FINM7008 Chap.1 The Investment Environment and Asset Classes
The Investment Environment and Asset Classes
Investments as claims on the future
The course defines an investment as committing money or other resources now in the expectation of future benefits, and separates a good decision from a lucky outcome.
The chapter sorts investment assets into real, financial and intangible, and explains why financial claims count in household wealth but cancel out in national wealth.
Markets and indexes
It then surveys the money market, the bond market and equities, and shows how equal, price and value weighting give different returns for the same stock index.
What the questions test
Tutorial questions on this material are short explanations: whether financial engineering creates wealth, why firms care about secondary-market prices, who gains when house prices double, and why commercial paper spreads widen in a recession.
Each answer turns on the same distinction between real assets and the claims written on them.
What this chapter covers
- 01
Expectation, luck and survivorship bias
- 02
Real, financial and intangible assets
- 03
Roles of financial markets
- 04
Asset allocation and security selection
- 05
Money market securities
- 06
Bonds and equities
- 07
Price-weighted and value-weighted indexes
Worked example · free
Classifying five holdings by asset type
- 1The apartment is a real asset: a building that produces housing services and income.
- 1The trademark is an intangible asset: valuable property that is not physical.
- 1The bank shares, the government bond and the term deposit are financial assets, claims on the income of the bank and the government.
- 1Each of those three claims is matched by its issuer's liability, so they cancel across the economy, while the apartment remains part of national wealth.
Key terms
- Real Asset
- A tangible asset, such as land or machinery, that determines the economy's productive capacity.
- Financial Asset
- A claim on real assets or on the income they generate, such as a share, a bond or a deposit.
- Residual Claim
- The shareholders' right to whatever is left after every other claimant on the firm has been paid.
- Value-Weighted Index
- A stock index whose weights are each firm's share of total market value.
- Limited Liability
- The rule that shareholders can lose at most what they paid for their shares if the firm fails.
The Investment Environment and Asset Classes FAQ
Why do financial assets not count in national wealth?
Every financial asset is also someone's liability: your bond is the issuer's debt. When all balance sheets in an economy are combined, these claims cancel, leaving the real assets that actually produce goods and services.
Why can a government not issue shares to raise money?
A share is partial ownership of a business, and a sovereign government is not a private business that can sell ownership of itself. Governments raise money by borrowing instead, through Treasury bills, notes and bonds.
How does price weighting differ from value weighting?
A price-weighted index, such as the Dow Jones Industrial Average, weights each stock by its share price, so an expensive share counts for more regardless of company size. A value-weighted index, such as the S&P 500, weights each stock by its total market value.
Is investing just a form of gambling?
The lecture argues not. Gambling is driven mainly by entertainment and excitement and has a negative expected value over time, while investing aims at wealth growth with a positive long-run expected value, relies on research and diversification, and runs over months to decades rather than hours.
What is the difference between top-down and bottom-up investing?
Top-down construction starts with asset allocation across broad classes and then picks securities within each class. Bottom-up construction starts from securities that look attractively priced and pays little attention to the overall mix, which risks a poorly diversified, more expensive portfolio.
Why are money market securities called cash equivalents?
Because they are short-term, highly liquid and low in risk, their prices are stable and they can be turned into cash quickly at low transaction cost. Treasury bills, certificates of deposit, commercial paper and bankers' acceptances are the main examples, and only Treasury bills are free of default risk.
Exam move
Draw the asset map from memory, then for each money-market and bond instrument name the issuer and its default risk. Practise one index-weighting calculation in all three ways until you can explain why the answers differ. For the short-answer style, practise writing each explanation in three sentences: the principle, how it applies to the case, and who gains or loses.
Keep the fair-coin game in mind as a test: a decision is judged by its expected return and risk before the outcome, never by whether it happened to win.
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