Bryant is a 25-year old young professional, employed in a major city in the northeast. Since joining the workforce three years ago, he contributes as much money as possible to his r

Course Details

• Textbook: Investments, 11th edition by Bodie, Kane, and Marcus Publisher: McGraw Hill

• Recommended reading: • The Wall Street Journal • Business Week • The New York Times Deal Book • …

Introduction

September 2018

September 2020 Amazon $1.68T

Best Buy $ 28.17B Macy's $ 2.39B Target $ 73.07B Costco $ 153.43B Nike $ 141.12B Sear's $ 0.08B Home Depot $ 294.72B Starbucks $ 100.83B McDonald's $ 158.61B Barnes & Noble $ 0.48B JC Penney $ 0.06B Dollar Tree $ 22.11B Office Depot $ 1.2B Nordstrom $ 2.5B Kroger $ 27.87B Kohl's $ 3.43B

Combined: $1.01T

Financial Assets

• Real assets vs financial assets

• Land, buildings, machines, knowledge vs.

• Stocks, bonds (claims on real assets)

Financial Assets

• Consumption Timing Use securities to store wealth and transfer consumption to the future

• Allocation of Risk Investors can select securities consistent with their tastes for risk, which benefits the firms that need to raise capital as security can be sold for the best possible price

Market Participants – Players

• Demanders of capital – Firms • Suppliers of capital – Households • Governments – Can be both borrowers or lenders • Financial Intermediaries: Pool and invest funds • Investment Companies • Banks • Insurance companies • Credit unions

Investment Process

• Portfolio: Collection of investment assets. • Asset allocation • Choice among broad asset classes

• Security selection • Choice of securities within each asset class

Investment Process

• Risk-Return Trade-Off Higher-risk assets are priced to offer higher expected returns than lower-risk assets

• Efficient Markets In fully efficient markets when prices quickly adjust to all relevant information, there should be neither underpriced nor overpriced securities

Investment Process

• Passive Management • Holding a highly diversified portfolio • No attempt to find undervalued securities • No attempt to time the market

• Active Management • Finding mispriced securities • Timing the market

Investment Objectives & Return Expectation

• When beginning to invest, we need to clarify our objectives and our expectations. • This is true whether we manage our own money or someone else’s!

• Possible objectives include: • Capital conservation • Growth • Speculation

How Much Risk Is Right for You?

Risk and reward are linked – and therefore, we should ask not just about the desired return but more about someone’s tolerance for risk. Sample Questions: • Two weeks after buying 100 shares for $20 each, the price suddenly jumps to

over $30. What do you do – buy more stock, sell it and take profits, sell half and let it run, sit and wait? • The market has been rallying a lot over the recent weeks. What do you do –

wish you’d invested more, call an expert for advice, feel relieved that you are not invested so you don’t have to worry about it, or just shrug it off? • You go to a casino for the first time. What do you play – quarter slot

machines, $5 roulette table, dollar slot machines, $25 minimum bet Black Jack?

Investment Constraints

Let’s assume we’ve figured out our objective. There may still be some constraints! • Time horizon: At our age, we have much more time to recoup any

short-term shortfalls or losses. • Tax concerns: Depending on your age and where you file your taxes,

your asset allocation leads to different tax liabilities, e.g. for capital gains and for dividends. • Liquidity risk: If your asset can be sold close to its intrinsic value with

short notice, it’s liquid. If it cannot be sold close to its intrinsic value, an investor has less flexibility!

Group Exercise

Form groups of 3-4 students – turn to people behind you if necessary. • Research the following companies: Amazon, Target, GM, Tesla • What is the current stock price, and what is the trading range of the stock in

the previous 52 weeks? • What is the industry of the company, and who are their main competitors? • What are the revenue and earnings numbers of the company? • How does the company make money? • Does the company pay a dividend? If so, how much? • What's the size of the company in terms of revenue and market cap and how

do they compare to the rest of their market industry?

Asset Classes and Financial Instruments

Money Market Securities

• Fed funds: Very short-term loans between banks • Treasury bills: Short-term debt of U.S. government • Repos and reverses: Short-term loan backed by government

securities. • Certificates of deposit: Time deposit with a bank • Commercial paper: Short-term, unsecured debt of a company • Eurodollars: Dollar-denominated time deposits in banks outside the

U.S.

Bond Market

• Treasury Notes and Bonds • Maturities • Notes – Maturities up to 10 years • Bonds – Maturities from 10 to 30 years

• Par Value – $1,000 • Interest paid semiannually • Quotes – Percentage of par

• International Bonds • Eurobonds and Yankee bonds

Bond Market

• Municipal Bonds • Issued by state and local governments • Interest is exempt from federal income tax and sometimes from state and

local tax • Types • General obligation bonds: Backed by taxing power of issuer • Revenue bonds: backed by project’s revenues or by the municipal agency

operating the project.

Bond Market

• Mortgage-Backed Securities • Proportional ownership of a mortgage pool or a specified obligation secured

by a pool • Produced by securitizing mortgages

• Mortgage-backed securities are called pass-throughs because the cash flows produced by homeowners paying off their mortgages are passed through to investors.

• Most were issued by Fannie Mae and Freddie Mac

Bond Market

• Corporate Bonds • Issued by private or public firms, raising capital in the debt market. • One firm may have multiple outstanding bonds with different maturities,

coupon rates, and other terms. • Credit rating to estimate the probability of default

Equities

• Common stock: Ownership • Residual claim • Limited liability

• Preferred stock: Perpetuity • Fixed dividends • Priority over common

• American Depository Receipts • Certificates traded in U.S. markets that represent ownership in shares of a

foreign company

Market Indices

• Dow Jones Industrial Average • Includes 30 large blue-chip corporations

• Computed since 1896

• Price-weighted average

• Standard & Poor’s 500 • Broadly based index of 500 firms

• Market-value-weighted index

• Investors can base their portfolios on an index • Buy an index mutual fund

• Buy exchange traded funds (ETFs)

Mutual Funds

• Fund’s prospectus describes: • Investment objectives • Fund investment adviser and portfolio manager • Fees and costs

• Statement of Additional Information (SAI) • Fund’s annual report

Exchange-Traded Funds (ETF)

• Financial institution holds assets in a trust and sells depositary receipts as claims on capital gains and cash flows of the underlying securities. • Advantage over mutual funds: • Smaller management fee, most of the time. • Tradable during market hours. • Allow to time realization of capital gains.

• Disadvantage against mutual funds: • Brokerage commission where applicable. • Cannot reinvest dividend more than quarterly.

Derivatives

• Options • Call: Right to buy underlying asset at the strike or exercise price • Value of calls decreases as strike price increases

• Put: Right to sell underlying asset at the strike or exercise price • Value of puts increase with strike price

• Value of both calls and puts increases with time until expiration

• Futures Contracts • An agreement made today regarding the delivery of an asset (or in some

cases, its cash value) at a specified delivery or maturity date for an agreed- upon price, called the futures

How Securities are Traded

• Primary Market • Market for newly-issued securities • Firms issue new securities through underwriter (investment banker) to public

• Secondary Market • Investors trade previously issued securities among themselves

IPOs

• Part 1 – The Pitch • Part 2 – The Kick-Off Meeting • Part 3 – The S-1 Filing • Part 4 – Pre-Selling the Offering • Part 5 – The Roadshow • Part 6 – The Pricing Meeting • Part 7 – The Allocation • Part 8 – Trading

IPOs

Secondary Market

Types of Markets: • Direct search

Buyers and sellers seek each other • Brokered markets

Brokers search out buyers and sellers

• Dealer markets Dealers have inventories of assets from which they buy and sell

• Auction markets Traders converge at one place to trade

Secondary Market

Bid Price • Bids are offers to buy. • In dealer markets, the bid price is

the price at which the dealer is willing to buy. • Investors “sell to the bid.” • Bid-asked spread is the profit for

making a market in a security.

Ask Price • Asked prices represent offers to sell. • In dealer markets, the asked price is

the price at which the dealer is willing to sell. • Investors must pay the asked price to

buy the security.

Secondary Market

Trading Costs:

• Brokerage Commission: Fee paid to broker for making the transaction • Explicit cost of trading • Full service vs. discount brokerage

• Spread: Difference between the bid and asked prices • Implicit cost of trading

Secondary Market

Example: Share price: $1,628.26

Bid: $1,628.00 Ask: $1,628.52

Brokerage fee: $2.95 / transaction

Secondary Market

• Market Order: Executed immediately Trader receives current market price

• Price-Contingent Order: Traders specify buying or selling price

• A large order may be filled at multiple prices

Secondary Market

Buying on Margin:

• Borrowing part of the total purchase price of a position using a loan from a broker • Investor contributes the remaining portion • Margin refers to the percentage or amount contributed by the

investor • You profit when the stock rises

Secondary Market

Buying on Margin:

Share price $100 60% Initial Margin 40% Maintenance Margin 100 Shares Purchased Initial Position Stock $10,000 Borrowed $4,000

Equity $6,000

Secondary Market

Buying on Margin:

Share price $100 60% Initial Margin 40% Maintenance Margin 100 Shares Purchased Initial Position Stock $10,000 Borrowed $4,000

Equity $6,000

Stock price falls to $70 per share New Position Stock $7,000

Borrowed $4,000 Equity $3,000

Margin % = $3,000/$7,000 = 43%