Investment Environment Chapter 1 Quiz

Investments Overview

• The chapter covers the investment environment, including the distinction between "real" and financial assets.

Real Assets vs. Financial Assets

• Real assets are used to produce goods and services, examples: land, buildings, machines, and intellectual property.
• Financial assets are claims to the income generated by real assets or claims on income from the government, examples: stocks, bonds.

Types of Financial Assets

• Fixed-income securities promise a fixed stream of income or a stream determined by a specified formula, example: corporate bond.
• Equity represents ownership share in a firm, example: common stock.
• Derivative securities' payoff depends on the value of other financial variables, examples: stock prices, interest rates, exchange rates.

Financial Markets and the Economy

• Financial markets play an informational role in the economy, helping in consumption timing and allocation of risk.
• Separation of ownership and management can lead to agency problems, which can be mitigated by compensation plans, monitoring, and the threat of takeover.

Corporate Governance and Corporate Ethics

• Corporate governance and ethics are crucial, as seen in scandals such as Enron, Rite Aid, and HealthSouth.
• The Sarbanes-Oxley Act (2002) was passed in response to ethics scandals, focusing on corporate governance.

The Investment Process

• A portfolio is a collection of investment assets, and asset allocation is the choice among broad asset classes.
• Security selection is the choice of securities within each asset class, involving security analysis and valuation.

Markets Are Competitive

• Financial markets are highly competitive, with a risk-return trade-off, where higher-risk assets offer higher expected returns.
• The efficient market hypothesis states that security prices fully reflect available information, making it difficult to find underpriced or overpriced securities.