Investments, 8

th
edition
Bodie, Kane and Marcus
Slides by Susan Hine
McGraw-Hill/Irwin
Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
CHAPTER 1
The Investment
Environment
1-2
Real Assets Versus Financial Assets
Essential nature of investment
Reduced current consumption
Planned later consumption
Real Assets
Assets used to produce goods and
services
Financial Assets
Claims on real assets
1-3
Table 1.1 Balance Sheet of U.S.
Households, 2007
1-4
Table 1.2 Domestic Net Worth
1-5
A Taxonomy of Financial Assets
Fixed income or debt
Money market instruments
Bank certificates of deposit
Capital market instruments
Bonds
Common stock or equity
Derivative securities
1-6
Financial Markets and the Economy
Information Role
The Google effect
Consumption Timing
Allocation of Risk
Separation of Ownership and
Management
Agency Issues
1-7
Financial Markets and the
Economy Continued
Corporate Governance and Corporate Ethics
Accounting Scandals
Examples Enron, Rite Aid, HealthSouth
Auditorswatchdogs of the firms
Analyst Scandals
Arthur Andersen
Sarbanes-Oxley Act
Tighten the rules of corporate governance


1-8
The Investment Process
Asset allocation
Choice among broad asset classes
Security selection
Choice of which securities to hold within
asset class
Security analysis
1-9
Markets are Competitive
Risk-Return Trade-Off
Efficient Markets
Active Management
Finding mispriced securities
Timing the market
Passive Management
No attempt to find undervalued
securities
No attempt to time the market
Holding a highly diversified portfolio
1-10
The Players
Business Firms net borrowers
Households net savers
Governments can be both borrowers and
savers
Financial Intermediaries
Investment Companies
Banks
Insurance companies
Credit unions

1-11
The Players Continued
Investment Bankers
Perform specialized services for
businesses
Markets in the primary market


1-12
Table 1.3 Balance Sheet of
Commercial Banks, 2007
1-13
Table 1.4 Balance Sheet of Nonfinancial
U.S. Business, 2007
1-14
Recent TrendsGlobalization
American Depository Receipts (ADRs)
Foreign securities offered in dollars
Mutual funds that invest internationally
Instruments and vehicles continue to
develop (WEBs)
Exchange Traded Funds (ETFs)
1-15
Figure 1.1 Globalization: A Debt Issue
Denominated in Euros
1-16
Recent TrendsSecuritization
Mortgage pass-through securities
Other pass-through arrangements
Car, student, home equity, credit card
loans
Offers opportunities for investors and
originators
1-17
Figure 1.2 Asset-backed Securities
Outstanding
1-18
Case: Bear Stearns
Established 1923
Wall Streets fifth largest
investment bank after Goldman
Sachs, Morgan Stanley, Lehman
Brothers, Merrill Lynch
Never had loss before 2007
recognized as the "Most
Admired" securities firm in
Fortunes "America's Most
Admired Companies" in 2005-
2007

1-19
Bear Stock
Mr. Cayne (former CEO) sold all of his shares for just
$61 million. Only a year ago, that stake was worth $1
billion (DealBook)
1-20
What happened?
Subprime mortgage meltdown
Subprime lending?
making loans to borrowers who do not qualify
for market interest rates due to various risk
factors, such as income level, size of the
down payment made, credit history, and
employment status.
1-21
How?
House Borrower Lender
mortgage-backed securities (MBS)
Or collateralized debt obligations (CDO)
Bear Stearns Lenders/ investors
Pool of Mortgage Loans
Housing
prices drop
Defaults
increase
Securities
Value
declines
Suffer
Losses
Get panic, withdraw
money
1-22
Recent TrendsFinancial Engineering
Use of mathematical models and computer-
based trading technology to synthesize new
financial products
Bundling and unbundling of cash flows
1-23
Figure 1.3 Bundling Creates a Complex
Security
1-24
Figure 1.4 Unbundling of Mortgages into
Principal- and Interest-Only Securities
1-25
Recent TrendsComputer Networks
Online information dissemination
Information is made cheaply and widely
available to the public
Automated trade crossing
Direct trading among investors