1、THE INVESTMENT ENVIRONMENTLecture 1Hafiz Hoque 1-1.1-2Real AssetsDetermine the productive capacity and net income of the economyExamples: Land, buildings, machines, knowledge used to produce goods and servicesFinancial AssetsClaims on real assetsReal Assets Versus Financial AssetsHafiz Hoque .1-3Fin

2、ancial Assets Three types:Fixed income or debtCommon stock or equityDerivative securitiesHafiz Hoque .1-4Fixed IncomePayments fixed or determined by a formulaMoney market debt: short term, highly marketable, usually low credit riskCapital market debt: long term bonds, can be safe or riskyHafiz Hoque

3、 .1-5Common Stock and DerivativesCommon Stock is equity or ownership in a corporation.Payments to stockholders are not fixed, but depend on the success of the firmDerivativesValue derives from prices of other securities, such as stocks and bondsUsed to transfer riskHafiz Hoque .1-6Financial Markets

4、and the EconomyInformation Role: Capital flows to companies with best prospectsConsumption Timing: Use securities to store wealth and transfer consumption to the futureHafiz Hoque .1-7Financial Markets and the Economy (Ctd.)Allocation of Risk: Investors can select securities consistent with their ta

5、stes for riskSeparation of Ownership and Management: With stability comes agency problemsHafiz Hoque .1-8Financial Markets and the Economy (Ctd.)Corporate Governance and Corporate EthicsAccounting ScandalsExamples Enron, Rite Aid, HealthSouthAuditors watchdogs of the firmsAnalyst ScandalsArthur Ande

6、rsenSarbanes-Oxley ActTighten the rules of corporate governance Hafiz Hoque .1-9The Investment ProcessAsset allocationChoice among broad asset classesSecurity selectionChoice of which securities to hold within asset classSecurity analysis to value securities and determine investment attractivenessHa

7、fiz Hoque .1-10Markets are CompetitiveRisk-Return Trade-OffEfficient MarketsActive ManagementFinding mispriced securitiesTiming the marketHafiz Hoque .1-11Markets are Competitive (Ctd.)Passive ManagementNo attempt to find undervalued securitiesNo attempt to time the marketHolding a highly diversifie

8、d portfolioHafiz Hoque .1-12The PlayersBusiness Firms net borrowersHouseholds net saversGovernments can be both borrowers and saversHafiz Hoque .1-13The Players (Ctd.)Financial Intermediaries: Pool and invest fundsInvestment CompaniesBanksInsurance companiesCredit unionsHafiz Hoque .1-14Universal Ba

9、nk ActivitiesInvestment BankingUnderwrite new stock and bond issuesSell newly issued securities to public in the primary marketInvestors trade previously issued securities among themselves in the secondary marketsCommercial BankingTake deposits and make loansHafiz Hoque .1-15Financial Crisis of 2021

10、Antecedents of the Crisis:“The Great Moderation: a time in which the U.S. had a stable economy with low interest rates and a tame business cycle with only mild recessions Historic boom in housing marketHafiz Hoque .1-16Figure 1.3 The Case-Shiller Index of U.S. Housing PricesHafiz Hoque .1-17Changes

11、in Housing FinanceOld WayLocal thrift institution made mortgage loans to homeownersThrifts major asset: a portfolio of long-term mortgage loans Thrifts main liability: deposits“Originate to holdNew WaySecuritization: Fannie Mae and Freddie Mac bought mortgage loans and bundled them into large poolsM

12、ortgage-backed securities are tradable claims against the underlying mortgage pool“Originate to distributeHafiz Hoque .1-18Figure 1.4 Cash Flows in a Mortgage Pass-Through SecurityHafiz Hoque .1-19Changes in Housing Finance(Ctd.)At first, Fannie Mae and Freddie Mac securitized conforming mortgages,

13、which were lower risk and properly documented.Later, private firms began securitizing nonconforming “subprime loans with higher default risk.Little due diligencePlaced higher default risk on investorsGreater use of ARMs and “piggyback loansHafiz Hoque .1-20Mortgage DerivativesCollateralized debt obl

14、igations (CDOs)Mortgage pool divided into slices or tranches to concentrate default riskSenior tranches: Lower risk, highest ratingJunior tranches: High risk, low or junk ratingHafiz Hoque .1-21Mortgage DerivativesProblem: Ratings were wrong! Risk was much higher than anticipated, even for the senio

15、r tranchesHafiz Hoque .1-22Why was Credit Risk Underestimated?No one expected the entire housing market to collapse all at onceGeographic diversification did not reduce risk as much as anticipatedAgency problems with rating agenciesCredit Default Swaps (CDS) did not reduce risk as anticipatedHafiz H

16、oque .1-23Credit Default Swap (CDS)A CDS is an insurance contract against the default of the borrowerInvestors bought sub-prime loans and used CDS to insure their safetyHafiz Hoque .1-24Credit Default Swap (CDS)Some big swap issuers did not have enough capital to back their CDS when the market colla

17、psed.Consequence: CDO insurance failedHafiz Hoque .1-25Rise of Systemic RiskSystemic Risk: a potential breakdown of the financial system in which problems in one market spill over and disrupt others.One default may set off a chain of further defaultsWaves of selling may occur in a downward spiral as

18、 asset prices dropPotential contagion from institution to institution, and from market to marketHafiz Hoque .1-26Rise of Systemic Risk (Ctd.)Banks had a mismatch between the maturity and liquidity of their assets and liabilities.Liabilities were short and liquidAssets were long and illiquidConstant

19、need to refinance the asset portfolioBanks were very highly levered, giving them almost no margin of safety.Hafiz Hoque .1-27Rise of Systemic Risk (Ctd.)Investors relied too much on “credit enhancement through structured products like CDSCDS traded mostly “over the counter, so less transparent, no p

20、osted margin requirementsOpaque linkages between financial instruments and institutionsHafiz Hoque .1-28The Shoe Drops2000-2006: Sharp increase in housing prices caused many investors to believe that continually rising home prices would bail out poorly performing loans2004: Interest rates began rising2006: Home prices peakedHafiz Hoque .1-29The Shoe Drops2007: Housing defaults and losses on mortgage-bac