Chapter 1. Introduction financial assets financial markets derivatives markets financial assets financial markets derivatives markets

I. Financial Assets assets = anything with value –tangible = physical property –intangible = legal claim to something of value assets = anything with value –tangible = physical property –intangible = legal claim to something of value

financial assets intangible assets claim to future cash flows –issuer pays cash flows –investor receives cash flows also called –financial instruments –securities intangible assets claim to future cash flows –issuer pays cash flows –investor receives cash flows also called –financial instruments –securities

financial assets finance tangible assets

debt vs. equity debt security –cash flows are fixed –bonds, loans equity security –cash flow variable, residual –common stock debt security –cash flows are fixed –bonds, loans equity security –cash flow variable, residual –common stock

Price & risk price of security = PV of expected cash flows –use appropriate discount rate –are cash flows certain? price of security = PV of expected cash flows –use appropriate discount rate –are cash flows certain?

RiskRisk degree of uncertainty about cash flows –inflation –default –exchange rates –liquidity –regulation degree of uncertainty about cash flows –inflation –default –exchange rates –liquidity –regulation

financial assets transfer funds from savers to borrowers redistribute risk vehicle of financial intermediaries transfer funds from savers to borrowers redistribute risk vehicle of financial intermediaries

II. Financial Markets Why have them? –determine price/value & allocate resources –ease of buying and selling securities –reduce transactions costs Why have them? –determine price/value & allocate resources –ease of buying and selling securities –reduce transactions costs

ClassificationClassification type of assets –debt market –equity market maturity of assets –money market (short-term debt) –capital market (long-term) type of assets –debt market –equity market maturity of assets –money market (short-term debt) –capital market (long-term)

time of delivery of assets –cash/spot market -- exchange immediately after trade –derivative market -- exchange in future even though trade today time of delivery of assets –cash/spot market -- exchange immediately after trade –derivative market -- exchange in future even though trade today

age of asset –primary market (newly issued) –secondary market (previously issued) structure of market –exchange (physical location) –over-the-counter (dealers) age of asset –primary market (newly issued) –secondary market (previously issued) structure of market –exchange (physical location) –over-the-counter (dealers)

GlobalizationGlobalization many financial markets in each country merging to an international market why? –advances in technology –deregulation –greater choice/lower cost funding –growth in institutional trading many financial markets in each country merging to an international market why? –advances in technology –deregulation –greater choice/lower cost funding –growth in institutional trading

III. Derivatives Markets what are derivatives? –contracts for future sale/purchase of an asset –contract values DERIVED from asset value –futures contracts, options contracts what are derivatives? –contracts for future sale/purchase of an asset –contract values DERIVED from asset value –futures contracts, options contracts

How are derivatives used? manage risk from changes in –interest rates –stock prices –exchange rates cheap way to manage risks manage risk from changes in –interest rates –stock prices –exchange rates cheap way to manage risks