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Study Guide

FINE 3200- Midterm Exam Guide - Comprehensive Notes for the exam ( 120 pages long!)


Department
Finance
Course Code
FINE 3200
Professor
George Klar
Study Guide
Midterm

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York
FINE 3200
MIDTERM EXAM
STUDY GUIDE

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Chapter 1: The Investment Environment
1.1 A SHORT HISTORY OF INVESTING
- To balance the needs of between current and future
- Crash in 1929 Great Depression
- Crash in 1987 Set the stage for the economic and financial boom of the 1990s
- 1990s tech era small firms with fast growth unsophisticated investors attracted and invested blindly lead to the BUBBLE
unwarranted inflation in asset values
- Commodity Boom 180% fain from 2002 to 2008 barely moved in 2013 for CA
- REAL ASSETS BUBBLE housing bubble oe people ale to fiae the puhase of hoes that should’e ee uaffodale
- End of 2007 largest banks in the world were owed billions by other institutions that could not honor their obligations bankrupt
frozen credit across the world gvt action of purchasing bank equity worked new bull market emerges
- Recessions caused by financial crises has greater and longer lasting effects quantitative easing: expanding the money supply
through printing new money to purchase gvt securities spur inflation
Inappropriate regulation of derivative security (衍生证券) + unrealistic market math model
1.2 THE ECONOMIC SYSTEM AND INVESTMENT
- Companies only got involved in the trade when 1. Raising new caps; 2. Repurchasing shares
Bonds: indebtedness + specific term of repayment
Stocks: ownership rights no guarantee of fixed/positive return relatively more liquid limited liability
Real Investment vs. Financial Investment
- FI: indi invest in stocks and bonds of corporations exchange of cash b/w investors = now new cap
- RI: corp takes cap and invests it in productivity assets (reinvestment of profits; new debt/equity issuance)
- Real Assets podutie apaity: lad, euip…et.
- Fiaial Assets od, stok …et.
- real assets = income-generating; financial assets = income/wealth allocation instruments
- Important rules for FA to allocate capital to RA efficiently
1. Information role: stock prices collective assessment of current performance and future prospects
2. Cosuptio tiig: help stoe oe’s ealth ad shifts it oe the ouse of oe’s lifetie
3. Separation of ownership & mgt: mgt help achieve the interests of the actual owner
Agency problem conflict of interest b/w owner and management
a. Compensation plan stock options
b. Board of Directors force out the mgt team
c. Outsider security analysts/ mutual funds and pension funds monitor closely
d. Threat of Takeover
i. PROXY CONTEST shareholders get enough proxies to take control of the firm and vote in another BoD often
ineffective Shareholder (own funds) vs. Mgt (corp coffers/funds)
ii. Takeover from other firms M&A increasing stock price is an incentive
1.3 THE PARTICIPANTS: INDIVIDUALS AND FINANCIAL INTERMEDIARIES
- Three participants in financial markets:
1. Households: suppliers of cap
2. Firms: Demanders of cap
3. Government: either tax rev and gvt expenditures
Individuals and Financial Objectives
- Investors have different expectation towards returns thus using different strategies
1. Hoarders: Prefer fixed and guaranteed return funds in savings act
2. Speculators: Opportunities to double investment in matter of days
- Saving (not spending all current income on consumption) a way of safely investing
- Investing (choosing what assets to hold)
- 1st significant investment = education = human cap investment
- 1st major economic asset personal residence (or alternately real estate)
- Main goal is to maintain the std of living once older: feel like they get less time hence shift to safe assets
The Investment Process
- Portfolio = collection of investment assets make two types of decisions
1. Asset allocation: choice decision among broad asset classes
2. Security selection: choice decision about which particular securities to hold within each asset class
- Top-down: starts with asset allocation
Security analysis: the valuation of certain securities that might be included in the portfolio various return and risk associates
ith diffeet asset lass Till, ods, stoks …et.
- Bottom-up: starts with securities that seem attractively priced w/o much concern for the resultant asset allocation untended bets
on certain sectors
Financial Intermediaries
- Financial intermediaries: institutions stand b/w security issuer and ultimate owner of the security investment bankers
represents security issuers to the investing public (indi investor+ large fine institutions)
1. To overcome the problem with direct investment due to size of indi household investors
2. Overcome problem with lack of advertising
3. Reduce risk by helping diversify investments
4. Help indi lender who is not equipped to assess and monitor the credit risk of borrowers
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- Investment companies, insurance companies and credit unions: pooling small investors, lending to many borrowers; build expertise
and achieve economies of scale
- Investment companies: expensive brokerage fees
Investment Bankers
- Aka Investment dealers advise the issuing prices, interest rates
Handles the marketing of the security in the primary market
Maintain reputation and creditability
1.4 RECENT TRENDS
Globalization
- Canadian investors can participate in foreign investment opportunities by trading on U.S.
1. Using American Depository Receipts (ADR)
2. Foreign securities offered in dollars
3. Mutual funds or exchange-traded funds that invest internationally
4. Derivative securities w/ payoffs that depend on prices in foreign security markets
- World Equity Benchmark Shares (WEBS) variation on ADRs each tracks the performance of an indx of share returns for a country
- EURO facilitate trade and encourage integration o markets across national boundaries for 11 countries
Financial Engineering
- Use of math 0 and computer-based trading tech to synthesize new financial products
- Principal-protected equity-linked note: guarantee a min fixed return + an additional amt that depends on performance of some
specified stock index
- Unbundling: breaking up and allocating the CF from one to create serval new securities
- Bundling: combining more than one security into a composite security
- Innovative instruments triggered by U.S. tax or regulatory restrictions US. Financial market dominance
1. Options/ futures: original derivatives
2. Portfolio insurance: creation of hedge fund portfolios
Securitization
- Converts non-marketable assets into traded securities by issuing claims against the firm backed by original assets offering reliable
credit quality to investors provides cash advances to issuing firm
- Mortgage-backed security (MBS)
- Pass-through securities: aka pass-through securities: pool of loans sold in package. Owners receive all principal and interest pmts
made by the borrowers
Information & computer networks
- online trading; online info dissemination and auto trade crossing
faster, cheaper, easier
1.5 THE AGENCY PROBLEM: EXECUTIVES, ANALYSTS, AND AUDITORS
- Should avoid overconfidence and optimistic valuation
- Sarbanes-Oxley (SOX) rules and penalties for noncompliance specific reference to audit committees, mgt and applicable penalties
- Inadequate disclosure about
1. Investment dealers conflict of interest v/w banking division and analyst sections
2. Accounting auditors cash flow and other risky assets info
3. Managers own investment or disinvestment in company shares thru inventive plans based on stock options/loans
- Bonuses: encourage high-risk behavior
Succeed = rewards the employees
Fail = costs the shareholders and taxpayers
- Agency Theory: shareholders = principals = who pays the agents (mgt, auditor, analyst)
1. Financial results are modified w/ approval of auditors satisfy mgt views
2. Directors do not question the actions nor compensation paid
3. Analysts dispute eithe gt’s pojetios o dietios to aoid jeopadizig iestet akig atiities
- Increasing use of stock since longer-term = better guarantee
- Indi investors in the end must evaluate info given carefully
1.6 LESSONS TO LEARN
- Investor role: help determine the true current value of equities and bonds
- alues of all the aailale istuets deped o idi’s peeptio of the alue of the fi that issues the piay istuent
- momentum investing + Growth stocks
- value investing
Free Lunch
- Securities that are so underpriced that they represent obvious bargains absence of free lunch since
1. Invest based on anticipated future returns, which often are inaccurate
2. No such thing as all else held equal always RISK-RETURN TRADEOFF (higher-risk assets priced to offer higher expected returns
than lower-risk assets
- Modern portfolio theory diversification to lower the risk
- Efficient Market Hypothesis no point in active analysis if the hypothesis reach extreme
a. Passive management: holding highly diversified portfolio w/o spending effort or tother resources to improve investment
performance through security analysis
b. Active management: improve performance either by identifying mispriced securities or by timing the performance of broad
asset classes
No 100% efficient market in near-efficiency once, profits still exists for creative and diligent investors
Diversification, Information and Patience
- Solutions to the macro vulnerability of a portfolio
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