Chapter 1 Introduction

Types of Assets zTangible Assets yValue is based on physical properties yExamples include buildings, land, machinery zIntangible Assets yClaim to future income yExamples include various types of financial assets

Types of Financial Assets zBank loans zGovernment bonds zCorporate bonds zMunicipal bonds zForeign bond z Common stock z Preferred stock z Foreign stock

Debt vs. Equity zDebt Instruments yFixed dollar payments yExamples include loans, bonds zEquity Claims yDollar payment is based on earnings yResidual claims yExamples include common stock, partnership share

Price of Financial Asset and Risk zThe price or value of a financial asset is equal to the present value of all expected future cash flows. yExpected rate of return yRisk of expected cash flow

Types of Investment Risks zPurchasing power risk or inflation risk zDefault or credit risk zExchange rate or currency risk

Role of Financial Assets zTransfer funds from surplus units to deficit units. zTransfer funds so as to redistribute unavoidable risk associated with cash flows generated from both tangible and intangible assets.

Role of Financial Markets zDetermine price or required rate of return of asset. zProvide liquidity. zReduce transactions costs, which consists of search costs and information costs.

Classification of Financial Markets zDebt vs. equity markets zMoney market vs. capital market zPrimary vs. secondary market zCash or spot vs. derivatives market zAuction vs. over-the-counter vs. intermediated market

Financial Market Participants zHouseholds zBusiness units zFederal, state, and local governments zGovernment agencies zSupranationals zRegulators

Globalization of Financial Markets zDeregulation or liberalization of financial markets zTechnological advances zIncreased institutionalization

Classification of Global Financial Markets Internal Market (also called national market) External Market (also called international market, offshore market, and Euromarket) Domestic MarketForeign Market

Motivation for Using Foreign Markets and Euromarkets zLimited fund availability in internal market zReduced cost of funds zDiversifying funding sources

Derivatives Market zFutures/forward contracts are obligations that must be fulfilled at maturity. zOptions contracts are rights, not obligations, to either buy (call) or sell (put the underlying financial instrument.

Role of Derivative Instruments zProtect against different types of investment risks, such as purchasing power risk, interest rate risk, exchange rate risk. zAdvantages: yLower transactions costs yFaster to carry out transaction yGreater liquidity