Chapter One, Two, and Three
Introduction of Investments
Real Assets vs. Financial Assets
Real Assets
• Determine the productive
capacity and net income
of the economy
• Examples: Land, buildings,
machines, intellectual
property
Financial Assets
• _______ on real assets
• Do not contribute directly
to productive capacity
• Examples: Stocks, bonds
Financial Assets
Financial Assets: Claims on Real Assets
Fixed-Income Securities
Equity
Promises a fixed stream of income
or a stream of income determined
by a specified formula; debt
Represents ownership share in a
corporation; common stock
Derivatives
Provide payoffs that are determined
by the prices of other assets; options,
forward/futures contract
The Investment Process
• ____________: Collection of investment assets
• Investors make two types of investment decisions in
constructing portfolios
• Asset allocation
• Choice among broad asset classes
• Security selection
• Choice of securities within each asset class
Fixed Income
Money Markets
Fixed Income
Capital Markets
Asset Classes
Equity
Derivatives
The Money Market
• Subsector of the fixed-income market
•
•
•
•
___________
___________
___________
Often have large denominations
• Money market mutual funds allow individuals to
access the money market
• Good investment strategy for those who want to
invest in __________ and _______ assets
Money Market Securities
• Treasury bills: Short-term and highly liquid debt of
_______________
• Certificates of deposit (CD): Time deposit with _____
• The bank pays interest and principal to the depositor only at the
end of the fixed term
• https://www.bankrate.com/cd.aspx
• Commercial paper (CP): Short-term, unsecured debt
issued by ________________
• http://www.federalreserve.gov/releases/cp/rates.htm
• Except for Treasury bills, money market securities are
not free of ______
Spread between 3-month CD
and Treasury Bills
Major Components of
the Money Market
The Capital Market
(1 of 2)
Treasury
Notes
Treasury
Bonds
Corporate
Bonds
Municipal
Bonds
Capital
Markets
International
Bonds
Federal
Agency
Debt
InflationProtected
Securities
The Capital Market
(2 of 2)
• Subsector of the fixed-income market
• ___________
• __________
• Low risk (but not as low as the Money Market)
• Examples are:
•
•
•
•
Treasury Notes and Bonds
Inflation-Protected Treasury Bonds
Municipal Bonds
Corporate Bonds
Capital Market:
Treasury Notes and Bonds
• Treasury Notes and Bonds
• Maturities
• Notes – Maturities up to ___ years
• Bonds – Maturities from ___ to 30 years
• Par Value — $1,000
• Interest paid semiannually
• Quotes — Percentage of par
Capital Market Securities
• Inflation-Protected Treasury Bonds
• Treasury Inflation Protected Securities (TIPS): Provide
inflation protection
• The principal amount is adjusted in proportion to
increases in inflation rate
• Municipal Bonds (“munis”)
• Issued by _________________________
• Interest is exempt from federal income tax and
sometimes from state and local tax
Capital Market:
Corporate Bonds
• Corporate Bonds
• Issued by corporations
• Semi-annual interest payments
• ________ default risk than government securities
• Options in corporate bonds
• Callable: a firm may repurchase the bond before the
maturity date
• Convertible: bondholders may convert each bond into
shares of stock
U.S. Fixed-Income Market
Equity
Asset Classes
Fixed Income
Common Stock
Equity
Preferred Stock
Derivatives
ADRs
Equity Securities:
Common Stock
• Common stock
• Ownership, residual claim, limited liability
• Preferred stock:
• Perpetuity, fixed dividends, priority over common
• American Depository Receipts (ADR)
• Certificates traded in U.S. markets that represent
ownership in shares of a foreign company
• The most common way for U.S. investors to invest in and
trade the shares of foreign corporations
Stock Market Indices
• Dow Jones Industrial Average
• Includes 30 large blue-chip corporations
• Computed since 1896
• _____________Index
• S&P 500
• Broad based index of 500 firms
• _________________Index
• Investors can base their portfolios on an index
• Buy an index mutual fund – Passive investment strategy
• Buy exchange-traded funds (ETFs)
Examples: Price/Value-Weighted
Index
Q1) Calculate a percentage change in price-weighted index?
Examples: Price/Value-Weighted
Index
• Q2) Calculate a percentage change in value-weighted index?
Derivatives
Fixed Income
Asset Classes
Equity
Options
Derivatives
Futures
• A derivative is a security that gets its value from the
value of another asset, such as commodity prices, bond
and stock prices, or market index values
Derivatives Markets: Options
• Call Option:
• Right to _____ underlying asset at the strike price
• Value of calls decreases as strike price increases
• Put Option:
• Right to ______ underlying asset at the strike price
• Value of puts increase with strike price
• Both calls and puts increases with
____________________
Derivatives Markets: Futures
• Futures Contracts:
• An agreement made today regarding the delivery of
an asset (or in some cases, its cash value) at a
specified delivery or maturity date for an agreed-upon
price, called the futures price, to be paid at contract
maturity
• Long position: Take delivery at maturity
• Short position: Make delivery at maturity
Comparison
Option
Futures Contract
• Right, but not obligation,
to buy or sell
• Option is exercised only
when it is profitable
• Options must be
purchased
• The premium is the price
of the option itself
• Obliged to make or take
delivery
• Long (short) position
must buy (sell) at the
futures price
• Futures contracts are
entered into without cost
How Firms Issue Securities
(1 of 3)
• Primary Market
• Market for newly-issued securities
• Firms issue new securities through underwriter
(investment banker) to public
• Secondary Market
• Investors trade previously issued securities among
themselves (e.g., NYSE, NASDAQ)
How Firms Issue Securities
(2 of 3)
• Privately Held Firms
• Up to 499 shareholders
• Raise funds through private placement
• Lower liquidity of shares
• Fewer obligations to release financial statements
How Firms Issue Securities
(3 of 3)
• Publicly Traded Companies
• Public offerings are marketed by underwriters
• Initial Public Offering (IPO): First issue of shares sold to
the general public
• Seasoned Equity Offering (SEO): The sale of additional
shares in firms that already are publicly traded
• Registration must be filed with the SEC
Relationship Among a Firm Issuing Securities,
the Underwriters, and the Public
Types of Orders
• Market Order:
• Executed ____________
• Trader receives _________________ price
• A large order may be filled at multiple prices. Why?
• Price-Contingent Order:
• Traders specify buying or selling price
• You may instruct the broker to buy (sell) some number of
shares if and when Facebook may be obtained at or below
(above) a stipulated price
Price-Contingent Order:
Example
U.S. Markets: NYSE
• The New York Stock Exchange
• The largest U.S. stock exchange as measured by the value
of the stocks listed on the exchange
• Automatic electronic trading runs side-by-side with
broker/specialist system
• NASDAQ
• Lists about 3,000 firms
• Today, NASDAQ’s Market Center offers a sophisticated
electronic trading platform with automatic trade execution
The Biggest Stock Markets in the World
by Domestic Market Capitalization (2015)
Trading Costs
• Brokerage Commission: Fee paid to broker for
making the transaction
• Explicit cost of trading
• Full service vs. discount brokerage
• Spread: Difference between the bid and asked prices
• Implicit cost of trading
Short Sales
• Purpose
• To profit from a _________ 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 it was borrowed
Insider Trading
• Officers, directors, major stockholders must report all
transactions in firm’s stock
• Evidence 1: Stock prices increase before public
announcement of good news
• Evidence 2: Insiders do exploit their knowledge
• Jaffe study:
• Inside buyers > Inside sellers = Stock does well
• Inside sellers > Inside buyers = Stock does poorly