.. slideconf:: :slide_classes: appear ============= Asset Classes ============= Introduction ============ What is an investment? .. rst-class:: to-build - A commitment of resources with the expectation of a future payoff. .. rst-class:: to-build - Financial investments: stocks, bonds, options, futures. .. rst-class:: to-build - Other investments: education, physical fitness, relationships. .. rst-class:: to-build Decisions faces by investors: .. rst-class:: to-build - Risk-return trade-off. .. rst-class:: to-build - Efficient pricing of financial assets. Real vs. Financial Assets ========================= Real assets are goods (generally tangible) that are used to produce other goods or services: buildings, machines, land, knowledge. .. rst-class:: to-build - Productivity of economy determined by real assets. .. rst-class:: to-build Financial assets are claims to income generated by real assets. .. rst-class:: to-build - Firms use the money raised through financial assets to invest in plants, equipment, labor, etc. .. rst-class:: to-build - Holder of financial asset receives a portion of the resulting returns from real assets. .. rst-class:: to-build While real assets determine wealth, financial assets determine distribution of wealth. Equity Assets ============= Equity (stock) is an ownership claim in a particular firm. .. rst-class:: to-build - Equity holder owns a prorated share of the real assets of a firm and is entitled to a portion of the profits that is not reinvested (dividends). .. rst-class:: to-build - The return to an equity asset is not guaranteed: it is tied to the financial well-being of the firm. Equity Example ============== Consider `The Coca-Cola Company `_. .. rst-class:: to-build - On 14 Jan 2014, there were 4.42 billion shares of KO outstanding. .. rst-class:: to-build - On 28 Nov 2013, KO decided to pay $1.24 billion in dividends to shareholders. .. rst-class:: to-build - This amounted to $0.28 paid to each share. .. rst-class:: to-build - If the company were liquidated, each share would entitle the holder to 1/4,420,000,000 of all KO assets. Equity Prices ============= There are several ways to think about the price of an equity share. .. rst-class:: to-build - Add the values of all firm assets and divide by the number of shares outstanding. .. rst-class:: to-build - Alternatively, it is the `present value `_ of all future payments (dividends). .. rst-class:: to-build .. math:: P = \sum_{t=1}^{\infty} \frac{D_t}{(1+r)^t} .. rst-class:: to-build - :math:`D_t` represents the dividend payment at future date :math:`t`, and :math:`r` is the competitive interest rate that you could otherwise earn on your money. Present Value ============= Recall that present value is a way to value future payments in current terms. .. rst-class:: to-build - Money paid to you in the future should be less than money paid now. .. rst-class:: to-build - Why? Present Value ============= Suppose you can earn 10% interest on every dollar you save tonight. .. rst-class:: to-build - Then if you save $0.9091 tonight, it will be worth $0.9091 :math:`\times` 1.1 = $1 tomorrow. .. rst-class:: to-build - If I offer you either $0.92 today or $1 tomorrow, which would you pick? .. rst-class:: to-build - If I offer you either $0.90 today or $1 tomorrow, which would you pick? Fixed Income Assets =================== Fixed income securities are assets with payments determined by a formula (e.g. bonds). .. rst-class:: to-build - U.S. Treasury bills/bonds, commercial paper, CDs. .. rst-class:: to-build - Although fixed income payments are determined mathematically there is still risk (interest rate risk, default risk). .. rst-class:: to-build - Longer maturity fixed income assets tend to be more risky. .. rst-class:: to-build - Fixed income is typically less risky than equity because the payments are guaranteed. Fixed Income Assets =================== - Fixed income assets are typically a way for firms or governments to borrow money. .. rst-class:: to-build - It is possible to hold both equity and debt (fixed income) assets for the same firm. Fixed Income Prices =================== Fixed income assets typically promise a stream of payments at future dates. .. rst-class:: to-build - Coupon payments at regular intervals. .. rst-class:: to-build - A final principal payment (face value) at the end. .. rst-class:: to-build - The price of a fixed income asset is the present value of these payments. .. rst-class:: to-build .. math:: P = \sum_{t=1}^T \frac{C_t}{(1+r)^t} + \frac{F}{(1+r)^T}. Derivatives =========== Derivatives are assets whose payoffs are determined by another (underlying) asset. .. rst-class:: to-build - Options are assets which allow the holder the option to buy or sell an asset at a pre-specified price at a future date. .. rst-class:: to-build - Futures are contracts to buy and sell assets (real or financial) for a pre-specified price at a future date. .. rst-class:: to-build - These assets are called derivatives because their value derives from the value of the underlying asset. .. rst-class:: to-build - Derivatives are commonly used for hedging (insurance) but are sometimes used for speculation, too. .. rst-class:: to-build .. header:: ""