1. The Investment Environment
Chapter 1
The Investment Environment
Shakil Al Mamun
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2. Investments & Financial Assets
Essential nature of investment
Reduced current consumption
Planned later consumption
Real Assets
Assets used to produce goods and services and it determine wealth of economy.
Financial Assets
Claims on real assets
Diff between FA vs RA?
1. Sell FA to buy RA
2.For balance sheet, RA will go only Assets side, but FA will go both side.
3.FA are created and destroyed e.g. accounts payable on credit side and AR on debit side. 4
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3. Role of Financial Assets and Markets in the Economy
Consumption Timing
Allocation of Risk
Separation of Ownership
Agency Issues
Consumption timings: By so doing, you can “shift” your consumption over the course of your lifetime, thereby allocating your consumption to periods that provide the greatest satisfaction
Allocation of risk: Financial markets and the diverse financial instruments traded in those markets allow investors with the greatest taste for risk to bear that risk, while other, less risk-tolerant individuals can, to a greater extent, stay on the side-lines.
Agency Problems: managers who hired as agents of shareholders, may pursue their own interests. They don’t engage themselves in risky projects.
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4. Financial System Clients and Their Needs
Household Sector
Primary Need: Invest Funds
Business/Corporate Sector
Primary Need: Raise Funds
Government Sector
Household: it make economy decision concerning such activities as work, job training, retirement planning, savings versus consumptions.
Corporate: corporation raise money by two ways, they borrow it either from bank or directly from household by issuing bonds, or they can take in new partners by issuing new shares which are new ownership shares of that firm.
Govt: govt needs money to finance their expenditures by borrowing. They cant sell equity shares, but they can issue bonds. Govt can print money, but they don’t go for it as it will make problem of inflation in economy.
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5. How the Financial System Meets the Needs of Participants
Financial Intermediation
Institutions that “connect” borrowers and lenders by accepting funds from lenders and loaning funds to borrowers.
Investment Banking
Firms specializing in the sale of new securities to the public, typically by underwriting the issue
Financial Innovation & Derivatives
Responding to Regulation & Taxes
Fin intermediation: These financial intermediaries include banks, investment companies, insurance companies, and credit unions. Financial intermediaries issue their own securities to raise funds to purchase the securities of other corporations. For example, a bank raises funds by borrowing (taking deposits) and lending that money to other borrowers. The spread between the interest rates paid to depositors and the rates charged to borrowers is the source of the bank’s profit. In this way, lenders and borrowers do not need to contact each other directly. Instead, each goes to the bank, which acts as an intermediary between the two.
Investment bankers: Investment bankers such as Goldman, Sachs, or Merrill Lynch, or Salomon Smith Barney advise the issuing corporation on the prices it can charge for the securities issued, appropriate interest rates, and so forth. Ultimately, the investment banking firm handles the marketing of the security issue to the public. At bd, Race mgt, LR global, IDLC etc. take money from bank, invest it to capital mkt.
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6. Financial Markets Direct Search Market Brokered Market (primary mkt)
Dealer market (secondary mkt)
Auction market
Direct Search Market: Buyers and sellers must seek each other out directly. An example of a transaction in such a market is the sale of a used refrigerator where the seller advertises for buyers in a local newspaper. Such markets are characterized by sporadic participation and low-priced and nonstandard goods.
Brokered mkt: markets where trading in a goods is active, brokers find it profitable to offer search services to buyers and sellers. A good example is the real estate market, where economies of scale in searches for available homes and for prospective buyers make it worthwhile for participants to pay brokers to conduct the searches. Brokers in particular markets develop specialized knowledge on valuing assets traded in that market.
Dealer mkt: When trading activity in a particular type of asset increases, dealer markets arise. The spreads between dealers’ buy (or “bid”) prices and sell (or “ask”) prices are a source of profit. Eg. OTC
Auction mkt: The most integrated market is an auction market, in which all traders converge at one place to buy or sell an asset. The New York Stock Exchange (NYSE) is an example of an auction market. An advantage of auction markets over dealer markets is that one need not search across dealers to find the best price for a good. If all participants converge, they can arrive at mutually agreeable prices and save the bid-ask spread.
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7. Investments and Innovation
Technology and Delivery of Service
Computer advancements
More complete and timely information
Globalization
Domestic firms compete in global markets
Performance in regions depends on other regions
Causes additional elements of risk
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8. Key Trends - Globalization
International and Global Markets Continue Developing
Managing foreign exchange
Diversification to improve performance
Instruments and vehicles continue to
develop
Information and analysis improves
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9. Key Trends - Securitization
Securitization & Credit Enhancement
Offers opportunities for investors and originators
Changes in financial institutions and regulation
Improvement in information capabilities
Credit enhancement and its role
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10. Key Trends - Financial Engineering
Repackaging Services of Financial Intermediaries
Bundling and unbundling of cash flows
Slicing and dicing of cash flows
Examples: strips, CMOs, dual purpose funds, principal/interest splits
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11. The Future Globalization continues and offers more opportunities
Securitization continues to develop
Continued development of derivatives and exotics
Strong fundamental foundation is critical
Integration of investments & corporate finance
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