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Fundamental Analysis • A firm’s value comes from its earnings prospects, which are determined by: – The global economic environment – Economic factors affecting the firm’s industry – The position of the firm within its industry

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Bond Pricing Relationships 1. Bond prices and yields are inversely related. 2. An increase in a bond’s yield to maturity results in a smaller price change than a decrease of equal magnitude. 3. Long-term bonds tend to be more price sensitive than short-term bonds.

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Bonds are debt. Issuers are borrowers and holders are creditors. – The indenture is the contract between the issuer and the bondholder. – The indenture gives the coupon rate, maturity date, and par value.

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9.1 Behavioral Critique • Behavioral Finance • Financial market model emphasizing potential implications of psychological factors affecting investor behavior • Existence of irrational investors is not sufficient to render capital markets inefficient

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Efficient Market Hypothesis (EMH) • Maurice Kendall (1953) found no predictable pattern in stock prices. • Prices are as likely to go up as to go down on any particular day. • How do we explain random stock price changes?

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Capital Asset Pricing Model (CAPM) • Equilibrium model that underlies all modern financial theory • Derived using principles of diversification with simplified assumptions • Markowitz, Sharpe, Lintner and Mossin are researchers credited with its development

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Extending Concepts to All Securities • The optimal combinations result in lowest level of risk for a given return • The optimal trade-off is described as the efficient frontier • These portfolios are dominant

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Dollar Weighted Returns Internal Rate of Return (IRR) - the discount rate that results present value of the future cash flows being equal to the investment amount • Considers changes in investment • Initial Investment is an outflow • Ending value is considered as an inflow • Additional investment is a negative flow • Reduced investment is a p...

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Investment Companies • Pool funds of individual investors and invest in a wide range of securities or other assets. • Services provided: – Administration & record keeping – Diversification & divisibility – Professional management – Reduced transaction costs

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Primary vs. Secondary Security Sales • Primary – New issue – Key factor: issuer receives the proceeds from the sale • Secondary – Existing owner sells to another party – Issuing firm doesn’t receive proceeds and is not directly involved

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