The Investment Environment Investments Cover image CHAPTER 1 The Investment Environment Slides by Richard D. Johnson McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved

Investments & Financial Assets Essential nature of investment Reduced current consumption Planned later consumption Real Assets Assets used to produce goods and services Financial Assets Claims on real assets

Table 1.1 Balance Sheet – U.S. Households

Table 1.2 Domestic Net Worth

Major Classes of Financial Assets Debt Money market instruments Bonds Common stock Preferred stock Derivative securities

Financial Markets and the Economy Information Role Consumption Timing Allocation of Risk Separation of Ownership and Management Agency Issues

Crisis in Corporate Governance Accounting Scandals Examples – Enron and WorldCom Analyst Scandals Example – Citigroup’s Salomon Smith Barney Initial Public Offerings Credit Swiss First Boston

The Investment Process Asset allocation Security selection Risk-return trade-off Market efficiency Active vs. passive management

Active vs. Passive Management Active Management Finding undervalued securities Timing the market Passive Management No attempt to find undervalued securities No attempt to time Holding an efficient portfolio

Players in the Financial Markets Business Firms – net borrowers Households – net savers Governments – can be both borrowers and savers Investment Bankers

Key Trends - Globalization International and Global Markets Continue Developing Managing foreign exchange Diversification to improve performance Instruments and vehicles continue to develop (WEBs) Information and analysis improves

Figure 1.1 Global Debt Issue

Key Trends - Securitization Securitization & Credit Enhancement Offers opportunities for investors and originators Changes in financial institutions and regulation Improvement in information capabilities Credit enhancement and its role

Figure 1.2 Asset-backed Securities

Key Trends - Financial Engineering Repackaging Services of Financial Intermediaries Bundling and unbundling of cash flows Slicing and dicing of cash flows Examples: strips, CMOs, dual purpose funds, principal/interest splits

Figure 1.3 Building a Complex Security

Figure 1.4 Unbundling – Mortgage Security