The material wealth of a society is ultimately determined by the productive capacity of its economy, that is, the goods and services its members can create. This capacity is a function of the real assets of the economy: the land, buildings, machines, and knowledge that can be used to produce goods and services.
real assets of the economy: the land, buildings, machines, and knowledge that can be u...
The material wealth of a society is ultimately determined by the productive capacity of its economy, that is, the goods and services its members can create. This capacity is a function of the real assets of the economy: the land, buildings, machines, and knowledge that can be used to produce goods and services.real assets of the economy: the land, buildings, machines, and knowledge that can be used to produce goods and servicesthese assets are the means by which individuals in well-developed economies hold their claims on real assets. Financial assets are claims to the income generated by real assets (or claims on income from the government). While real assets generate net income to the economy, financial assets simply define the allocation of income or wealth among investors. investors’ returns on securities ultimately come from the income produced by the real assets that were financed by the issuance of those securities.Financial assets allow us to make the most of the economy’s real assets.You shouldn’t lose sight of the fact that the successes or failures of the financial assets we choose to purchase ultimately depend on the performance of the underlying real assets.financial assets:fixed income, equity, and derivatives. Fixed-income or debt securities promise either a fixed stream of income or a stream of income that is determined according to a specified formula.floating-rate bonds least closely tied to the financial condition of the issuertwo extremes:capital market: money market: short-term, highly marketable IOUs (usually of very low risk)equity(common stock):represents an ownership share in the corporation. is tied directly to the success of the firm and its real assets. derivative securities:such as options and futures contracts provide payoffs that are determined by the prices of other assets such as bond or stock prices. the primary use, is to hedge risks or transfer them to other parties. Derivatives also can be used to take highly speculative positionsRole of Financial Markets:Consumption: shift your purchasing power from high-earnings periods to low-earnings periods.“Store” your wealth in financial assets.(student loans, pension funds)Allocation of Risk: Financial markets and the diverse financial instruments traded in those markets allow investors with the greatest taste for risk to bear that risk, while other, less risk-tolerant individuals can, to a greater extent, stay on the sidelines.When investors are able to select security types with the risk–return characteristics that best suit their preferences, each security can be sold for the best possible price. This facilitates the process of building the economy’s stock of real assets.Separation of Ownership and Management: These potential conflicts of interest are called agency problems because managers, who are hired as agents of the shareholders, may pursue their own interests instead.Saving: is often taken to mean investing in safe assets such as an insured bank account. Two types of decisions in constructing their portfolios: The asset allocation decision is the choice among these broad asset classes, while the security selection decision is the choice of which particular securities to hold within each asset class.“Top-down” portfolio construction starts with asset allocation. “bottom-up”: the portfolio is constructed from the securities that seem attractively priced without as much concern for the resultant asset allocation. It might turn out that the portfolio ends up with a very heavy representation of firms in one industry, from one part of the country, or with exposure to one source of uncertainty. EMH: Passive management calls for holding highly diversified portfolios without spending effort or other resources attempting to improve investment performance through security analysis. Active management is the attempt to improve performance either by identifying mis-priced securities or by timing the performance of broad asset classes.Four important trends have changed the contemporary investment environment: (1) globalization, (2) securitization, (3) financial engineering, and (4) information and computer networks.