FIN 3300 Chapter Notes - Chapter 1: Freddie Mac, United States Treasury Security, Passive Management
Chapter 1 – The Investment Environment (Essentials of Investments book notes)
• Real assets: determine the wealth of an economy
• Financial assets: represent claims on real assets (stocks, bonds)
• Portfolio: collection of investment assets
o 2 decisions:
▪ Asset Allocation
▪ Security selection
• Risk-return trade-off: with higher risk assets priced to offer higher expected returns than
with lower risk assets
• Active management:
o Seeking undervalued securities
o Market timing
• Passive management:
o No attempt to find undervalued securities
o No attempt to time the market
• Firms – demanders of capital, income of real assets, provides returns to investors who
purchase the securities
• Households – suppliers of capital
• Governments – can be borrowers or lenders, has to borrow $ to cover budget deficit,
borrow funds through Treasury bills, notes, bonds
• Financial intermediaries: stand between the firm and the individual investor
o Ex: large financial institutions ->pension funds, mutual funds, insurance
companies, banks
o Mutual funds/hedge funds pool and invest money of many clients
o Profit for financial intermediaries:
▪ Economies of scale
▪ Specialization
• Underwriters (investment bankers): handles primary market, where new issues are
offered to the public
• Secondary market: investors can trade previously issued securities among themselves
• Venture capital: new start up companies equity investments
• Securitizaiton: Fannie Mae and Freddie Mac bought mortgage loans from banks and
bundled them into large pools so that they could be traded like any other financial asset
o Supposedly “low-conforming mortgages”
▪ Ratio of loan amount to house value < or = 80%
▪ Criteria for ability to repay loan
o SUB-PRIME loans “nonconforming”
▪ Invest or bear risk of default, no contact with borrowers, relied on credit
scores
• Why invest in subprime mortgages?
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