Chapter 1 - Investment Environment . Investment - current commitment of money or other resources in expectation of reaping future benefits · Real assets - Assets used to produce goods and services such as land, buildings, and equipment and knowledge to produce g + s . Financial asset - stocks and bonds . 3 broad types of financial asset : fixed income. equity, and derivatives. . Stock prices are reflected by investors expectations as if it is optimistic they will be higher · Mechanisms to mitigate agency problems include - compensation plans, Options, force out underperforming management teams, security analysts monitoring the firm., bad performers are subject to threat of takeover - can launch a proxy contest to obtain enough proxies - right to vote for the shares of other stakeholders to take control of the firm and vote in another board. . The material wealth of a society, determined by the productive capacity of the economy is a function of real asset, . real assets generate net income to the economy, financial assets defined the allocation of income or wealth among investors. . Fixed income securities - A security such as a bond that pays a specified cash flow over a specific period. - floating rate bonds and junk bonds . Debt securities - Bonds; also called fixed-income securities. . Money market refers to securities that are short term and low risk such as treasury bills and CDfls, bank certificates of deposit. . Fixed income capital market includes long term securities such as treasury bonds and bonds issued from federal agencies, they are very safe in terms of default risk. · Derivative securities - A security whose payoff depends on the value of other financial variables such as stock prices, interest rates, or exchange rates. Main use is to hedge risks and transfer to other parties. · Investor's portfolio is collection of investment assets. It is updated or rebalanced by selling existing securities and buying new securities. · Investors have 2 types of decisions in constructing portfolio: ff. Asset allocation - Allocating a portfolio across broad asset classes such as stocks versus bonds. 2. Security selection - choice of specific securities within a given asset class . Top-down portfolio construction starts with asset allocation then looks at particular securities to be held in each asset class. · Security analysis - valuation of particular securities that might be included In portfolios . Bottom up - portfolio is constructed from securities that are good prices // focuses on portfolio on assets that offer most investment opportunities, . Risk return trade off in securities market - Assets with higher expected return entail greater risk. . Diversification means that many assets are held in the portfolio so that exposure to any particular asset is limited. · Passive management - Buying a diversified portfolio, often a broad-based market index, without attempting to identify mispriced securities.
· Active management - improve performance by identifying mispriced securities or timing the performance of broad asset classes. .