Investment and Money Review Essay

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Investment & Money Management
Midterm Review

1. Overview of investment process (objectives, constraints, etc.), the general principles, i.e., what are the objectives and what are the constraints for an investor?

Overview of Investment Process
Objectives:
Return requirements
Risk Tolerance

Constraints:
Wealth
Liquidity
Horizon
Regulation
Taxes
Unique Needs

2. Distinction between Financial and Real Assets.

Financial Assets: assets that have claims to real assets
Real Assets: assets that are used to produce goods and services

3. How the financial system meets the needs of participants (a broad sense)

Financial Intermediation
Investment banking
Financial Innovation & Derivatives
Responding to regulation & Taxes

Financial System Clients and Their Needs:
1. Household Sector: Primary Need – Investment Funds
2. Business Sector: Primary Needs – Raising Funds
3. Government Sector: Primary Needs – Raising Funds

4. The role of Financial Assets

Consumption timing
Allocation of Risk
Separation of ownership

5. Major classes of financial assets (bond, Common stocks, preferred shares, derivatives.) 1. Bonds
2. Common Stocks
3. Preferred Shares
4. Derivatives

6. Difference between Forward and Futures contracts

Forwards Contracts: an arrangement calling for future delivery of an assets at an agreed price
Futures Contracts: obliges traders to purchase or sell asset at an agreed price on a specified future date.

7. Money market versus capital market

Money Markets: usually more liquid; cash equivalents
Debt Instruments:
Derivatives: Forwards & Futures (Calls & Puts)
Capital Markets: less liquid than money markets; traded in the market.
Bonds
Equity
Derivatives (Call Options)

8. What is “Securitization”?

Securitization: a financial process that pools varies types of loans and transforms them into securities through financial engineering, that trade like securities

9. What are asset backed securities?

Asset backed securities: a financial security backed receivables (ie. Loans & leases) against assets other than real estate and mortgage-backed securities.

10. Distinguish between “seasoned new issues” and “Initial Public Offering”

Seasoned new issues: an issue of additional securities from an established company who already has securities trading in the secondary market.

Initial Public Offering (IPO): an issue of new securities from a company that is not traded on the secondary market; evidence of underpricing and performance

11. Relationship between before-tax and after-tax return

Before-Tax returns are returns on investments before taxes and deductions have been calculated. While after-tax returns are returns on the investment after taxes and deductions have been calculated.

12. Arithmetic return versus Geometric return.

Arithmetic return: assumes all return are independent of each other; calculates the average return at the end of the period. ra = (r1 + r2 + r3 + ... rn) / n ra = (.10 + .25 - .20 + .25) / 4 = .10 or 10%

Geometric return: assumes all returns are not independent of each other; Calculates average returns per period and compounds the returns over periods. rg = {[(1+r1) (1+r2) .... (1+rN)]} 1/n - 1 rg = {[(1.1) (1.25) (.8) (1.25)]} 1/4 - 1 = (1.375) 1/4 -1 = .0829 = 8.29%

13. You should be able to calculate price-weighted index, market value weighted index and equal value-weighted index.

Price-Weighted Index
(Stock Price a + Stock Price b … + Stock Price i)/ Certain #
**20 stocks divisor is 20**

Market Value-Weighted Index
(Stock market value a + Stock market value b … +Stock market value i)/ 10
**10 is the arbitrary divisor**

Equal Value-Weighted Index
???
**Does not correspond to buy and hold portfolio strategies**

14. Primary versus secondary markets.

Primary Market: the market where securities are created. Firms sell new stocks and bonds to the public
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