The summary of Investment Analysis is an extensive summary of the book and the lecture slides provided during the course. This summary is a bit longer, since I found this course quite difficult and therefore wanted my summary to be very clear.
The summary includes chapters 1 - 11 and 18 & 19 of...
Summary Investments Ch. 1 - 13
Lecture 1: Introduction to investments and financial markets 3
Chapter 1 Investments: Background and Issues 3
1.1 Real Assets versus Financial Assets 3
1.2 Financial Assets 3
1.3 Financial Markets and the Economy 4
1.4 The Investment Process 5
1.5 Markets are Competitive 5
1.6 The Players 6
1.7 The Financial Crisis of 2008 8
Lecture 2 Risk and Return and Diversification 9
Chapter 5 Risk and Return: Past and Prologue 9
5.1 Rates of Return 9
5.2 Inflation and the Real Rate of Interest 10
5.3 Risk and Risk Premiums 10
5.4 The Historical Record 14
5.5 Asset Allocation Across Risky and Risk-Free Portfolios 15
5.6 Passive Strategies and the Capital Market Line 17
Chapter 6 Efficient Diversification 18
6.1 Diversification and Portfolio Risk 18
6.2 Asset Allocation with Two Risky Assets 18
6.3 The Optimal Risky Portfolio with a Risk-Free Asset 21
6.4 Efficient Diversification with Many Risky Assets 22
6.5 A Single-Index Stock Market 24
6.6 Risk of Long-Term Investments 26
Lecture 3 CAPM and Multifactor Models 28
Chapter 7 Capital Asset Pricing and Arbitrage Pricing Theory 28
7.1 The Capital Asset Pricing Model 28
7.2 The CAPM and Index Models 32
7.3 The CAPM and the Real World 34
7.4 Multifactor Models and the CAPM 34
7.5 Arbitrage Pricing Theory 36
Lecture 5 Bond and Bond Portfolio 48
Chapter 10 Bond Prices and Yields 48
10.1 Bond Characteristics 48
1
, 10.2 Bond Pricing 51
10.3 Bond Yields 52
10.4 Bond Prices Over Time 54
10.5 Default Risk and Bond Pricing 55
Chapter 11 Managing Bond Portfolios 59
11.1 Interest Rate Risk 59
11.2 Passive Bond Management 61
11.3 Convexity 62
11.4 Active Bond Management 63
Lecture 6 Efficient Market & Behavioural Finance 65
Chapter 8 The Efficient Market Hypothesis 65
8.1 Random Walks and the Efficient Market Hypothesis 65
8.2 Implications of the EMH 66
8.3 Are Markets Efficient? 69
8.4 Mutual Fund and Analyst Performance 73
Chapter 9 Behavioural Finance and Technical Analysis 74
9.1 The Behavioural Critique 74
Lecture 7 International investing and financial innovation in financing and investment 79
Chapter 19 Globalization and International Investing 79
19.1 Global Markets for Equities 79
19.2 Risk Factors in International Investing 79
19.3 International Investing: Risk, Return, and Benefits from Diversification 80
2
,Lecture 1: Introduction to investments and financial
markets
Chapter 1 - 4
Chapter 1 Investments: Background and Issues
- Investment: commitment of current resources in the expectation of serving greater resources in the future
1.1 Real Assets versus Financial Assets
- Real assets: assets used to produce goods and services (productive capacity of its economy)
● Example: the land, buildings, equipment, and knowledge that can be used to produce goods and
services
● Generate net income to the economy
- Financial assets: claims on real assets or the income generated by them
● Example: stocks and bonds
● These assets are the means by which individuals in well-developed economies hold their claims on
real assets
● Claims to the income generated by real assets
● Define the allocation of income or wealth among investors
● Investors’ returns on securities ultimately come from the income produced by the real assets that
were financed by the issuance of those securities
1.2 Financial Assets
- Three broad types of financial assets
● Debt
● Equity
● Derivatives
- Fixed-income/debt securities: pay a specified cash flow over a specific period → promise either a fixed stream
of income or a stream of income that is determined according to a specified formula
- Investment performance of debt securities is least closely tied to the financial condition of the issuer
- Debt securities come in a variety of maturities and payment provisions.
● At one extreme → money market refers to fixed-income securities that are short term, highly
marketable, and generally of very low risk
● Fixed-income capital market includes long-term securities (Treasury bonds), as well as bonds issued by
federal agencies, state and local municipalities, and corporations
➔ Range from very safe in terms of default risk to relatively risky
➔ Designed with extremely diverse provisions regarding payments provided to the investor and
protection against the bankruptcy of the issuer
- Equity: an ownership share in a cooperation (common stock)
- Equity holders are not promised any particular payment → receive dividends the firm may pay and have
prorated ownership in the real assets of the firm
- The performance of equity investments is directly tied to the success of the firm and its real assets
- Equity investments tend to be riskier than investment in debt securities
- Derivative securities: securities providing payoffs that depend on the values of other assets
● Example: options and future contracts
● Values derived from the prices of other assets
● Primary use → to hedge risk or transfer them to other parties
➔ Also used to take highly speculative positions
3
, - Commodity and derivative markets allow firms to adjust their exposure to various business risks
1.3 Financial Markets and the Economy
- Financial assets allow us to make the most of the economy’s real assets
The Informational Role of Financial Markets
- Stock prices reflect investors’ collective assessment of a firm’s current performance and future prospects
- Stock prices play a major role in the allocation of capital in market economies, directing capital to the firms and
applications with the greatest perceived potential (at the time)
- Stock prices reflect the collective judgment of professionals who analyse the prospects of firms whose shares
trade on the stock market
Consumption timing
- To shift your purchasing power from high-earning periods to low-earning periods of life you can store your
wealth in financial assets
- Financial markets allow individuals to separate decisions concerning current consumption from constraints that
otherwise would be imposed by current earnings
Allocation of Risk
- Financial markets and the diverse financial instruments traded in those markets allow investors with the
greatest taste for risk to bear that risk (stock), while other, less risk-tolerant individuals can stay on the sidelines
(bonds)
- The bonds promise to provide a fixed payment, the stockholders bear most of the business risk but reap
potentially higher rewards
- Capital markets allow the risk that is inherent to all investments to be borne by the investors most willing to
bear that risk
- Allocation of risk → benefits the firms that need to raise capital to finance their investments → 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
Separation of Ownership and Management
- Large and globally operating companies have a lot of stockholders → elect a board of directors that in turn
hires and supervises the management of the firm → owners and managers of the firm are different parties
- Gives the firm a stability that the owner-managed firm can’t achieve
- Financial assets and the ability to buy and sell those assets in the financial markets allow for easy separation of
ownership and management
- The firm’s management should pursue strategies that enhance the value of their shares (stakeholders), but do
mangers really attempt to maximize firm value? → potential conflicts of interest
● Agency problems: conflicts of interest between management and stockholders
- Several mechanisms to mitigate potential agency problems
● Tie the income of manager to the success of the firm
● Board of directors forcing out management teams that are underperforming
● Outsiders (security analysts/large institutional investors) monitor the firm closely and make the life of
poor performing at the least uncomfortable
● Bad performers are subject to the threat of takeover
➔ Proxy contest → usually minimal threat, shareholders have to use their own funds and
management can defend itself using corporate offers
➔ Real takeover threat is from other firms → acquire the underperforming business and replace
management with its own team. Stock price should rise to reflect the prospects of improved
performance, which provides incentive for firms to engage in such takeover activity
4
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