FIN4504 Investments Prof Danling Jiang Exam 1 Review Exam Breakdown 40 Multiple Choice Questions Lecture 1 8 questions Real vs Financial Assets Roll of Financial Markets Agency Problem Top Down vs Bottom Up Major Players in Financial Markets Financial Crisis of 2008 Lecture 2 10 questions Asset classes Debt Common Stock Derivatives Money Market Instruments T Bills etc Bonds T notes T Bonds munis Stocks Indices Preferred vs Common Stock BDY vs BEY Lecture 3 12 questions Primary vs Secondary Markets Venues for Trading Types of Orders Cost of Trading Bid Ask Commissions Margin Trading heavily covered on the exam Short Sales Lecture 4 10 questions Types of Services Open Ended vs Close Ended Types of Mutual Funds NAV and Returns Cost of Investing in Mutual Funds LECTURE 1 Inflation Risk Risk of holding money without investing Real Investment Produces goods and services Financial Investment Claim to cash flow generated from real assets Information Role Consumption Timing Allocation of Risk Separation of Ownership Management Agency Problem Yahoo Example Microsoft offers to buy Yahoo 31 share was currently trading 19 share Yahoo rejects offer hold out for 37 share Carl Icahn starts proxy fight to seize control large shareholder Carl loses fight Yahoo rejects offer Next day stock falls from 29 to 21 Bottom Up Security Analysis determine value find mis pricing Ex Jim Cramer Mad Money on CNBC Advantage identify mis priced stocks Disadvantage undervalued stocks means less stocks less diversified due to time cost spent researching Top Down Asset Allocation choose between stocks or bonds Security Selection choose areas companies Advantage more diversified less risk and cost effective Disadvantage overlook undervalued securities Worst single stock to invest in your own company The Players Business Firms net borrowers Households net lenders Government net borrowers and net savers Financial Intermediaries bring savers and borrowers together Banks Investment Companies Credit Unions etc Investment Bankers specialized firms in selling stocks and bonds to public There is no independent investment banking sector Glass Steagall Act 1933 Reversed in 1999 In response to the Great Depression Separated commercial and investment banking sectors Only 10 of commercial banks income could come from securities under writers Financial Crisis of 2008 The Great Moderation The US had a stable economy with low interest rates and a tame business cycle with only mild recessions Lybor Rate overnight borrowing rate between big bangs minus T Bill Rate Spread between T Bill Rate and Lybor Rate High high chance of default risk Low low chance of default risk Changes to Financing Housing Old Way Originate to Hold New Way Originate to Distribute Collateralized Debt Obligations CDOs Divided the mortgage pool into trenches Senior Trench low risk higher rating Junior Trench high risk low or junk rating Credit Default Swap CDS An insurance contract against the default of the borrower Created to back purchasers of CDOs against the risk of default When the market tanked there wasn t enough money to cover the claims insurance failed LECTURE 2 Financial Assets Debt fixed income bank certificates T Bills commercial paper Common Stock ownership stake in the entity residual cash flow Derivatives contract that has its value is derived from some underlying market condition usually stocks or bonds Calculating Bond Equivalent Yield BEY Fixed Income Instruments Par Value typically 1 000 Price is quoted in units of 1 32 of a point Notes maturity up to 10 years Bonds maturity longer than 10 years 30 year bonds Calculating Tax Equivalent Yield on Municipal Bonds Mortgage Backed Securities Proportional stake of a mortgage pool or specified obligation backed by the pool Produced by securitizing mortgages Referred to as pass through because the cash flows produced are passed through to investors Equity Common Stock Entitled to a vote and dividend payment Residual claim limited liability Preferred Stock Nonvoting shares which usually pay cumulative dividends with priority over common stock holders American Depository Receipts ADR Negotiable certificate issued by a US bank representing a specified number of shares or one share in a foreign stock that is traded on a US exchange They are denominated in US dollars with underlying security held by a US financial institution overseas They help to reduce the administrative and duty costs that would otherwise be levied on each transaction Via Investopedia Price Weighted Index Dow Jones Value Weighted Index S P500 Nasdaq LECTURE 3 Primary Market Firms issue new securities through an underwriter to the public Investors get the new securities and the firms get funding Secondary Market Investors trade previously issued securities among themselves Issuance of Securities Stocks Initial Public Offering IPO or Seasoned Offering SEO Bonds Public Offering or Private Placement Market Types Direct Search Markets Buyers and sellers locate one another on their own Dealer Markets 3rd party acts as intermediate for buyer and seller Brokered Markets 3rd party assistance in location of buyer or seller Auction Markets Brokers and dealers trade in one location trading is more or less continuous Order Types Market Order Price Contingent Orders Limit Order A limit order is an order to buy or sell a stock at a specific price or better Stop Order Also referred to as a stop loss order is an order to buy or sell a stock Discretionary Order Gives the broker the power to buy and sell for your account at the once the price of the stock reaches a specified price broker s discretion Time Dimension on Orders other than market orders IOC Immediate or Cancel Day By default GTC Good Until Canceled usually max of 60 days Brokerage Commission Fees paid to broker Full Service vs Discount Broker Explicit Cost of Trading Bid Ask Spread Implicit cost of trading Bid price that dealer is willing to buy from you Ask price that a dealer is willing to sell to you Typically Ask Bid Bid Ask Spread Ask Bid which is the dealer s gain Bid Price Offers to buy Investors sell to the bid Ask Price Offers to sell Investors must pay the asked price to buy the security U S Security Markets Nasdaq dealer market Small stock OTC Pink Sheets Organized Exchanges New York Stock Exchange NYSE American Stock Exchange Regionals Electronic Communication Networks ECNs National Market System Initial Margin Requirement IMR Currently 50 set up by the Fed Reg T You can borrow