FIN 310 1st EditionExam # 1 Study Guide I. The Investment EnvironmentReal vs. Financial AssetsReal Assets: assets to produce goods or serviceFinancial Assets: claims on real assets of the income generated by themConsumption Timing-Storing wealth in financial assets, making changes during high and low periods. By doing this consumption can be “shifted” over the course of a person’s life, andthis allocates consumption to time periods that provide greatest satisfaction.Allocation of Risk: selecting investments with the wanted or appropriate amount of risk, the market allows risk that is inherent to all investments to be borne by the investors most willing to take on the risk.Top down vs. Bottom Up Portfolio FormationBottom Up: Constructing a portfolio from attractively priced securities without regard for asset allocationTop down: Allocating assets based of careful planning of diversificationFinancial Intermediaries-Institutions that “connect” borrowers and lenders by accepting funds from lenders and loaning funds to borrowersFinancial Intermediaries have evolved to bring together the suppliers of capital with the demands of capital. The intermediaries include: banks, investment companies, insurance companies, and credit unions. Four types of MarketsDirect Search: the least organized market, buyers and sellers have to seek out each other, an example of this would be CraigslistBrokered Markets: next level of organized market. In this market traders find it profitable to offer services to buyers and sellers, an example is Real Estate.Dealer Markets: when trading activity in a particular type of asset increases, dealers market arise. Dealers specialize in particular assets, purchase these assets for their own accounts, and later sell them to profit. Most bonds trade in over the counter dealer marketsAuction Market: A market where all traders meet at one place to buy and sell an asset, an example is the NYSEII. Asset Class and Financial InstrumentsAsset Classes:-Equities: Common stocks, preferred stocks-Bonds: Treasury Bonds and notes, Federal Agency debt, Municipal bonds, Corporate bonds, Mortgage-backed securities-Derivative Markets: Options, Futures and forwards, SwapsCorporate Bond vs Tax Free Municipal BondCorporate Bond: Long-term debt issued by private corporations typically paying semiannual coupons and returning the face value of the bond at maturityMunicipal Bond: Tax-exempt bonds issues by state and local governmentsWhen choosing between a taxable or tax-exempt bond needs to compare after-tax returns on each bondIndicesPrice-weighted average: An average computed by adding the prices of the stocks and dividing by a “divisor”-To calculate this you take the difference in the initial value and the final value of the index, and the divide that number by the initial value.Market-value weighted: Index return equals the weighted average of returns of each component security, with weights proportional to outstanding market value-Calculated by find the total value of the 500 firms in the index and the total of those firms on the day previous, the percentage increase represents the increase in the indexEqually-weighted Index: An index of computed from a simple average of returns-To reset a portfolio to equal weights you would need to rebalance by selling some of one stock and purchasing more of the other.III. How Securities are TradedHow firms issue securitiesPrimary Market: Market for new issues of securitiesSecondary Market: Market for already-existing securitiesFirms need to raise new capital to help pay for their many investment projects, they issue securities to raise this capital. Once the securities are traded investors might trade among themselves.Underwriters and UnderpricingPecking Order Theory-postulates that the cost of financing increases with asymmetric information. Financing comes from three sources, internal funds, debt and new equity. Companies prioritize their sources of financing, first preferring internal financing, and then debt, lastly raising equity as a “last resort”. Hence: internal financing is used first; when that is depleted, then debt is issued; and when it is no longer sensible to issue any more debt, equity is issued.NYSE vs. NASDAQNew York Stock Exchange: publishes a market value- weighted composite index of all NYSE-listed stocks, in addition to sub indexes for industrial, utility, transportation, and financial stocksNASDAQ: The computer- linked price quotation and trade execution system. National Association of Securities Dealers publishes an index of more than 3,000 firms trades on the Nasdaq market. -NYSE is an organized exchange while NASDAQ is an electronic marketSpecialists- Market makers with functions of a broker and a dealerBuy orders, Sell order, raise the price or sell out of their own inventory to meet demandBuy orders, Sell order, lower the price or purchase for their own inventoryMarket Vs. Limit OrdersMarket: Market orders are buy or sell orders that are to be executed immediately at current market prices- Bid price: price at which a dealer or other trader is willing to purchase a security- Ask price: The price at which a dealer of other trader will sell a security- Bid-ask spread: the difference between the bid and asked pricesLimit Order: An order specifying a price at which an investor is willing to buy or sellTrading Costs:Explicit Cost- commission that must be paid to brokersImplicit Cost- the dealer’s bid-ask spread, or investor may be forced to make for trading in quantities greater than associated with the posted bid or asked pricesTrading on Margin/short sellingMargin: Describes securities purchased with money borrowed in part from a broker, the margin in the new worth of the investor’s account. Purchasing stocks on margin means the investor borrows part of the purchase price of the stock from a broker.Short Selling: Allows investors to profit from a decline in a security’s price. An investor borrows a share of stock from a broker and sells it, later the short-seller has to buy a share of the same stock to replace the one that was borrowed. Insider Trading-Using information that is not available to the public to make investment decisions illegallyIV. Investment CompaniesInvestment companies:- Financial intermediaries that invest the funds of individual investors in securities or other assetsNet Asset Value-Assets minus liabilities expressed on a per-share basisNet Asset Value= Market Value of