Chap 001 Portfolio Management

8/17/2019 Chap 001 Portfolio Management

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INVESTMENTS (ASIA GLOBAL EDITION) | BODIE, KANE, MARCUS, JAINCopyright © 2011 by The McGraw-Hill Companies, Inc. ll rights reser!e". McGraw-Hill#Irwin

Chapter 1

The Investment Environment


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INVESTMENTS (ASIA GLOBAL EDITION) | BODIE, KANE, MARCUS, JAIN

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Real Aet Ver! "#$a$%#alAet

• Real Assets

– Determine the productive capacity andnet income of the economy

– Examples: Land, buildings, machines,no!ledge used to produce goods andservices

• "inancial Assets

– #laims on real assets


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"#$a$%#al Aet

• $hree types:

%& "ixed income or debt

'& #ommon stoc or e(uity)& Derivative securities


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"#&e' I$%e

• *ayments fixed or determined by aformula

• +oney maret debt: short term, highlymaretable, usually lo! credit ris

• #apital maret debt: long term bonds,can be safe or risy


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C$ St%* a$' Der#+at#+e

• #ommon toc is e(uity or o!nershipin a corporation&

– *ayments to stocholders are not fixed,

but depend on the success of the firm• Derivatives

– -alue derives from prices of other

securities, such as stocs and bonds

– .sed to transfer ris


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"#$a$%#al Mar*et a$' theE%$

• /nformation Role: #apital flo!s to

companies !ith best prospects

• #onsumption $iming: .se securities

to store !ealth and transfer

consumption to the future


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"#$a$%#al Mar*et a$' theE%$ (Ct'-)

• Allocation of Ris: /nvestors can select

securities consistent !ith their tastes

for ris

• eparation of 0!nership and

+anagement: 1ith stability comes

agency problems


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"#$a$%#al Mar*et a$' theE%$ (Ct'-)

• #orporate 2overnance and #orporate Ethics

– Accounting candals

• atyam 3/ndia4, 0lympus 35apan4, Longtop

"inancial $echnologies 3#hina4 – Auditors – !atchdogs of the firms

• Arthur Andersen 3Enron4

– toc Analysts – optimistic research reports

– arbanes60xley Act

• $ighten the rules of corporate governance


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The I$+ete$t .r%e

• Asset allocation

– #hoice among broad asset classes

• ecurity selection – #hoice of !hich securities to hold within

asset class

– ecurity analysis to value securities anddetermine investment attractiveness


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Mar*et are Cpet#t#+e

• Ris6Return $rade60ff

• Efficient +arets – Active +anagement

• "inding mispriced securities

• $iming the maret


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Mar*et are Cpet#t#+e (Ct'-)

– *assive +anagement

• 7o attempt to find undervalued

securities

• 7o attempt to time the maret

• 8olding a highly diversified portfolio


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The .laer

• 9usiness "irms – net borro!ers

• 8ouseholds – net savers

• 2overnments – can be both borro!ers

and savers


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The .laer (Ct'-)

• "inancial /ntermediaries: *ool and invest

funds

– /nvestment #ompanies

– 9ans

– /nsurance companies

– #redit unions


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U$#+eral Ba$* A%t#+#t#e

Investment Banking• .nder!rite ne! stoc

and bond issues

• ell ne!ly issued

securities to public in theprimary maret

• /nvestors trade previously

issued securities among

themselves in thesecondary marets

Commercial Banking

• $ae deposits and

mae loans


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"#$a$%#al Cr## / 02

• Antecedents of the #risis:

– $he 2reat +oderation;: a time in !hich the

.&& had a stable economy !ith lo! interest

rates and a tame business cycle !ith onlymild recessions

– 8istoric boom in housing maret


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"#3!re 1-4 The Cae5Sh#ller I$'e& /U-S- 6!#$3 .r#%e


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Cha$3e #$ 6!#$3 "#$a$%e

Old Way

• Local thrift institution

made mortgage loans to

homeo!ners

• $hrift


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"#3!re 1-7 Cah "l8 #$ aMrt3a3e .a5Thr!3h Se%!r#t

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Cha$3e #$ 6!#$3 "#$a$%e(Ct'-)

• At first, "annie +ae and "reddie +acsecuriti>ed conforming mortgages, !hich!ere lo!er ris and properly documented&

• Later, private firms began securiti>ingnonconforming subprime; loans !ithhigher default ris&

– Little due diligence – *laced higher default ris on investors

– 2reater use of AR+s and piggybac; loans

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Mrt3a3e Der#+at#+e

• #ollaterali>ed debt obligations 3#D0s4

– +ortgage pool divided into slices or tranches

to concentrate default ris

– enior tranches: Lo!er ris, highest rating

– 5unior tranches: 8igh ris, lo! or =un rating

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Mrt3a3e Der#+at#+e

• *roblem: Ratings !ere !rong? Ris !as

much higher than anticipated, even for the

senior tranches

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9h 8a Cre'#t R#*U$'eret#ate':

• 7o one expected the entire housing

maret to collapse all at once

• 2eographic diversification did not

reduce ris as much as anticipated

• Agency problems !ith rating agencies

• #redit Default !aps 3#D4 did notreduce ris as anticipated

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Cre'#t De/a!lt S8ap (CDS)

• A #D is an insurance contract against

the default of the borro!er

• /nvestors bought sub6prime loans and

used #D to insure their safety

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Cre'#t De/a!lt S8ap (CDS)

• ome big s!ap issuers did not have

enough capital to bac their #D !hen

the maret collapsed&

• #onse(uence: #D0 insurance failed

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R#e / Ste#% R#*

• ystemic Ris: a potential breado!n of the

financial system in !hich problems in one

maret spill over and disrupt others&

– 0ne default may set off a chain of furtherdefaults

– 1aves of selling may occur in a do!n!ard

spiral as asset prices drop

– *otential contagion from institution to

institution, and from maret to maret

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R#e / Ste#% R#* (Ct'-)

• 9ans had a mismatch bet!een thematurity and li(uidity of their assets and

liabilities&

– Liabilities !ere short and li(uid – Assets !ere long and illi(uid

– #onstant need to refinance the asset portfolio

• 9ans !ere very highly levered, givingthem almost no margin of safety&

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R#e / Ste#% R#* (Ct'-)

• /nvestors relied too much on credit

enhancement; through structured

products lie #D

• #D traded mostly over the counter;,

so less transparent, no posted margin

re(uirements

• 0pa(ue linages bet!een financial

instruments and institutions

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The She Drp

• '@@@6'@@: harp increase in housing prices

caused many investors to believe that

continually rising home prices !ould bail out

poorly performing loans

• '@@B: /nterest rates began rising

• '@@: 8ome prices peaed

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The She Drp

• '@@C: 8ousing defaults and losses on

mortgage6baced securities surged

• '@@C: 9ear tearns announces trouble at

its subprime mortgage–related hedge

funds

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The She Drp

• '@@: $roubled firms include 9ear

tearns, "annie +ae, "reddie +ac, +errill

Lynch, Lehman 9rothers, and A/2

– +oney maret breas do!n

– #redit marets free>e up

– "ederal bailout to stabili>e financial system

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INVESTMENTS (ASIA GLOBAL EDITION) | BODIE, KANE, MARCUS,JAIN

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Ste#% R#* a$' the RealE%$

• Add li(uidity to reduce insolvency ris and

brea a vicious circle of valuation

riscounterparty risli(uidity ris

• /ncrease transparency of structured

products lie #D contracts

• #hange incentives to discourage

excessive ris6taing and to reduce

agency problems at rating agencies

Documents

Chap 001 Portfolio Management