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FIN 4504 Study Guide - Summer 2019, Comprehensive Final Exam Notes - Inflation, Government Bond, Interest Rate


Department
Finance
Course Code
FIN 4504
Professor
Glenn Williams
Study Guide
Final

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FIN 4504

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Chapter 1: Investments: Background and Issues
Nature of investment: reduce current consumption for greater future consumption
Top-down- starts with asset allocation
Bottom-up- the portfolio is constructed from the securities that seem attractively priced
without as much concern for the resultant asset allocation; can result in unintended
bets on one or another sector of the economy
Financial assets- claims on real assets or real asset income
- Includes stocks, bonds, derivatives, debt, equity
- Do not have productive capacity
- Cannot generate income
- Give you the option to save or invest your income
Real assets- a function of productive capacity
- Property, plants and equipment, human capital, land, buildings, consumer durables
**Real assets have productive capacity, financial assets do not**
Residual income- debt holders are the first to claim income, equity claim next, the rest
is residual income
Financial assets and liabilities must balance; cancel out on balance sheet and only thing
that exists is real assets
Types of financial assets:
1. Common stock (equity)- ownership stake in entity, residual cash flow
- Have their own price, can estimate independent
- Riskier than fixed income
2. Fixed income securities (debt)- money market instruments, bonds, preferred stock,
fixed rate bond, floating rate bond
- Have their own price, can estimate independent
3. Derivative securities- contract, value derived from underlying market condition
- Don’t have their own price, need underlying asset price
- Invest to hedge
Most important role of financial markets is informative
- Allocate capital efficiency
2nd role is consumption timing
- Save whenever you have more income
3rd role is risk allocation
- Investors can choose desired risk level
- More risk
more return
Risk aversion- when price increases, expected return decreases
When you have more profitability, you need more investment
Large firms require separate principals & agents
- Agency conflict arises because we all want to maximize our profit
Reduce agency problem by:
1. Give agents equity-based competition
2. Board of directors (oversees management)
3. Threat of takeover (fire management)
Sarbanes-Oxley Act- give shareholders actual information on the firm
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Chapter 1: Investments: Background and Issues
1. Independent board of directors
2. CFO personally verify financial statements
3. Created new oversight board for the accounting audit industry
4. Charged board w/ maintaining a culture of high ethical standards
Investment process: asset allocation & security selection
Security selection- choice of specific securities within each asset class
Asset allocation- the allocation of the investment portfolio across broad asset classes
Volatility is a measure of risk; standard deviation of return
- Some risks are diversifiable, others are not
- Market will compensate for non-diversifiable risk (systematic risk) cannot avoid it
Efficient market- cannot take advantage of public information to make profit
- Would not do active portfolio management
- **passive portfolio management** when market is efficient
The players:
- Business firms (net borrowers)
- Householders (net savers)
- Governments (both borrowers and savers)
- Financial intermediaries (connectors of borrowers and lenders)
- Commercial banks
- Investment companies (take $ from general public)
- Pension funds
- Hedge funds
Investment bankers- firms that specialize in helping companies raise capital by selling
securities to the public
Primary market- newly issued securities offered to public
- IPU
Secondary market- preexisting securities traded among investors
Angel investors lend money to venture capital firms (newer firms)
- Some highly profitable and highly risky firms
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