Fabozzi Fofmi4 Ch01 Gi

Introduction

Chapter 1

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall 2

Types of Assets

Tangible Assets

Value is based on physical properties

Examples include buildings, land, machinery

Intangible Assets

Claim to future income

Examples include various types of financial assets


Types of Financial Assets

Bank loans

Government

bonds

Corporate bonds

Municipal bonds

Foreign bond

Common stock

Preferred stock

Foreign stock


Debt vs. Equity

Debt Instruments

Fixed dollar payments

Examples include loans, bonds

Equity Claims

Dollar payment is based on earnings

Residual claims

Examples include common stock, partnership share


Price of Financial Asset and Risk

The price or value of a financial asset is equal to

the present value of all expected future cash

flows.

Expected rate of return

Risk of expected cash flow


Types of Investment Risks

Purchasing power risk or inflation risk

Default or credit risk

Exchange rate or currency risk


Role of Financial Assets

Transfer funds from surplus units to deficit units.

Transfer funds so as to redistribute unavoidable

risk associated with cash flows generated from

both tangible and intangible assets.


Key Points You Should

Understand

Difference between tangible and financial assets

Difference between debt and equity

Cash flow of a financial asset

Three types of risks associated with financial

asset

Two principal economic functions of financial

assets


Role of Financial Markets

Determine price or required rate of return of

asset.

Provide liquidity.

Reduce transactions costs, which consists of

search costs and information costs.


Classification of Financial

Markets

Debt vs. equity markets

Money market vs. capital market

Primary vs. secondary market

Cash or spot vs. derivatives market

Auction vs. over-the-counter vs. intermediated

market


Financial Market Participants

Households

Business units

Federal, state, and local governments

Government agencies

Supranationals

Regulators



Understand

Three economic functions of financial markets

Ways that financial markets can be classified

Market participants


Globalization of Financial

Markets

Deregulation or liberalization of financial markets

Technological advances

Increased institutionalization


Classification of Global Financial Markets

Internal Market

(also called national

market)

External Market

(also called international

market, offshore market,

and Euromarket)

Domestic Market Foreign Market


Motivation for Using Foreign Markets and Euromarkets

Limited fund availability in internal market

Reduced cost of funds

Diversifying funding sources


Derivatives Market

Futures/forward contracts are obligations that

must be fulfilled at maturity.

Options contracts are rights, not obligations, to

either buy (call) or sell (put the underlying

financial instrument.


Role of Derivative Instruments

Protect against different types of investment risks,

such as purchasing power risk, interest rate risk,

exchange rate risk.

Advantages:

Lower transactions costs

Faster to carry out transaction

Greater liquidity



Understand

Three major factors that have integrated financial

markets

Institutionalization of financial markets

Internal and external markets

Motive to raise money outside of domestic market

Two basic types of derivatives

Principal economic role of derivatives

Potential uses of derivatives


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Fabozzi Fofmi4 Ch01 Gi

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