Asset Classes and
Financial Instruments
Market overview
NASDAQ
Dow Jones
World Indices
Crude Oil
Bitcoin Tesla, Gold, Apple, Amazon,
Nvidia, Novo Nordisk (NVO), Eli Lilly
(LLY)
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Investments
& Financial
Assets
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Essential
nature of
investment
Real Assets
Financial
Assets
Reduced current
consumption
Planned later
consumption
Assets used to
produce goods
and services
(land, building,
machine,
knowlegde)
Claims on real
assets or income
generated by
them (stocks,
bonds)
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• Fixed Income Securities
• a fixed stream of income or a stream of income
that is determined according to a specified
formula
• Bonds, treasury bills, Corporate notes
• Money market, Capital market
Represents an ownership share in a
Classes of • Equity:
corporation
holders are not promised any particular
Financial • Equity
payment (no fix income stream)
dividend and pro rata ownership of
Assets • Benefits:
assets
• Preferred stock and Common Stocks
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• Derivative securities
• Provide payoffs that are determined by the
prices of other underlying assets
• Index, Gold, Currency, Corn, Coffee, etc.
Futures,
Options
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• Consumption Timing:
Financial
Markets
and the
Economy
One way is to “store” your wealth in financial assets.
In high-earnings periods, you can invest your savings
in financial assets such as stocks and bonds. In lowearnings periods, you can sell these assets to provide
funds for your consumption needs.
• Allocation of Risk:
Virtually all real assets involve some risk. There is no
good or bad investment, only the risk/return ratio is
not suitable for the investor. The aim is to find, which
match to our character and find the fair price of the
investment.
• Separation of Ownership and Management
Agency Issues – Conflicts of interest between managers
and stockholders.
Compensation of management, board actively
monitor this, market analysts
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• Asset allocation: Allocation of an investment
portfolio across broad asset classes (cash/money
market, fixed income, equity,)
• Security selection: Choice of specific securities
within each asset class (t-bill, long or short term
bonds, corporate or municipal )
The
Investment
Process
• Security analysis: Choice of specific securities
within each asset class (Google, Twitter, Apple
or Yahoo??)
Risk-return trade-off: Choice of specific securities
within each asset class
Market efficiency: there would be neither
underpriced nor overpriced securities
Active vs. passive management: Active - improve
performance either by identifying mispriced
securities
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Players of Financial Markets
• Business Firms – net borrowers
• Households – net savers
• Governments – can be both
• Financial intermediaries connect borrowers and savers
• Investment Bankers - organizing new security sales
and underwrite them
• Investment companies – collect and manage funds
and savings, executing buy and sell orders of the
clients (brokerage)
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Active Management
• Finding undervalued securities
Active vs.
Passive
Management
• Timing is essential
Passive Management
• No attempt to find undervalued
securities
• No attempt to time
• Holding an efficient portfolio
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Classes of
Financial
Assets
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1.
2.
3.
4.
5.
Money market
Bond market
Equity markets
Indexes
Derivative markets
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Subsector of the fixed-income market. Highly liquid,
and relatively low-risk debt instruments.
• Treasury bills
• Federal Fund
• Certificates of deposits (CD)
• Commercial Paper
• Repurchase agreement (REPO)
Money
Market
Instruments
Different instrumets represent different risk level
within the class
Purpose: Provides a place for warehousing surplus
funds for short periods of time
Borrowers from money market provide low-cost
source of temporary funds
Corporations and U.S. government use these markets
because the timing of cash inflows and outflows are
not well synchronized.
Money markets provide a way to solve these cashtiming problems.
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The purpose of Money Markets
Why Do We Need Money Markets?
• The banking industry should handle the needs for short-term.
• Banks have an information advantage.
• Banks, however, are heavily regulated.
• Creates a distinct cost advantage for money markets over banks.
• Investors in Money Market: Provides a place for warehousing surplus
funds for short periods of time
• Borrowers from money market provide low-cost source of temporary
funds
• Corporations and U.S. government use these markets because the
timing of cash inflows and outflows are not well synchronized.
• Money markets provide a way to solve these cash-timing problems.
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Money Market Instruments
Treasury Bills
• T-bills have 28-day maturities through
12-month maturities.
• Discounting: When an investor pays less for the security than
it will be worth when it matures, and the increase in price
provides a return. This is common to short-term securities
because they often mature before the issuer can mail out
interest checks.
FED Funds:
• Short-term funds transferred (loaned or borrowed) between
financial institutions, usually for a period of one day.
• Used by banks to meet short-term needs to meet reserve
requirements.
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Money Market Instruments
Repurchase Agreements (REPO):
• These work similar to the market for fed funds, but nonbanks
can participate.
• A firm sells Treasury securities, but agrees to buy them back at
a certain date (usually 3–14 days later) for a certain price.
• This set-up makes a repo agreements essentially a short-term
collateralized loan.
• This is one market the Fed may use to conduct its monetary
policy, whereby the Fed purchases/sells Treasury securities in
the repo market.
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Money Market Instruments
Commercial Paper:
Unsecured promissory notes, issued by corporations, that
mature in no more than 270 days.
• The use of commercial paper increased significantly in the
early 1980s because of the rising cost of bank loans.
• Risk of a particular commercial paper = risk of issuer
company’s default risk
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Bond Market
Include longer-term, relatively riskier securities than
money market securities, but still represents lower
risk than other asset classes.
• Treasury Notes and Bonds
• Federal Agency Debt
• International Bonds
• Municipal Bonds
• Corporate Bonds
• Mortgages and Mortgage-Backed Securities
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Maturities
Treasury
Notes and
Bonds
• Notes – maturities up to 10 years
• Bonds – maturities in excess of 10 years
• 30-year bond
• 2001 Treasury suspended sales
• 2005 discussion to possibly resume sales
Par Value - $1,000
Quotes – percentage of par
US Federal Agency Debt
Major issuers
• Federal Home Loan Bank
• Federal National Mortgage Association
• Government National Mortgage Association
• Federal Home Loan Mortgage Corporation
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Corporate
Bonds
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• Issued by private firms
• Semi-annual interest payments
• Subject to larger default risk than
government securities (by definition…)
• Options in corporate bonds
• Callable
• Convertible
Key features of a Bond
• Tenor: short or long term
• Interest rate: fix or floating
• Currency: denomination in USD, EUR,
GBP, etc.
• Ranking: Senior, junior (subordinated)
• Guarantee/Collateral: Real Estate, Acc.
Receivables,
• Straight or Convertible
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Equity
Markets
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Common
stock
• Residual claim
• Limited liability
Preferred
stock
• Priority over common
• Fixed dividends
• Tax treatment
• Special voting right,
dividend pref, fix dividend,
„Golden shares”
Depository
receipts
• Foreign companies’ listings
What is the difference Investments
between
Bond (debt) and Equity?
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• Most countries of the world have their own
currencies: the U.S dollar., the euro in Europe,
the Brazilian real, and the Chinese yuan, just
to name a few.
Foreign
Exchange
Market
• The trading of currencies and banks deposits
is what makes up the foreign exchange
market.
• Two kinds of exchange rate transactions make
up the foreign exchange market:
─ Spot transactions involve the nearimmediate exchange of bank deposits,
completed at the spot rate.
─ Forward transactions involve exchanges
at some future date, completed at the
forward rate.
• FX traded in over-the-counter market
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Stock
Indexes
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Uses of Indexes
• Indicator - Track average returns
• Created from the index „basket”
• Comparing performance
• Base of derivatives
• Benchmarks of fund
performances - Index tracking
funds
Factors for Index Construction
• Representative?
Nasdaq
• Broad or narrow?
vs. BUX
• How is it weighted? Priceweighted, market value-weighted,
equally-weighted
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Examples of Indexes
Examples of National Indexes
• Dow Jones Industrial Average (30 Stocks)
• Standard & Poor’s 500 Composite
• NASDAQ Composite (2000+ stocks)
• Dow Transportation, Pharma
• BUX, WIG,
Examples of Indexes - Int’l
• MSCI (Morgan Stanley Capital International)
• CETOP20
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Composition of Dow changed
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• How are stocks weighted?
• Price weighted (DJIA)
Construction
of Indexes
• Market-value weighted
(S&P500, NASDAQ)
• Equally weighted (Value Line
Index)
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Derivatives Securities
• Payoffs that depend on the values of other underlying assets
• Underlying: Index, Stock, Currency, Commodities: Gold, Oil,
Corn, Coffee,Meat, OJ etc.
• Futures, Options
Options: gives its holder the
right to purchase an asset for a
specified price
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• Futures: delivery of an asset at a
specified delivery or maturity date,
for an agreed-upon price,
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Alternative Investments
• Alternative investments are often equity investments in some
non-publicly traded asset.
• Alternative investments beckon investors to areas of the
market where potential extra return is more likely to be
found than in more liquid and efficient markets.
• Alternative assets are assets not traded on exchanges.
E.g. Artwork, Classical Car, Coin, Jewellery, Collection etc.
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Alternative Investments
The common features of alternative investments :
• Illiquidity
• Difficulty in determining current market values.
• Limited historical risk and return data.
• Extensive investment analysis required.
• A liquidity risk premium
• Segmentation risk premium
• Alternative investments can be characterized as raising unique legal
and tax considerations.
• Many forms of alternative investments involve special legal structures
that avoid some taxes (exchange traded funds) or avoid some
regulations (hedge funds).
• In some cases, alternative investments may look more like an
investment strategy than an asset class.
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International and Global
Markets Continue Developing
Key Trends Globalization
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Tendency toward a worldwide
investment environment, and the
integration of national capital
markets.
•
Managing foreign exchange
activity
•
Diversification to improve
performance
•
Instruments and vehicles
continue to develop Information
and analysis improves
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Securitization & Credit
Enhancement
Key Trends Securitization
Pooling loans into standardized
securities backed by those loans,
which can then be traded like any
other security.
• Offers opportunities for investors
and originators
• Changes in financial institutions
and regulation
• Improvement in information
capabilities
• Credit enhancement and its role
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Financial
Engineering
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Repackaging Services of
Financial Intermediaries
Creating and designing securities
with custom-tailored characteristics
• Bundling and unbundling of cash
flows
• Examples: index tracker fund,
fund‘s fund, principal/interest
splits,
Growth of information and
computer networks
• Online trading (remote trading)
• Quick and cheap information
(real time reaction)
• Trading algorithms
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Thank you for the attention!
Any Questions?
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