ECO 325: Money and Capital Markets—Weeks 1-2
ECO 325: Money and Capital Markets—Weeks 1-2 Econ 325
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This 6 page Class Notes was uploaded by Natalie Chevalier on Tuesday September 20, 2016. The Class Notes belongs to Econ 325 at Pace University - New York taught by Delalex in Fall 2016. Since its upload, it has received 19 views.
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Date Created: 09/20/16
Eco 325: Money and Capital Markets Week 1 (9/7/16) Introduction: Learning Objectives— What a financial asset is What is a derivative instrument Classifications of financial markets What is a financial asset and why is it different from money Reasons for the globalization of financial markets Principal economic functions a financial market performs What is an asset class Financial Assets Asset— any possession that has value in an exchange Tangible Asset— the value depends on particular physical properties i.e. buildings, land, or machinery. Not very liquid so the risk is higher. Intangible assets— represent legal claims to some future benefit, i.e. options, derivatives Investor— The owner of the financial asset Financial assets include: Bond issued by U.S. Dept. of Treasury Bond issued by GE Corp. Bond issued by California Bond issued by France Automobile loan Home mortgage loan Common stock issued by Microsoft Common stock issued by Honda Questions to think about What assets have not been securitized yet, that can provide a steady stream of receivables? Private equity firms can buy foreclosed properties at a discount from banks and securitize the rental income to turn the asset into a steady stream of receivables because the property is now generating rental income. Media receivables; studios are securitizing the future revenue from their movies to raise money for production when they know there is a minimum guaranteed amount of revenues i.e. movie franchises like James Bond, Marvel etc. In order to securitize something you must estimate the Cash Flows and weigh your risk of success. The higher the risk for the bond holder the higher the interest on the return. Debt versus Equity Claims Debt instrument— the claims of the holder of a financial asset is a fixed dollar amount Equity claim (residual claim)— obligates the issuer of the financial asset to pay the holder an amount based on earnings, if any, after holders of debt instruments have been paid off. Fixed income instruments— both debt and preferred stock that pays a fixed dollar amount i.e. dividends Why pay dividends? For a company like Johnson & Johnson or Coca Cola revenues are pretty much standard so by paying shareholders dividends they make their stock more attractive and competitive with more volatile stocks like new technology companies. Valuation— the process of determining the fair value or price of a financial asset. Fundamental principle of valuation— The value of any financial asset is the present value of all the cash flow it will produce later in life. Cash Flow— the cash that is expected to be received each period from investing in a particular financial asset The type of financial asset and the characteristics of the issuer determine the degree of certainty Default on the debt is when you cannot pay back the loans you’ve taken out. U.S. defaulted during the Revolutionary period. PV (Present Value) formula: t PV= CFs / (l+r) r= discount rate which is usually unknown CFs= Cash flows How do you determine the price of money? Week 2 (9/12/16) Questions from last class... What assets have not been securitized yet, that can provide a steady stream of receivables? Private equity firms can buy foreclosed properties at a discount from banks and securitize the rental income to turn the asset into a steady stream of receivables because the property is now generating rental income. Media receivables; studios are securitizing the future revenue from their movies to raise money for production when they know there is a minimum guaranteed amount of revenues i.e. movie franchises like James Bond, Marvel etc. In order to securitize something you must estimate the Cash Flows and weigh your risk of success. The higher the risk for the bond holder the higher the interest on the return. Valuing a Financial Asset 1. Estimate cash flows 2. Determine appropriate interest rate for discounting the cash flow 3. Value of financial asset= present value of expected cash flow Any increase in the risk of r will decrease the PV Types of Risk Credit Risk— risk of issuer or borrower defaulting. Purchasing Power risk (Inflation risk)— risk attached to the potential purchasing power of the cash flow expected. Must take into account the monetary policy of the country. Foreign Exchange risk— risk that the exchange rate will change adversely. The Role of a Financial Asset The transfer of funds from those parties who have surplus to invest to those who need funds Transfer funds to redistribute the unavoidable risk associated with the cash flow generated by tangible assets among those seeking and providing the funds. Financial Intermediaries— entities who seek to transform the final liabilities into different financial assets preferred by the public i.e. investment bank that will package the loan and sell the bond. Properties of Financial Assets Moneyness— closely approximate to money in that it can be transformed into money at little cost, delay, or risk. Divisibility and Denomination— the minimum size at which a financial asset can be liquidated and exchanged for money the smaller the size the more financial asset is divisible. Reversibility— cost of investing in a financial asset and than backing out into cash again Bidask spread— difference between price at which a mart maker is willing to sell and price at which a market maker is willing to buy. When you buy currency it is more expensive because that is how the middleman makes a living. Bidask spread is defined by supply and demand. Term to maturity— the length of the interval until the date when the instrument is scheduled to make its final payment or the owner is entitled to demand liquidation. Demand instruments are instruments for which the creditor can ask for repayment at any time. Liquidity— the ease with which an asset can be bought or sold. Serves an important and widely used function. The more liquid the lower the risk the lower the price and vice versa. Liquidity closely related to a market being thick or thin. Thinness always increases the roundtrip cost, even of a liquid financial asset. Complexity— goes to liquidity and to price. The more complex the asset the higher the risk the higher the price and vice versa. Tax Status— Private Equity Firms Acquiring a private company with the intent of providing its founders the capital necessary. Establish finds that raise capital from investors who are referred to as limited parteners or LPs. Invest funds on behalf of investors, along with funds borrowed from banks and other lenders. Improve company performance. Hold companies for approximately 5 years and then sell them when revenues peak hoping to realize a gain on the sale as a result of increased value. Investor types Limited partners Pension funds Governments Insurance companies High net worth individuals Corporations Charitable foundations University endowments