Financial Assets. What kinds of financial assets will we study? There are three broad types of financial assets

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2 What kinds of financial assets will we study? There are three broad types of financial assets

3 What kinds of financial assets will we study? There are three broad types of financial assets Debt securities (bonds) Equity (stocks) Derivatives

4 billions of dollars 82,000.0 Financial Assets Let's get an update! households and nonprofits Financial Assets 81, , ,235 78, , , ,892 72, , ,782 69, , /1/ /1/ /1/ /1/2017 financial assets

5 Let's get an update! Total financial assets held by US households December 31, 2014: $69,303,400,000,000 (z.1 6/7/2018) Total financial assets held by US households March 31, 2018: $81,745,200,000,000 (z.1 6/7/2018)

6 Back to bonds... What are bonds? What is so special about bonds? Why would people invest in bonds when they can get a higher return with stocks? Are bonds boring compared to stocks?

7 Let's talk about stocks... What are stocks? How do you get a return from stocks? Can you make money on stocks if prices drop? How? What else do you have to take on if you want the higher return from stocks?

8 What are derivatives all about? What are examples of derivatives? How do futures work? How can options be like insurance? How can derivatives go really bad?

9 How does buying a call option work? 1. The buyer buys the right to buy Apple stocks at $520 for a certain amount of time. 2. If the stock price rises, the buyer can exercise his right to buy the stock low, then sell it high and make a profit. 3. If the stock price is lower than $520, the option expires worthless. Payoff to call holder at expiration stock price payoff profit

10 What do markets do? What kinds of functions do financial markets perform? Prices convey information markets deploy capital resources to their most productive uses Time-shift consumption earn more than you consume vs. consume more than you earn Reallocate risk own vs. loan Separate Ownership from Management agency problems Corporate governance and corporate ethics

11 Let's start from the bottom! The Investment Process: Building your portfolio from the bottom up Let's buy some investments...what stocks look good?

12 Step 1, the asset allocation decision, is far more important than step 2, the security selection decision, when it comes to overall investment performance. Asset allocation is the primary determinant of the risk-return profile of the investment portfolio. Financial Assets Let's start from the top! The Investment Process: Building your portfolio from the top down step 1. How are we going to allocate our assets? How much will we put in stocks, bonds, real estate, commodities, etc? step 2. Within each asset class, what securities will we purchase?

13 Markets are very competitive. There is no "free lunch." For a higher return, you need to accept higher risk. Securities are fairly priced. Markets are efficient. There are no bargains, or if they do exist, they disappear quickly. Financial Assets Are there any bargains out there? There are thousands of financial analysts looking for the best market buys. This creates the following implications:

14 Active Management: Attempting to identify mispriced securities or to forecast broad market trends. Financial Assets Passive or Active Investing? If there are no bargains, why not just be a passive investor? Passive Management: Buying and holding a diversified portfolio without attempting to identify mispriced securities. Is there any value to being an active investor?

15 Who is at the table? Who are the players in the Financial Markets? 1. Corporations need capital. 2. Investors need a place to put their money. 3. Financial Intermediaries bring the two together.

16 Where the jobs are! Financial Intermediaries: banks investment companies insurance companies credit unions

17 What did we learn? The definition of an investment Real assets Financial assets Stocks, bonds, derivatives Market Functions Top-down investing Markets are efficient Market players Financial intermediaries