McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. Investments: Background and Issues Bodie, Kane and Marcus Essentials of Investments 9 th Global Edition 1 Dr. Emilio Tomasini Adjunct Professor of Corporate Finance University of Bologna - ITALY

D R. E MILIO T OMASINI Phone Skype tomasini4 Exam: written quiz, 22 closed questions, 3 exercises 4 points each Questions taken from those on the books basic + intermediate Text book: Bodie/Kane/Marcus and Emilio Tomasini /Urban Jaekle … see website Office hours: SKYPE 09:00 – 24:00 every day except Sunday Free software: Visual Trader, Ex-Ante, I-Ratings

PROGRAM 14 April hours introduction PART ONE 15 April hours bonds PART THREE 22 April hours bonds PART THREE 28 April hours Portfolio Theory PART TWO 29 April hours Efficient markets, behavioural finance and technical analysis PART TWO 5 May hours Portfolio Theory PART TWO 6 May hours Modern technical analysis PART TWO 12 May hours Futures PART FIVE 13 May hours Futures PART FIVE 19 May hours Options PART FIVE 20 May hours Options PART FIVE 26 May hours Trading systems PART SIX bonus 27 May hours Trading systems PART SIX bonus

N O FISCAL ASPECTS OF FINANCE They change continuosly They are different in every country They depend on the fact you are an individual a corporation a bank an insurance a branch etc.

F OCUS ON THE FUTURE Financial crisis in 2008 was mostly unforeseen Do not explaing today what happened yesterday as it was easy to understand There will be many financial crisis in the future Try to give you a rule to understand a crisis is underway

MOTIVATION Why are we here ? Quant Finance makes me feeling clever I like talking difficult and theoretical complexity I did not know what to do in life Bologna is full of young people and so fascinating I come from Latvia and my boyfriend is from Granarolo Emilia … …

M OTIVATION Why I am here ?

M OTIVATION … NO DISCRIMINATION

MY MOTIVATION 100% COMPETITION: LITTLE GUYS CAN WIN OVER BIG GUYS A NOBEL RESERACH CAN BE PERFORMED IN YOUR KITCHEN WITH AN OLD PC NO INTERMEDIATION THERE IS NO RULE JUST YOURSELF COOPERATION IS EVERYTHING … DEATH ALSO

W HAT IS MISSING IN THE TEXTBOOK ? RESEARCH + SOFTWARE + TIME = MONEY YES YOU CAN

W HAT MY GOALS IN TEACHING WILL BE ? YES YOU CAN TEST EVERYTHING WITHOUT PRE- CONCEPTIONS LISTEN TO EVERYBODY: HOW AN UCKAINIAN STUDENT CAN BEAT THE STREET ? DISTRUST YOUR UNIVERSITY PROFESSOR: WHO KNOWS DOES, WHO DOES NOT KNOWS TEACH, HOW DOES NOT KNOW HOW TO TEACH TEACH GYM

1.1 R EAL VERSUS F INANCIAL A SSETS What is an Investment ? Reduce current consumption for greater future consumption (either borrowing money...) Real Assets Used to produce goods and services: Property, plants and equipment, human capital, etc. Financial Assets Claims on real assets or claims on real-asset income

T ABLE 1.1 B ALANCE S HEET, U.S. H OUSEHOLDS, 2011 Assets $ Billion% TotalLiabilities and Net Worth$ Billion% Total Real assets Real estate18, %Mortgages10, % Consumer durables4,6656.5%Consumer credit2,4043.3% Other3030.4%Bank and other loans3840.5% Total real assets23, %Security credit3160.4% Other5560.8% Total liabilities13, % Financial assets Deposits8, % Life insurance reserves1,2981.8% Pension reserves13, % Corporate equity8, % Equity in noncorp. business6,5859.2% Mutual fund shares5,0507.0% Debt securities4,1295.7% Other1,5362.1% Total financial assets48, %Net worth58, % TOTAL71, %71, % Note: Column sums may differ from total because of rounding error. SOURCE: Flow of Funds Accounts of the United States, Board of Governors of the Federal Reserve System, June 2011.

1.1 R EAL VERSUS F INANCIAL A SSETS All financial assets (owner of the claim) are offset by a financial liability (issuer of the claim) When all balance sheets are aggregated, only real assets remain Net wealth of economy: Sum of real assets

T ABLE 1.2 D OMESTIC N ET W ORTH, 2011 Assets$ Billion Commercial real estate14,248 Residential real estate18,117 Equipment and software4,413 Inventories1,974 Consumer durables4,665 TOTAL43,417 Note: Column sums may differ from total because of rounding error. SOURCE: Flow of Funds Accounts of the United States, Board of Governors of the Federal Reserve System, June 2011.

1.2 F INANCIAL A SSETS Major Classes of Financial Assets or Securities 1. Fixed-income (debt) securities Money market instruments Bank certificates of deposit, T-bills, commercial paper, etc. Bonds Preferred stock 2. Common stock (equity) Ownership stake in entity, residual cash flow 3. Derivative securities Contract, value derived from underlying security

1.3 F INANCIAL M ARKETS AND THE E CONOMY 1. Informational Role of Financial Markets Do market prices equal the fair value estimate of a security's expected future risky cash flows? Can we rely on markets to allocate capital to the best uses? Other mechanisms to allocate capital? Advantages/disadvantages of other systems?

2. Consumption Timing Consumption smooths over time When current basic needs are met, shift consumption through time by investing surplus 1.3 F INANCIAL M ARKETS AND THE E CONOMY 3. Price variability reduction Ezekiel cobweb system If you bring surplus to the next year and production fits to the new surplus arriving from the previous year variability will be lower

4. Risk Allocation Speculators and producers / hedgers Specialization in risk taking Lower price for risk in the society 1.3 F INANCIAL M ARKETS AND THE E CONOMY

5. Separation of Ownership and Management Large size of firms requires separate principals and agents Investors are not managers and managers are not investors Specialization and risk reduction 1.3 F INANCIAL M ARKETS AND THE E CONOMY

T HE F INANCIAL C RISIS OF 2008 Just ask yourself a question: “This is good or bad finance ?” And then you know if a new crisis will happen in the future

Corporate Governance and Corporate Ethics Businesses and markets require trust to operate efficiently Without trust additional laws and regulations are required Laws and regulations are costly Governance and ethics failures cost the economy billions, if not trillions Eroding public support and confidence 1.3 F INANCIAL M ARKETS AND THE E CONOMY

Corporate Governance and Corporate Ethics Accounting scandals Enron, WorldCom, Rite-Aid, HealthSouth, Global Crossing, Qwest Misleading research reports Citicorp, Merrill Lynch, others Auditors: Watchdogs or consultants? Arthur Andersen and Enron 1.3 F INANCIAL M ARKETS AND THE E CONOMY

Corporate Governance and Corporate Ethics Sarbanes-Oxley Act: Requires more independent directors on company boards Requires CFO to personally verify the financial statements Created new oversight board for the accounting/audit industry Charged board with maintaining a culture of high ethical standards 1.3 F INANCIAL M ARKETS AND THE E CONOMY

1.4 T HE I NVESTMENT P ROCESS Asset Allocation Primary determinant of a portfolio's return Percentage of fund in asset classes Stocks 60% Bonds 30% Alternative assets 6% Money market securities 4% Security selection and analysis Choosing specific securities within asset class

1.5 M ARKETS A RE C OMPETITIVE Risk-Return Trade-Off Assets with higher expected returns have higher risk Stock portfolio loses money 1 of 4 years on average Bonds Have lower average rates of return (under 6%) Have not lost more than 13% of their value in any one year Average Annual ReturnMinimum (1931)Maximum (1933) StocksAbout 12%−46%55%

1.5 M ARKETS A RE C OMPETITIVE Risk-Return Trade-Off How do we measure risk? How does diversification affect risk?

1.5 M ARKETS A RE C OMPETITIVE Efficient Markets Securities should be neither under-priced nor over-priced on average Security prices should reflect all information available to investors Choice of appropriate investment- management style based on belief in market efficiency

1.5 M ARKETS A RE C OMPETITIVE Active versus Passive Management Active management (inefficient markets) Finding undervalued securities (security selection) Market timing (asset allocation) Passive management (efficient markets) No attempt to find undervalued securities No attempt to time Holding a diversified portfolio Indexing; constructing “efficient” portfolio

1.6 T HE P LAYERS Business Firms (net borrowers) Households (net savers) Governments (can be both borrowers and savers) Financial Intermediaries (connectors of borrowers and lenders) Commercial banks Investment companies Insurance companies Pension funds Hedge funds

1.6 T HE P LAYERS Investment Bankers Firms that specialize in primary market transactions Primary market Newly issued securities offered to public Investment banker typically “underwrites” issue Secondary market Pre-existing securities traded among investors

1.6 T HE P LAYERS Investment Bankers Commercial and investment banks' functions and organizations separated by law Post-1999: Large investment banks independent from commercial banks Large commercial banks increased investment- banking activities, pressuring investment banks’ profit margins September 2008: Mortgage-market collapse Major investment banks bankrupt; purchased/reorganized

1.6 T HE P LAYERS Investment Bankers Investment banks may become commercial banks Obtain deposit funding Have access to government assistance Major banks now under stricter commercial bank regulations

1.6 T HE P LAYERS Venture Capital and Private Equity Venture capital Investment to finance new firm Private equity Investments in companies not traded on stock exchange