The Investment Environment

Investment analysis
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A] The Investment Environment
Real assets and financial assets
Typically increased savings and investment result to reduced current consumption as well as planned later consumption. In a balance sheet assets are related of the net worth of a business, and real assets are tangible asserts that determine productive capacity. In comparison financial assets are claims to real assets and include many of the financial securities. As such, financial assets are easily convertible to cash, since the assets are more liquid compared to real assets. The main forms of financial assets are fixed income, equity (common stock) and derivative securities.
Financial markets and the economy
In the digital age, information is more diffused since people are likely to access information through the Google effect (Bodie, Kane & Marcus, 2011). At the same time, consumption timing and allocation of risk influence the decision of investors. For market players in the financial markets, separation of ownership and stewardship are important to improving corporate governance and adhering to corporate ethics. The emergence of corporate scandals resulting from flouting ethics and fraud has highlighted the benefits of corporate governance. As such, the role of watch dogs has a played a prominent role towards improving oversight of companies to ensure that information presented to the public is timely and accurate.
The investment process
The investment process focuses on asset allocation, selection of security and security analysis. Asset allocation is related to making a choice when there is a broad array of asset classes. Investors/ portfolio managers take into account the interaction from risk and return with the aim of managing the investment risk. Asset allocation further delves into investment between safe and risky assets in a portfolio. As such, the choice is made to identify securities which they would wish to hold in the asset class, with the choice dependent on the security analysis. Security analysis highlights on valuation of specific securities that are likely to be included in a portfolio. At other times, investments can be based on a ‘bottom- up’ strategy whereby securities that are attractively priced are chosen with no emphasis on asset allocation (Bodie, Kane & Marcus, 2011).Markets are competitive
Markets are competitive, and analysts have to carefully identify securities that are bargains and undervalued. Even though, investors anticipate returns, the risk and returns are rarely similar to the actual results. Typically, securities with high risk are also likely to have higher returns, but when the price increases the likely returns from these securities is low. As such, the higher risk assets command higher prices because of the risk return trade-off. Diversification is necessary in a portfolio to spread the risk, and since market players may not necessarily have more information than their counterparts. In any case, the financial markets are assumed to be efficient and integrate all the information available to influence the value of securities.The Players
Business firms are typically net borrowers in the financial markets while household are net savers. Businesses need capital to pay for investments and generate income, while households raise funds to purchase securities (Bodie, Kane & Marcus, 2011). On the other hand, governments can be borrowers and savers, depending on whether the government runs budget surpluses or deficits. The governments and corporations then rely on financial intermediaries who transact directly with the securities. Investment bankers and corporations are mainly relied upon to deal with the financials securities, but banks, credit unions and insurance companies. Investment bankers provide specialized services as the main financial intermediaries in the primary market. The Financial Crisis of 2008
The Financial Crisis of 2008 illustrated the link between real assets and financial assets. Given that the mortgage backed securities were identified as possible causes on the subprime mortgage crisis, which resulted to debt defaults and increased foreclosures. There were no concerns on credit still to begin with, but low interest rate and a stable economy resulted to a housing boom that eventually burst, exposing financial institutions issuing the mortgage backed securities at risk of financial problems in case of default as houses were overvalued. In any case, financial institutions increasingly borrowed short-term loans without focusing on the systematic risk to the financial system.
B] Asset Classes and Financial Instruments
The money market
The money market has various forms of financial securities in the fixed-income market including treasury bills, commercial paper, certificates of deposits and bankers acceptance. Treasury bills are sold by the government at a discount, with the holders receiving the full amount after the maturity date. The certificate of deposit is a time deposit whereby the banks pay both the interest and principal. Commercial papers are short-term debts issued by large companies rather than borrow from the banks. Bankers’ acceptance is the agreement that the customer would pay a specified amount at a future date mostly within 6 months (Bodie, Kane & Marcus, 2011).
The bond market
The bond market facilitates the trade of debt securities including corporate debt securities and the government-issued securities. As a fixed-income market, it allows the transfer of capital to the issuers of debt securities, and has similar risk return payoff like the stock market (Fabozzi, 2003). The primary market facilitates the issue and sale of the bond securities for the first time, and there is a secondary market for previously issued debt securities. The issuers, underwriters as well as the purchasers are the main players in the bond market. Treasury notes and bonds issued by the U.S typically mature in 10 to 30 years. Government agencies may also issue federal agency debt especially the agencies dealing with mortgage related activities. International bonds are issued are open to foreigners while municipal bonds are issued boy cal and state governments. Mortgages and mortgage-backed securities are typically issued in the secondary market and they are securitization of mortgage loans which have claims (Bodie, Kane & Marcus, 2011).
Equity securities
Equity securities are traded in the stock exchange and are mainly common stock, preferred stock and depository receipts. Common stocks are the main form of equity securities which represents ownership shares in a publicly traded entity (Bodie, Kane& Marcus, 2011). The shareholders have voting rights, to ensure that the corporation follows corporate governance. Stockholders have residual claims against the asset and income of a corporation (Fabozzi, 2003). There is also limited liability that characterizes the common stock in the event of failure in a corporation. The preferred stock is a form of perpetuity which has equity and debt securities (Bodie, Kane &Marcus, 2011). The stock holders are paid income yearly, but preferred stock owners have no voting rights in annual meetings. The American Depository Receipts represent negotiable certificates denominated in dollars whereby shares of a foreign corporation are traded in the US exchange.
Stock and bond market indexes
There are various stock indexes that highlight on the performance of the stock exchanges in the U.S and globally. The Dow Jones is one of the most cited stock index that indicates stocks performance in the U.S. the Dow Jones Average highlights on 30 blue chip companies as and takes into account the average stock price to assess performance. The Standard & Poor Index is more comprehensive taking into account the performance of 500 large firms the NASDAQ Composite and NYSE Composite are also commonly relied upon in the U.S. There are other major stock indexes in Tokyo (Nikkei), London (FTSE), Honk Kong (Hang Seng), Germany DAX and Canada (TSX) (Bodie, Kane &Marcus, 2011). The three most commonly cited bond market indicators are the Merrill Lynch, Barclays as well as the Salomon Smith Barney Index (Bodie, Kane &Marcus, 2011).
Derivative Markets
The derivatives marked takes into account options which are the Call (buy) and put (sell) option. Options give the holder the right but not the obligation to sell or buy the security. The derivatives can also be in the form of futures with the basic position being either the long (buy) or the short (sell). Futures contract highlight on the delivery of assets at a specified delivery date at an agreed upon price (Bodie, Kane &Marcus, 2011).For options, the expiration price, expiration date are important elements to determine the terms of the securities. On the other hand, the delivery date is the most important element to understand the terms of a futures contract.
C] How Securities Are Traded
How Firms Issue Securities
Firms can issue securities through primary markets or the secondary market. The primary market represents new issue of securities ...