Fin 3710 Chap 1 textbook

In this process, the portfolio is constructed from securities that seem attractively priced without as much concern for the resultant asset allocation.

"Bottom-up" Strategy

Securities that are so underpriced that they represent obvious bargains.

"Free-lunches" Securities

Once the portfolio is established, it is updated or _______________ by selling existing securities and using the proceeds to buy new securities, by investing additional funds to increase the overall size of the portfolio, or by selling securities to decrease the size of the portfolio.

"Rebalanced"

Without ongoing security analysis, prices eventually would depart from _____________ values, creating new _______________ for experts to move in.

'Correct', Incentives

What advantages do firms offer in their intermediary role?

- By pooling the resources of many small investors, they are able to lend considerable sums to large borrowers - By lending to many borrowers, intermediaries achieve significant diversification, so they can accept loans that individually might otherwise be too risky - Intermediaries build expertise through the volume of business they do and can use economies of scale and scope to asses and monitor risk

What are the three major players in the financial markets?

- Firms - Households - Governments

What are the mechanisms that have evolved to mitigate potential agency problems?

1. Compensation plans tie the income of managers to the success of the firm 2. While boards of directors have sometimes been portrayed as defenders of top management, they can, and in recent years increasingly have, forced out management teams that are underperforming 3. Outsiders such as security analysts and large institutional investors such as mutual funds or pension funds monitor the firm closely and make the life of poor performers at the least uncomfortable 4. Bad performers are subject to the threat of takeover

Proposed several mechanisms to mitigate systemic risk. The act calls for stricter rules for bank capital, liquidity, and risk management practices

2010 Dodd-Frank Wall Street Reform and Consumer Protection Act

Market signals will help to allocate capital efficiently only if investors are acting on _____________ _______________

Accurate Information

Efficient Market Hypothesis: Is the attempt to improve performance either by identifying mispriced securities or by timing the performance of broad asset classes.

Active Management

In recent years, the odds of a successful proxy contest has increased along with the rise of so-called ______________ investors

Activist

Large and deep-pocketed investors, often hedge funds, that identify firms they believe to be mismanaged in some respect. They can buy large positions in shares of those firms, and then campaign for slots on the board of directors and/or for specific reforms.

Activist Investors

________________ have taken share positions in about half of the S&P 500 firms

Activists

Potential conflicts of interest caused by managers, who are hired as agents of the shareholders, may pursue their own interests instead

Agency Problems

Is simply his collection of investment assets.

An Investor's Portfolio

"Top-down" portfolio construction starts with what?

Asset Allocation

If returns were independent of risk, there would be a rush to sell high-risk ____________

Assets

The stock market encourages allocation of capital to those firms that appear ____ ______ _______ to have the best prospects.

At the time

A bottom-up strategy does focus the portfolio on the assets that seem to offer the most ______________ ______________ ______________

Attractive Investment Opportunities

Why are derivative securities named derivative securities?

Because their values derive from the prices of other assets

Derivatives: Every so often, one of these highly speculative positions _________ _______, resulting in well-publicized losses of hundreds of millions of dollars.

Blows up

An individual lender is not equipped to assess and monitor the credit risk of ___________________

Borrowers

It is very expensive in terms of ___________ _________ and ____________ ______________ to purchase one or two shares of many different firms.

Brokerage Fees and Research Costs

What is an agency problem that can arise from stock options?

Can create an incentive for managers to manipulate information to prop up a stock price temporarily, giving them a chance to cash out before the price returns to a level reflective of the firm's true prospects.

Includes long-term securities such as treasury bonds, as well as bonds issued by federal agencies, state and local municipalities, and corporations

Capital Market

Securities markets can play an important role in facilitating the deployment of _______________ ________________ to their most ________________ uses.

Capital resources, productive

When lenders such as banks have limited capital, and are afraid of further losses, they may rationally choose to hoard their _____________ instead of lending it out to customers such as small firms, thereby exacerbating funding problems for their customary ________________.

Capital, Borrowers

Financial markets are highly ________________

Competitive

An insurance contract against the default of one or more borrowers.

Credit Default Swaps (CDS)

The Dodd-Frank Act creates an Office of ___________ ____________ within the Securities and Exchange Commission to oversee the credit rating agencies

Credit Ratings

Equity investments tend to be riskier than investments in ____________ ________________

Debt Securities

What are the three broad types of financial asssets?

Debt, equity, and derivatives

What are the sources of venture capital?

Dedicated venture capital funds, wealthy individuals known as angel investors, and institutions such as pension funds.

Futures and swap contracts are ___________ ______________

Derivative Securities

Provide payoffs that are determined by the prices of other assets such as bond or stock prices. Ex. Options and Futures contracts

Derivative Securities

If the board of directors is lax in monitoring management, unhappy shareholders in principle can elect a ____________ board

Different

Means that many assets are held in the portfolio so that the exposure to any particular asset is limited

Diversification

Equityholders receive any _______________ the firm may pay and have prorated ________________ in the real assets of the firm.

Dividends, ownership

In a firm represents an ownership share in the corporation

Equity

If the efficient market hypothesis were taken to the ____________, there would be no point in active ___________ ____________

Extreme, Security Analysis

When banks have more capital, they have less incentive to ramp up risk, as potential losses will come at their own expense and not the __________

FDIC's

Financial intermediaries are distinguished from other businesses in that both their assets and liabilities are overwhelmingly ___________________

Financial

Such securities are no more than sheets of paper or, far more likely, computer entries and do not directly contribute to the productive capacity of the economy. These assets are the means by which individuals in well-developed economies hold their claims on real assets. Are claims to the income generated by real assets (or claims on income from the governments). Ex. Stocks and bonds

Financial Assets

Large financial institutions such as pension funds, mutual funds, insurance companies, and banks, investment companies, and credit unions.

Financial Intermediaries

What kind of asset is a $5 bill?

Financial asset

What kind of asset is a lease obligation

Financial asset

The real takeover threat is from other _______________

Firms

Three major players of financial markets: Are net demanders of capital. They raise capital now to pay for investments in plant and equipment. The income generated by those real assets provides the returns to investors who purchase the securities issued by the firm

Firms

Promise either a fixed stream of income or a stream of income that is determined according to a specified formula.

Fixed-income or debt securities

Who is the Volcker Rule named after?

Former chairman of the Federal Reserve Paul Volcker

Treasury bills are effectively risk ______________

Free

Shareholders who attempt a proxy contest have to use their own ___________, while management can defend itself using ___________ ______________

Funds, Corporate Coffers

Three major players in financial markets: Can be borrowers or lenders, depending on the relationship between tax revenue and government expenditures.

Governments

Who are two pioneers of the modern portfolio theory?

Harry Markowitz and William Sharpe (Nobel Prize winners)

If you want higher expected returns, you will have to pay a price in terms of accepting ____________ ____________ ____________

Higher Investment Risk

Hedge funds are more likely to pursue complex and ______________ strategies

Higher-risk

Three major players in financial markets: Typically are suppliers of capital. They purchase the securities issued by firms that need to raise funds.

Households

If the firm is successful, the value of equity will __________ ; if not, it will _________________

Increase, decrease

Corporations and governments do not sell all or even most of their securities directly to _________________

Individuals

With more capital supporting banks, the potential for one ________________ to trigger another could be contained

Insolvency

Hedge funds are only open to ________________ ________________ such as pension funds, endowment funds, or wealthy individuals

Institutional Investors

Current commitment of money or other resources in the expectation of reaping future benefits

Investment

Both bonds and stocks must be evaluated for ___________________ _____________________, but valuation is far more difficult for stocks because a stock's performance usually is far more sensitive to the condition of the ________________ _______________

Investment Attractiveness, Issuing Firm

Advise an issuing corporation on the prices it can charge for the securities issued, appropriate interest rates, and so forth

Investment Bankers

In September 2008, all remaining major U.S. _____________ _______________ were absorbed into commercial banks, declared bankruptcy, or reorganized as commercial banks

Investment Banks

Pool and manage the money of many investors, also arise out of economies of scale

Investment Companies

The allocation of risk also benefits the firms to raise capital to finance their _______________

Investments

Capital market bonds also are designed with extremely diverse provisions regarding payments provided to the _____________ and protection against the bankruptcy of the ___________

Investor, issuer

What is the primary use of derivatives?

Is to hedge risks or transfer them to other parties

What is the major way government borrows funds from the public?

Issuance of Treasury Bills, Notes, and Bonds

What can the "bottom-up" strategy result in?

It can result in unintended bets on one or another sector of the economy

Newsletters, databases, and brokerage house research services all engage in research to be sold to a _________ _________ _________

Large Client Base

Mutual funds have the advantage of ______________ trading and portfolio management.

Large-scale

Most venture capital funds are set up as ____________ ________________

Limited Partnerships

Venture capital investors commonly take an active role in the ___________________ of a start-up firm.

Management

The threat of a proxy contest is usually ______________

Minimal

Refers to fixed-income securities that are short term, highly marketable, and generally of very low risk

Money Market

Real assets generate ____________ to the economy

Net Income

Start-up companies rely instead on bank loans and investors who are willing to invest in them in return for an ______________ ____________ in the firm.

Ownership Stake

Owners and managers of the firm are different ___________

Parties

If markets are efficient and prices reflect all relevant information, perhaps it is better to follow ____________ strategies instead of spending resources in a futile attempt to outguess your competitors in the financial markets.

Passive

Efficient Market Hypothesis: Calls for holding highly diversified portfolios without spending effort or other resources attempting to improve investment performance through security analysis.

Passive Management

Equityholders are not promised any particular ______________

Payment

Derivatives can also be used to take highly speculative ____________

Positions

When investors are able to select security types with the risk-return characteristics that best suit their preferences, each security can be sold for the best possible __________

Price

Ultimately, the investment banking firm handles the marketing of the security in the _____________ ____________, where new issues of securities are offered to the public. In this role the banks are called the __________________.

Primary Market, Underwriters

Investments in firms that do not trade on public stock exchanges

Private Equity Investments

Unhappy shareholders can elect a different board by launching a ____________ _____________ in which they seek to obtain enough proxies (i.e. rights to vote the shares of other shareholders) to take control of the firm and vote in another board.

Proxy Contest

Corporations do not directly market their securities to the ________________. Instead, they agents, called _________________ ________________, to represent them to the investing public.

Public, Investment Bankers

Financial Intermediaries issue their own securities to raise funds to _________________ the securities of other _______________.

Purchase, Corporations

The land, buildings, equipment, and knowledge that can be used to produce goods and services

Real Assets

What kind of asset is a college eduacation?

Real asset

What kind of asset is a customer goodwill?

Real asset

What kind of asset is a patent?

Real asset

Investors' returns on securities ultimatley come from the income produced by the __________ ____________ that were financed by the issuance of those securities

Real assets

The price of a stock will rise until its expected ___________ is no more than commensurate with ___________

Return, Risk

When the market is more optimistic about the firm, its share price will _________

Rise

An individual lender would not be able to diversify across borrowers to reduce ____________

Risk

Virtually all real assets involve some ________

Risk

Commodity and derivative markets allow firms to adjust their exposure to various business __________

Risks

If any particular asset offered a higher expected return without exposing extra risk, investors would __________ to buy it, with the result that its price would be __________ _______

Rush, Driven Up

Law passed in 2002 to tighten the rules of corporate governance

Sarbanes-Oxley Act

Households want desirable investments for their _____________, yet the small (financial) size of most households makes direct investment _______________.

Savings, Difficult

Investors trade previously issued securities among themselves

Secondary Market

Involves the valuation of particular securities that might be included in the portfolio.

Security Analysis

___________ _____________ and __________ ________________ ______________ hold about half of the stock in publicly listed firms in the U.S.

Security Analysts and Large Institutional Investors (ex. mutual funds and pension funds)

The firm's management should pursue strategies that enhance the value of their ___________

Shares

While large firms can raise funds directly from the stock and bond markets with help from their investment bankers, _____________ and _____________ firms that have not yet issued securities to the public do not have that option.

Smaller and Younger

The management company usually sits on the ____________ company's board of directors, helps recruit senior managers, and provides business advice.

Start-up

___________ ____________ reflect investors' collective assessment of a firm's current performance and future prospects.

Stock Prices

Investment assets can be categorized into broad asset classes, such as....

Stocks, bonds, real estate, commodities

What does National Wealth consist of?

Structures, equipment, inventories of goods, and land

A potential breakdown of the financial system when problems in one market spill over and disrupt others

Systemic Risk

What is the treasury bill rate also called?

TED spread

Who hires and supervises the management of the firm?

The Board of Directors

What are the two implications of the no-free-lunch proposition?

The Risk-Return Trade-off and Efficient Markets

Who elects the board of directors for a corporation?

The Stockholders with ownership stake in the corporation.

The choice among broad asset classes

The asset allocation decision

What are the two types of decisions investors make in constructing their portfolios?

The asset allocation decision and the security selection decision

The choice of which particular securities to hold within each asset class

The security selection decision

What is the source of a bank's profit?

The spread between the interest rates paid to depositors and the rates charged to borrowers is the source of the bank's profit

Hedge funds typically keep a portion of _______________ _____________ as part of their fees, whereas mutual funds charge a fixed percentage of ____________ under management

Trading Profits, Assets

We say that markets need to be ________________ for investors to make informed decisions

Transparent

What is an exaple of a money market?

U.S. Treasury Bills or bank certificates of deposit (CDs)

Wherever there is ______________, investors may be interested in trading, either to speculate or to lay off their _________, and a market may arise to meet that demand

Uncertainty, risks

The management company charges a fee to the _________ fund for overseeing the investments. After some period of time, for example, 10 years, the fund is liquidated and proceeds are distributed to the _______________

VC, Investors

Equity investment in young companies

Venture Capital (VC)

Capital market bonds range from _________ _________ in terms of default risk (for ex., treasury securities) to _______________ _____________ (for ex., high-yield or "junk" bonds)

Very safe, Relatively risky

Limits a bank's ability to trade for its own account and to own or invest in a hedge fund or private equity fund

Volcker Rule (Dodd-Frank Act)

Why are Treasury bills are effectively risk free?

You know what interest rate you will earn when you buy the bills.

The performance of equity investments is tied directly to the success of the _________ and its _______ ____________

firm, real assets

Financial assets simply define the allocation of ___________ or _____________ among investors

income or wealth