitive

An implication of the efficient market hypothesis concerns the choice between Passive investment-management strategies

Buying and holding a diversified portfolio without _______________________________

______________________________________.

Active investment-management strategies Attempting to ___________________________

______________________________________.

attempting to identify mispriced securities

identify mispriced securities or to forecast broad market trends