Investments, 8

th
edition
Bodie, Kane and Marcus
Slides by Susan Hine
McGraw-Hill/Irwin
Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
CHAPTER 1
The Investment
Environment
1-2
Real Assets Versus Financial Assets
Essential nature of investment
Reduced current consumption
Planned later consumption
Real Assets
Assets used to produce goods and
services
Financial Assets
Claims on real assets
1-3
Table 1.1 Balance Sheet of U.S.
Households, 2007
1-4
Table 1.2 Domestic Net Worth
1-5
A Taxonomy of Financial Assets
Fixed income or debt
Money market instruments
Bank certificates of deposit
Capital market instruments
Bonds
Common stock or equity
Derivative securities
1-6
Financial Markets and the Economy
Information Role
The Google effect
Consumption Timing
Allocation of Risk
Separation of Ownership and
Management
Agency Issues
1-7
Financial Markets and the
Economy Continued
Corporate Governance and Corporate Ethics
Accounting Scandals
Examples Enron, Rite Aid, HealthSouth
Auditorswatchdogs of the firms
Analyst Scandals
Arthur Andersen
Sarbanes-Oxley Act
Tighten the rules of corporate governance


1-8
The Investment Process
Asset allocation
Choice among broad asset classes
Security selection
Choice of which securities to hold within
asset class
Security analysis
1-9
Markets are Competitive
Risk-Return Trade-Off
Efficient Markets
Active Management
Finding mispriced securities
Timing the market
Passive Management
No attempt to find undervalued
securities
No attempt to time the market
Holding a highly diversified portfolio
1-10
The Players
Business Firms net borrowers
Households net savers
Governments can be both borrowers and
savers
Financial Intermediaries
Investment Companies
Banks
Insurance companies
Credit unions

1-11
The Players Continued
Investment Bankers
Perform specialized services for
businesses
Markets in the primary market


1-12
Table 1.3 Balance Sheet of
Commercial Banks, 2007
1-13
Table 1.4 Balance Sheet of Nonfinancial
U.S. Business, 2007
1-14
Recent TrendsGlobalization
American Depository Receipts (ADRs)
Foreign securities offered in dollars
Mutual funds that invest internationally
Instruments and vehicles continue to
develop (WEBs)
Exchange Traded Funds (ETFs)
1-15
Figure 1.1 Globalization: A Debt Issue
Denominated in Euros
1-16
Recent TrendsSecuritization
Mortgage pass-through securities
Other pass-through arrangements
Car, student, home equity, credit card
loans
Offers opportunities for investors and
originators
1-17
Figure 1.2 Asset-backed Securities
Outstanding
1-18
Recent TrendsFinancial Engineering
Use of mathematical models and computer-
based trading technology to synthesize new
financial products
Bundling and unbundling of cash flows
1-19
Figure 1.3 Building Creates a Complex
Security
1-20
Figure 1.4 Unbundling of Mortgages into
Principal- and Interest-Only Securities
1-21
Recent TrendsComputer Networks
Online information dissemination
Information is made cheaply and widely
available to the public
Automated trade crossing
Direct trading among investors
Investments, 8
th
edition
Bodie, Kane and Marcus
Slides by Susan Hine
McGraw-Hill/Irwin
Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
CHAPTER 2
Asset Classes
and Financial
Instruments
1-23
Major Classes of Financial Assets or
Securities
Money market
Bond market
Equity Securities
Indexes
Derivative markets
1-24
The Money Market
Treasury bills
Bid and asked price
Bank discount method
Certificates of Deposits
Commercial Paper
Bankers Acceptances
1-25
The Money Market Continued
Eurodollars
Repurchase Agreements (RPs) and Reverse
RPs
Brokers Calls
Federal Funds
LIBOR Market
1-26
Figure 2.1 Rates on Money Market Securities
1-27
Table 2.1 Major Components of the
Money Market
1-28
Figure 2.2 Treasury Bill Yields
1-29
Figure 2.3 The Spread between 3-month
CD and Treasury Bill Rates
1-30
The Bond Market
Treasury Notes and Bonds
Inflation-Protected Treasury Bonds
Federal Agency Debt
International Bonds
Municipal Bonds
Corporate Bonds
Mortgages and Mortgage-Backed Securities
1-31
Treasury Notes and Bonds
Maturities
Notes maturities up to 10 years
Bonds maturities in excess of 10 years
30-year bond
Par Value - $1,000
Quotes percentage of par
1-32
Figure 2.4 Lisiting of Treasury Issues
1-33
Federal Agency Debt
Major issuers
Federal Home Loan Bank
Federal National Mortgage Association
Government National Mortgage
Association
Federal Home Loan Mortgage Corporation
1-34
Municipal Bonds
Issued by state and local governments
Types
General obligation bonds
Revenue bonds
Industrial revenue bonds
Maturities range up to 30 years
1-35
Figure 2.5 Tax-exempt Debt Outstanding
1-36
Municipal Bond Yields
Interest income on municipal bonds is not
subject to federal and sometimes not to state
and local tax

To compare yields on taxable securities a
Taxable Equivalent Yield is constructed
1-37
Table 2.2 Equivalent Taxable Yields
Corresponding to Various Tax-Exempt
Yields
1-38
Figure 2.6 Ratio of Yields on Tax-Exempt
to Taxable Bonds
1-39
Corporate Bonds
Issued by private firms
Semi-annual interest payments
Subject to larger default risk than government
securities
Options in corporate bonds
Callable
Convertible
1-40
Developed in the 1970s to help liquidity of
financial institutions
Proportional ownership of a pool or a
specified obligation secured by a pool
Market has experienced very high rates of
growth
Mortgages and Mortgage-Backed
Securities
1-41
Figure 2.7 Mortgage-backed Securities
Outstanding, 1979-2007
1-42
Equity Securities
Common stock
Residual claim
Limited liability
Preferred stock
Fixed dividends -limited
Priority over common
Tax treatment
Depository receipts
1-43
Figure 2.8 Listing of Stocks Traded on
the NYSE
1-44
There are several broadly based indexes
computed and published daily
There are several indexes of bond market
performance
Others include:
Nikkei Average
Financial Times Index
Stock Market Indexes
1-45
Dow Jones Industrial Average
Includes 30 large blue-chip corporations
Computed since 1896
Price-weighted average

1-46
Example 2.2 Price-Weighted Average
Portfolio: Initial value $25 + $100 = $125
Final value $30 + $ 90 = $120
Percentage change in portfolio value
= 5/125 = -.04 = -4%
Index: Initial index value (25+100)/2 = 62.5
Final index value (30 + 90)/2 = 60
Percentage change in index -2.5/62.5
= -.04 = -4%
1-47
Broadly based index of 500 firms
Market-value-weighted index
Index funds
Exchange Traded Funds (ETFs)
Standard & Poors Indexes
1-48
Other U.S. Market-Value Indexes
NASDAQ Composite
NYSE Composite
Wilshire 5000
1-49
Figure 2.9 Comparative Performance of
Several Stock Stock Indexes, 2001-2006
1-50
Foreign and International
Stock Market Indexes
Nikkei (Japan)
FTSE (Financial Times of London)
Dax (Germany)
MSCI (Morgan Stanley Capital International)
Hang Seng (Hong Kong)
TSX (Canada)
1-51
Derivatives Markets
Options
Basic Positions
Call (Buy)
Put (Sell)
Terms
Exercise Price
Expiration Date
Assets
Futures
Basic Positions
Long (Buy)
Short (Sell)
Terms
Delivery Date
Assets
1-52
Figure 2.10 Trading Data on GE Options
1-53
Figure 2.11 Listing of Selected
Futures Contracts
Investments, 8
th
edition
Bodie, Kane and Marcus
Slides by Susan Hine
McGraw-Hill/Irwin
Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
CHAPTER 3
How Securities
are Traded
1-55
How Firms Issue Securities
Primary
New issue
Key factor: issuer receives the proceeds
from the sale
Secondary
Existing owner sells to another party
Issuing firm doesnt receive proceeds
and is not directly involved
1-56
How Firms Issue Securities Continued
Investment Banking
Shelf Registration
Private Placements
Initial Public Offerings (IPOs)

1-57

Investment Banking

Underwritten: firm commitment on proceeds
to the issuing firm
Red herring
Prospectus

1-58
Figure 3.1 Relationship Among a Firm Issuing
Securities, the Underwriters and the Public
1-59
Shelf Registrations
SEC Rule 415
Introduced in 1982
Ready to be issued on the shelf
1-60
Sale to a limited number of sophisticated
investors not requiring the protection of
registration
Allowed under Rule 144A
Dominated by institutions
Very active market for debt securities
Not active for stock offerings
Private Placements
1-61
Initial Public Offerings
Process
Road shows
Bookbuilding
Underpricing
Post sale returns
Cost to the issuing firm

1-62
Figure 3.2 Average Initial Returns for
IPOs in Various Countries
1-63
Figure 3.3 Long-term Relative
Performance of Initial Public Offerings
1-64
How Securities are Traded
Types of Markets
Direct search
Least organized
Brokered
Trading in a good is active
Dealer
Trading in a particular type of asset
increases
Auction
Most integrated
1-65
Types of Orders
Marketexecuted immediately
Bid Price
Ask Price
Price-contingent
Investors specify prices
Stop orders
1-66
Figure 3.4 The Limit Order Book for Intel
on the Archipelago Market,
January 19, 2007
1-67
Figure 3.5 Price-Contingent Orders
1-68
Trading Mechanisms
Dealer markets
Electronic communication networks (ECNs)
Specialists markets
1-69
U.S. Security Markets
Nasdaq and NYSE have evolved in response
to new information technology
Both have increased their commitment to
automated electronic trading
1-70
Nasdaq
National Market System
Nasdaq Small Cap Market
Levels of subscribers
Level 1 inside quotes
Level 2 receives all quotes but they cant
enter quotes
Level 3 dealers making markets

1-71
Table 3.1 Partial Requirements for Listing
on NASDAQ Markets
1-72
New York Stock Exchange
Member functions
Commission brokers
Floor brokers
Specialists
Block houses
SuperDot

1-73
Table 3.2 Some Initial Listing
Requirements for the NYSE
1-74
Table 3.3 Block Transactions on the
New York Stock Exchange
1-75
Other Systems
Electronic Communication Networks
Private computer networks that directly link
buyers with sellers
National Market System
Securities Act of Amendments of 1975
Bond Trading
Automated Bond System (ABS)
1-76
Market Structure in Other Countries
London - predominately electronic trading
Euronext market formed by combination of
the Paris, Amsterdam and Brussels
exchanges
Tokyo Stock Exchange
Globalization and consolidation of stock
markets
1-77
Figure 3.6 Market Capitalization of Major
World Stock Exchanges, 2007
1-78
Trading Costs
Commission: fee paid to broker for making
the transaction
Spread: cost of trading with dealer
Bid: price dealer will buy from you
Ask: price dealer will sell to you
Spread: ask - bid
Combination: on some trades both are paid
1-79
Buying on Margin
Using only a portion of the proceeds for an
investment
Borrow remaining component
Margin arrangements differ for stocks and
futures
1-80
Stock Margin Trading
Margin is currently 50%; you can borrow up to
50% of the stock value
Set by the Fed
Maintenance margin: minimum amount equity
in trading can be before additional funds must
be put into the account
Margin call: notification from broker that you
must put up additional funds
1-81
Margin Trading - Initial Conditions
Example 3.1
X Corp $100
60% Initial Margin
40% Maintenance Margin
100 Shares Purchased
Initial Position
Stock $10,000 Borrowed $4,000
Equity $6,000
1-82
Margin Trading - Maintenance Margin
Example 3.1
Stock price falls to $70 per share
New Position
Stock $7,000 Borrowed $4,000
Equity $3,000
Margin% = $3,000/$7,000 = 43%
1-83
Margin Trading - Margin Call Example 3.2
How far can the stock price fall before a
margin call?
(100P - $4,000)
*
/ 100P = 30%
P = $57.14
* 100P - Amt Borrowed = Equity
1-84
Table 3.4 Illustration of Buying Stock
on Margin
1-85
Short Sales
Purpose: to profit from a decline in the price
of a stock or security
Mechanics
Borrow stock through a dealer
Sell it and deposit proceeds and margin in
an account
Closing out the position: buy the stock
and return to the party from which is was
borrowed
1-86
Short Sale Initial Conditions Example 3.3
Dot Bomb 1,000 Shares
50% Initial Margin
30% Maintenance Margin
$100 Initial Price

Sale Proceeds $100,000
Margin & Equity 50,000
Stock Owed 100,000
1-87
Short Sale - Maintenance Margin
Stock Price Rises to $110

Sale Proceeds $10,000
Initial Margin 5,000
Stock Owed 11,000
Net Equity 4,000
Margin % (4000/11,000) 36%
1-88
Short Sale - Margin Call
How much can the stock price rise before a
margin call?

($150,000
*
- 1000P) / (100P) = 30%
P = $115.38

* Initial margin plus sale proceeds

1-89
Regulation of Securities Markets
Major regulations
Securities Act of 1933
Securities Act of 1934
Securities Investor Protection Act of 1970

Self-Regulation
Stock markets are largely self-regulating
1-90
Regulation Securities Markets Continued
Regulatory Responses to Recent Scandals
Public Company Accounting Oversight
Board
Financial experts to serve on audit
committees of boards of directors
CEOs and CFOs personally certify firms
financial reports
Boards must have independent directors
Sarbanes-Oxley Act

1-91
Circuit Breakers
Trading halts
Collars
1-92
Insider Trading
Officers, directors, major stockholders must
report all transactions in firms stock
Insiders do exploit their knowledge
Leakage of useful information to some
traders
Investments, 8
th
edition
Bodie, Kane and Marcus
Slides by Susan Hine
McGraw-Hill/Irwin
Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
CHAPTER 4
Mutual Funds
and Other
Investment
Companies
1-94
Investment Companies
These companies perform several
important functions for investors:
Administration & record keeping
Diversification & divisibility
Professional management
Reduced transaction costs
1-95
Net Asset Value
Used as a basis for valuation of investment
company shares
Selling new shares
Redeeming existing shares
Calculation
Market Value of Assets - Liabilities
Shares Outstanding
1-96
Types of Investment Companies
Unit Trusts
Managed Investment Companies
Open-End
Open-end: shares outstanding change
when new shares are sold or old shares
are redeemed
Priced at Net Asset Value(NAV)
Closed-End
no change in shares outstanding unless
new stock is offered
Priced at Premium or discount to NAV
1-97
Figure 4.1 Closed-End Mutual Funds
1-98
Types of Investment
Companies Continued
Other investment organizations
Commingled funds
REITs
Hedge Funds

1-99
Mutual FundsInvestment Policies
Money Market
Equity
Sector
Bond
Balanced
Asset Allocation and Flexible
Index
International

1-100
Table 4.1 U.S. Mutual Funds by
Investment Classification
1-101
How Funds Are Sold
Direct-marketed funds
Sales force distributed
Revenue sharing on sales force distributed
Potential conflicts of interest
Financial Supermarkets
1-102
Costs of Investing in Mutual Funds
Fee Structure
Operating expenses
Front-end load
Back-end load
12 b-1 charges
distribution costs paid by the fund
Alternative to a load
1-103

Fees and Mutual Fund Returns

1 0
0
NAV NAV Income and capital gain distributions
Rate of return =
NAV

0
10
20
30
40
50
60
70
80
90
1st Qtr 2nd Qtr 3rd Qtr 4th Qtr
East
West
North
1-104
Fees and Mutual Fund Returns:
An Example
Initial NAV = $20
Income distributions of $.15
Capital gain distributions of $.05
Ending NAV = $20.10:


$20.10 - $20.00 + $.15 + $.05
Rate of Return = 1.5%
$20.00

1-105
Table 4.2 Impacts of Costs on
Investment Performance
1-106
Trading Scandal with Mutual Funds
Late trading allowing some investors to
purchase or sell later than other investors
Market timing allowing investors to buy or
sell on stale net asset values
International
Net effect is to transfer value from other
shareholders to privileged traders
Reduction in the rate of return of the
mutual fund

1-107
Potential Reforms
Strict 4:00 PM cutoff with late orders
executed the following trading day
Fair value pricing with net asset values being
adjusted for trading in open markets
Imposition of redemption fees
1-108
Taxation on Mutual Fund Income
Pass-through status under the U.S. tax code
Taxes are paid only by the investor
High turnover leads to tax inefficiency
1-109
Exchange Traded Funds
ETF allow investors to trade index portfolios
like shares of stock
Examples - SPDRs and WEBS
Potential advantages
Lower taxes
Trade continuously
Lower costs
Potential disadvantages
Prices can depart by small amounts from
NAV

1-110
Table 4.3 EFT Sponsors and Products
1-111
Mutual Fund Investment Performance:
A First Look
Evidence shows that average mutual fund
performance is generally less than broad
market performance
Evidence that performance is consistent from
one period to the next is suggestive but
inconclusive
1-112
Figure 4.2 Diversified Equity Funds
versus Wilshire 5000 Index
1-113
Table 4.4 Consistency of
Investment Results
1-114
Information on Mutual Funds
Wiesenbergers Investment Companies
Morningstar (www.morningstar.com)
Yahoo (biz.yahoo.com/funds)
Investment Company Institute (www.ici.org)
Directory of Mutual Funds