Chapter 1

Introduction
Types of Assets
Tangible Assets
Value is based on physical properties
Examples include buildings, land, machinery
Intangible Assets
Claim to future income
Examples include various types of financial
assets
Types of Financial Assets
Bank loans
Government bonds
Corporate bonds
Municipal bonds
Foreign bond

Common stock
Preferred stock
Foreign stock
Debt vs. Equity
Debt Instruments
Fixed dollar payments
Examples include loans, bonds
Equity Claims
Dollar payment is based on earnings
Residual claims
Examples include common stock, partnership
share

Price of Financial Asset
and Risk
The price or value of a financial asset is
equal to the present value of all expected
future cash flows.
Expected rate of return
Risk of expected cash flow
Types of Investment Risks
Purchasing power risk or inflation risk
Default or credit risk
Exchange rate or currency risk
Role of Financial Assets
Transfer funds from surplus units to
deficit units.
Transfer funds so as to redistribute
unavoidable risk associated with cash
flows generated from both tangible and
intangible assets.
Role of Financial Markets
Determine price or required rate of return
of asset.
Provide liquidity.
Reduce transactions costs, which consists
of search costs and information costs.
Classification of Financial
Markets
Debt vs. equity markets
Money market vs. capital market
Primary vs. secondary market
Cash or spot vs. derivatives market
Auction vs. over-the-counter vs.
intermediated market
Financial Market
Participants
Households
Business units
Federal, state, and local governments
Government agencies
Supranationals
Regulators
Globalization of Financial
Markets
Deregulation or liberalization of financial
markets

Technological advances

Increased institutionalization
Classification of Global
Financial Markets
Internal Market
(also called national
market)
External Market
(also called international
market, offshore market,
and Euromarket)
Domestic Market Foreign Market
Motivation for Using Foreign
Markets and Euromarkets
Limited fund availability in internal market
Reduced cost of funds
Diversifying funding sources
Derivatives Market
Futures/forward contracts are obligations
that must be fulfilled at maturity.
Options contracts are rights, not
obligations, to either buy (call) or sell (put
the underlying financial instrument.
Role of Derivative
Instruments
Protect against different types of
investment risks, such as purchasing
power risk, interest rate risk, exchange
rate risk.
Advantages:
Lower transactions costs
Faster to carry out transaction
Greater liquidity