Sep.

1, 2014
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Equity
Analysis
Portfolio
Theory
Debt
Securities
Option
derivatives
Why study investments?
Be a smart investor!
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An investment is the commitment of current
money or other resources in the expectation
of reaping future benefits.
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If you have HK$50,000 or more to invest,

how should you invest?
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Real Assets
Produce goods and services to consumers
Examples: land, buildings, plant & equipment,
human capital, etc.
Financial Assets
Claims on real assets or claims to the income
generated by real assets
Examples: stocks, bonds, and derivatives
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Share prices of Apple Inc. (AAPL)
Source: finance.yahoo.com
You buy shares of Apple (financial assets) Apple use money to
build plants (real assets) to produce iPhones generate income
generate higher returns of stocks (financial assets)
Three types:
1. Fixed income or debt
2. Common stock or equity
3. Derivative
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1. Debt (fixed-income, fixed stream of income or a stream of
income determined by a specified formula)
o Money market debt (short term, marketable, low credit risk)
CD (fixed deposits, term deposits), Treasury-bills
o Capital market debt (long term bonds, can be safe or risky)
Treasury, municipal, and corporate bonds.
2. Equity (common stocks)
o Ownership stake in a corporation
o Payments to shareholders are not fixed, but depend on the
success of the firm
3. Derivative (contract whose value is derived from the values
of some underlying assets)
o Option, futures, swaps
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Asset allocation
Security selection
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Allocate portfolio investment across broad asset
classes:
Stocks
Bonds
Real estate
Commodities
50%
20%
26%
4%
Choosing specific securities within an asset class:
e.g. IBM or Dell stocks?
The asset allocation decision is the primary
determinant of a portfolios return
Top-down
Bottom-up
1.5 Markets Are Competitive
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Stocks:highreturn(>12%),highrisk(46%to55%)
Bonds:lowreturn(<6%),lowrisk(SD<13%)
Thousandsofintelligentanalystsaresearchingfor
thebestbuys.
Thiscompetitionmeansthatweshouldexpectto
findfew,ifany,underpricedsecuritiesthatoffer
obviousbargains.
Inotherwords,thereisnofreelunch.
Riskreturntradeoff(higherexpectedreturns
entailgreaterrisk):
Firms are net borrowers
--Raise capital to pay for investments
Households typically are net lenders
--Purchase securities issued by firms
Government can be borrowers or lenders
--Issue Treasury-bills, notes, bonds
However, firms and governments do not sell all or even
most of their securities directly to individuals.
Financial Intermediaries: bring lenders and borrowers
together
o Commercial Banks (take deposits and make loans)
o Investment Banks (IPOs: Facebook, 2012; Google, 2004; Morgan Stanley)
o Mutual / Hedge /Pension Funds ( BlockRock, about $3.67 trillion in assets)
o Insurance companies
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I want to be an investment banker. If you had
10, 000 shares I sell them for you. I make a
lot of money. I will like my job very, very
much. I will help people. I will be a
millionaire. I will have a big house. It will be
fun for me.
---- Seven-year-old Minnesota schoolboy, What I
Want to Be When I Grow Up, dated March 1985.
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Started from US and the real economic
effects were felt throughout the world
including Europe and Asia.
9 million jobs lost during 2008 and 2009
U.S. housing prices fell nearly 30% on average
U.S. stock market fell approximately 50% by early 2009
Chinas export fell by 21% from June. 2008 to June. 2009
The real GDP of Hong Kong and other Asian countries fell by
13% on average from Sep.2008 to March.2009.
Subprime-mortgage loans and securities is the main cause of
the crisis.
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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.
Low interest rates and stable economy lead to historic boom
in U.S. housing market.
Sharp increase in housing price caused many investor to
believe that home prices will continually rise.
This leads to a sharp increase in mortgage loans, including
low-quality subprime mortgage loans to people who may
have difficulty maintaining the repayment schedule.
The percentage of those low-quality loans increased from 8%
to approximately 20% from 2004 to 2006.
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Fannie Mae and Freddie Mac bought mortgage
loans from the originators and bundled them into
large pools.
Those mortgage-backed securities are then sold
to investors such as mutual funds or pension
funds.
The housing price peaked in 2006 and start to
decline sharply in mid-2006.
From 2004, interest rate began to increase.
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Sharp declined housing price and the poor ability to
refinance the loan induced many low credit homebuyers to
walk away from the mortgage loan.
Housing defaults and the losses on the mortgage-backed
securities held by financial firms surged in 2007.
During 2008, three of the largest investment banks in U. S.
either went bankrupt (Lehman Brothers) or were sold at
fire sale prices to other banks (Bear Stearns and Merrill
Lynch).
The remaining two investment banks, Morgan Stanley and
Goldman Sachs, opted to become commercial banks,
thereby subjecting themselves to more strict regulation.
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Real vs. financial assets
3 types of financial assets:
debt, equity, derivatives
Investment process:
asset allocation vs. security selection
top-down vs. bottom-up strategies
Risk-return trade-off
Financial intermediaries
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