An investor’s portfolio is simply his collection of investment assets. Once the portfolio is established, it is updated or “rebalanced” by selling existing securities and using the proceeds to buy new securities, by investing additional funds to increase the overall size of the portfolio, or by selling securities to decrease the size of the portfolio.
Investment assets can be categorized into broad asset classes, such as stocks, bonds, real estate, commodities, and so on. Investors make 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. For example, an individual who currently holds all of his money in a bank account would first decide what proportion of the overall portfolio ought to be moved into stocks, bonds, and so on. In this way, the broad features of the portfolio are established. A top-down investor first makes crucial asset allocation decisions before turning to the decision of the particular securities to be held in each asset class.
Security analysis involves the valuation of particular securities that might be included in the portfolio. Both bonds and stocks must be evaluated for investment attractiveness, but valuation is far more difficult for stocks because a stock’s performance usually is far more sensitive to the condition of the issuing firm.
In contrast to top-down portfolio management is the “bottom-up” strategy. In this process, the portfolio is constructed from the securities that seem attractively priced without as much concern for the resultant asset allocation. Such a technique can result in unintended bets on one or another sector of the economy. For example, 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. However, a bottom-up strategy does focus the portfolio on the assets that seem to offer the most attractive investment opportunities.
25.9.15
16.9.15
What is the Point of Financial Markets?
The key word is shift of consumption, that is consumption timing of individual investor.
Some individuals in an economy are earning more than they currently wish to spend. Others, for example, retirees, spend more than they currently earn. How can they shift their purchasing powers from high-earnings periods to low-earnings periods of life?
One way is to “store” their wealth in financial assets. In high-earnings periods, they can invest their savings in financial assets such as stocks and bonds. In low-earnings periods, they can sell these assets to provide funds for their consumption needs. By so doing, they can “shift” their consumption over the course of their lifetime, thereby allocating their consumption to periods that provide the greatest satisfaction. Thus, financial markets allow individuals to separate decisions concerning current consumption from constraints that otherwise would be imposed by current earnings.
Anyway these actions are not performed without some risk. Investing in bonds is usually considered as a smaller risk while investing in stocks represent greater risk to potential investor in securities. This allocation of risk also benefits the firms that need to raise capital to finance their investments in real assets. When investors in financial assets 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.
Some individuals in an economy are earning more than they currently wish to spend. Others, for example, retirees, spend more than they currently earn. How can they shift their purchasing powers from high-earnings periods to low-earnings periods of life?
One way is to “store” their wealth in financial assets. In high-earnings periods, they can invest their savings in financial assets such as stocks and bonds. In low-earnings periods, they can sell these assets to provide funds for their consumption needs. By so doing, they can “shift” their consumption over the course of their lifetime, thereby allocating their consumption to periods that provide the greatest satisfaction. Thus, financial markets allow individuals to separate decisions concerning current consumption from constraints that otherwise would be imposed by current earnings.
Anyway these actions are not performed without some risk. Investing in bonds is usually considered as a smaller risk while investing in stocks represent greater risk to potential investor in securities. This allocation of risk also benefits the firms that need to raise capital to finance their investments in real assets. When investors in financial assets 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.
Financial Markets
Financial assets and the markets in which they trade play several crucial roles in developed economies. Financial assets allow us to make the most of the economy’s real assets.
Stock prices reflect investors’ collective assessment of a firm’s current performance and future prospects. When the market is more optimistic about the firm, its share price will rise. At that higher price, fewer shares must be issued to raise the funds necessary to finance a prospective project, for example, a research and development effort or an expansion of operations. And when fewer shares are issued, a smaller proportion of profits are absorbed by the new shareholders,leaving more for the existing shareholders and making the potential investment more attractive. The firm therefore is more inclined to pursue the opportunity. In this manner, stock prices play a major role in the allocation of capital in market economies, directing capital to the firms and applications with the greatest perceived potential.
Do capital markets actually channel resources to the most efficient use? At times, they appear to fail miserably. Companies or whole industries can be “hot” for a period of time (think about the dot-com bubble that peaked in 2000), attract a large flow of investor capital, and then fail after only a few years.
It is unreasonable to expect that markets will never make mistakes. The stock market encourages allocation of capital to those firms that appear at the time to have the best prospects. Many smart, well-trained, and well-paid professionals analyze the prospects of firms whose shares trade on the stock market. Stock prices reflect their collective judgment.
Stock prices reflect investors’ collective assessment of a firm’s current performance and future prospects. When the market is more optimistic about the firm, its share price will rise. At that higher price, fewer shares must be issued to raise the funds necessary to finance a prospective project, for example, a research and development effort or an expansion of operations. And when fewer shares are issued, a smaller proportion of profits are absorbed by the new shareholders,leaving more for the existing shareholders and making the potential investment more attractive. The firm therefore is more inclined to pursue the opportunity. In this manner, stock prices play a major role in the allocation of capital in market economies, directing capital to the firms and applications with the greatest perceived potential.
Do capital markets actually channel resources to the most efficient use? At times, they appear to fail miserably. Companies or whole industries can be “hot” for a period of time (think about the dot-com bubble that peaked in 2000), attract a large flow of investor capital, and then fail after only a few years.
It is unreasonable to expect that markets will never make mistakes. The stock market encourages allocation of capital to those firms that appear at the time to have the best prospects. Many smart, well-trained, and well-paid professionals analyze the prospects of firms whose shares trade on the stock market. Stock prices reflect their collective judgment.
14.9.15
Financial Assets
It is common to distinguish among three broad types of financial assets: debt, 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. For example, a corporate bond typically would promise that the bondholder will receive a fixed amount of interest each year. Other so-called floating-rate bonds promise payments that depend on current interest rates.
Unlike debt securities, common stock, or equity, in a firm represents an ownership share in the corporation. Equityholders are not promised any particular payment. They receive any dividends the firm may pay and have prorated ownership in the real assets of the firm. If the firm is successful, the value of equity will increase; if not, it will decrease. The performance of equity investments, therefore, is tied directly to the success of the firm and its real assets. For this reason, equity investments tend to be riskier than investments in debt securities.
Finally, 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. Derivative securities are so named because their values derive from the prices of other assets. Derivatives have become an integral part of the investment environment. One use of derivatives, perhaps the primary use, is to hedge risks or transfer them to other parties.
Investors also might invest directly in some real assets. For example, dozens of commodities are traded on exchanges such as the New York Mercantile Exchange or the Chicago Board of trade. You can buy or sell corn, wheat, natural gas, gold, silver, and so on. Commodity and derivative markets allow firms to adjust their exposure to various business risks.
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. For example, a corporate bond typically would promise that the bondholder will receive a fixed amount of interest each year. Other so-called floating-rate bonds promise payments that depend on current interest rates.
Unlike debt securities, common stock, or equity, in a firm represents an ownership share in the corporation. Equityholders are not promised any particular payment. They receive any dividends the firm may pay and have prorated ownership in the real assets of the firm. If the firm is successful, the value of equity will increase; if not, it will decrease. The performance of equity investments, therefore, is tied directly to the success of the firm and its real assets. For this reason, equity investments tend to be riskier than investments in debt securities.
Finally, 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. Derivative securities are so named because their values derive from the prices of other assets. Derivatives have become an integral part of the investment environment. One use of derivatives, perhaps the primary use, is to hedge risks or transfer them to other parties.
Investors also might invest directly in some real assets. For example, dozens of commodities are traded on exchanges such as the New York Mercantile Exchange or the Chicago Board of trade. You can buy or sell corn, wheat, natural gas, gold, silver, and so on. Commodity and derivative markets allow firms to adjust their exposure to various business risks.
Assets
The material wealth of society is ultimately determined by the productive capacity of its economy, that is, the goods and services its members can create. This capacity is function of real assets of the economy: the land, buildings, equipment, and knowledge that can be used to produce goods and services.
In contrast to such real assets are financial assets such as stocks and bonds. Such securities are not more than sheets of paper or, more likely, computer entries and do not directly contribute to the productive capacity of the economy. Instead, these 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). If we cannot own our own auto plant (a real asset), we can still buy shares in Honda or Toyota (financial assets) and, thereby, share in the income derived from the production of automobiles.
While real assets generate net income to the economy, financial assets simply define the allocation of income or wealth among investors. Individuals can choose between consuming their wealth today or investing for the future. If they choose to invest, they may place their wealth in financial assets by purchasing various securities. When investors buy these securities from companies, the firms use the money so raised to pay for real assets, such as plant, equipment, technology, or inventory. So investors’ returns on securities ultimately come from the income produced by the real assets that were financed by the issuance of those securities.
In contrast to such real assets are financial assets such as stocks and bonds. Such securities are not more than sheets of paper or, more likely, computer entries and do not directly contribute to the productive capacity of the economy. Instead, these 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). If we cannot own our own auto plant (a real asset), we can still buy shares in Honda or Toyota (financial assets) and, thereby, share in the income derived from the production of automobiles.
While real assets generate net income to the economy, financial assets simply define the allocation of income or wealth among investors. Individuals can choose between consuming their wealth today or investing for the future. If they choose to invest, they may place their wealth in financial assets by purchasing various securities. When investors buy these securities from companies, the firms use the money so raised to pay for real assets, such as plant, equipment, technology, or inventory. So investors’ returns on securities ultimately come from the income produced by the real assets that were financed by the issuance of those securities.
What is an Investment?
An investment is the current commitment of money or other resources in the expectation of deriving greater resources in the future. That means that you sacrifice something of value now, expecting to benefit from that sacrifice later.
In an economic sense, an investment is the purchase of goods that are not consumed today but are used in the future to create wealth. In finance, an investment is a monetary asset purchased with the idea that the asset will provide income in the future or appreciate and be sold at a higher price.
The building of a factory used to produce goods and the investment one makes by going to college or university are both examples of investments in the economic sense. In the financial sense investments include the purchase of bonds, stocks or real estate property.
Investing is the act of committing money or capital to an endeavor (a business, project, real estate, etc.) with the expectation of obtaining an additional income or profit. Investing also can include the amount of time you put into the study of a prospective company, especially since time is money.
Investing is the key to building wealth, but investing in and of itself is not enough. You have to invest wisely!
In an economic sense, an investment is the purchase of goods that are not consumed today but are used in the future to create wealth. In finance, an investment is a monetary asset purchased with the idea that the asset will provide income in the future or appreciate and be sold at a higher price.
The building of a factory used to produce goods and the investment one makes by going to college or university are both examples of investments in the economic sense. In the financial sense investments include the purchase of bonds, stocks or real estate property.
Investing is the act of committing money or capital to an endeavor (a business, project, real estate, etc.) with the expectation of obtaining an additional income or profit. Investing also can include the amount of time you put into the study of a prospective company, especially since time is money.
Investing is the key to building wealth, but investing in and of itself is not enough. You have to invest wisely!
Background
Hi!
I am currently student on MBA study in Quantitative Finance (QF) on ZSEM (Zagreb School of Economics and Management). I thought it might be useful for other students worldwide to share what I have learnt as I progress through the study. There are lot of topics in QF program, but I will focus on investment issues. I will occasionally throw random notes here as I advance through the program.
I hope it will be an interesting trip through investments, so enjoy the reading!
I am currently student on MBA study in Quantitative Finance (QF) on ZSEM (Zagreb School of Economics and Management). I thought it might be useful for other students worldwide to share what I have learnt as I progress through the study. There are lot of topics in QF program, but I will focus on investment issues. I will occasionally throw random notes here as I advance through the program.
I hope it will be an interesting trip through investments, so enjoy the reading!
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