Chapter 4
Overview of
Security Types
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Ayşe Yüce
Copyright © 2012 McGraw-Hill Ryerson
Classifying Securities
Interest-Bearing Assets
Equities
Derivatives
Option Contracts
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Security Types
Our goal in this chapter is to introduce the different
types of securities that investors routinely buy and sell
in financial markets around the world.
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 For each security type, we will examine:
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Its distinguishing characteristics,
Its potential gains and losses, and
How its prices are quoted in the financial press.
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Classifying Securities
Basic Types
Major Subtypes
Money market instruments
Interest-bearing
Fixed-income securities
Equities
Derivatives
Common stock
Preferred stock
Options
Futures
© 2009 McGraw-Hill Ryerson
Limited
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Interest-Bearing Assets
Money market instruments are short-term debt
obligations of large corporations and governments.
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These securities promise to make one future payment.
When they are issued, their lives are less than one year.
Examples: Treasury bills (T-bills), bank certificates of deposit
(CDs), corporate and municipal money market instruments.
Potential gains/losses: A known future payment/except when the
borrower defaults (i.e., does not pay).
Price quotations: Usually, the instruments are sold on a discount
basis, and only the interest rates are quoted. Therefore, investors
must be able to calculate prices from the quoted rates.
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Interest Bearing Securities
Fixed-income securities are longer-term debt obligations of
corporations or governments.
 These securities promise to make fixed payments according to a
pre-set schedule.
 When they are issued, their lives exceed one year.
Examples: Treasury notes, corporate bonds, car loans, student loans.
Potential gains/losses:
 Fixed coupon payments and final payment at maturity, except when
the borrower defaults.
 Possibility of gain (loss) from fall (rise) in interest rates
 Depending on the debt issue, illiquidity can be a problem.
Illiquidity means that you might not be able to sell securities
quickly for their current market value.
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Quote Example: Fixed-Income Securities
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Price Quotations from www.wsj.com—the online version of
The Wall Street Journal (some columns are self-explanatory):
The price (per $100 face) of
the bond when it last traded.
The Yield to Maturity (YTM) of the
bond.
Equities
Common stock: Represents ownership in a
corporation. A part owner receives a pro rated share of
whatever is left over after all obligations have been met in
the event of a liquidation.
Examples: RIM shares, Royal Bank shares, Magna
shares , etc.
Potential gains/losses:
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• Many companies pay cash dividends to their shareholders.
However, neither the timing nor the amount of any dividend is
guaranteed.
• The stock value may rise or fall depending on the prospects for
the company and market-wide circumstances.
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Common Stock Price Quotes
Common Stock Price Quotes Online
at http://finance.yahoo.com
First, enter symbol.
Resulting
Screen
Equities
Preferred stock: The dividend is usually fixed and
must be paid before any dividends for the common
shareholders. In the event of a liquidation, preferred shares
have a particular face value.
Example: Citigroup preferred stock.
Potential gains/losses:
• Dividends are “promised.” However, there is no legal
requirement that the dividends be paid, as long as no
common dividends are distributed.
• The stock value may rise or fall depending on the
prospects for the company and market-wide circumstances.
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Derivatives
Primary asset: Security originally sold by a business or
government to raise money.
 Derivative asset: A financial asset that is derived from
an existing traded asset, rather than issued by a business
or government to raise capital. More generally, any
financial asset that is not a primary asset.
 Futures contract: An agreement made today regarding
the terms of a trade that will take place later.
 Option contract: An agreement that gives the owner
the right, but not the obligation, to buy or sell a specific
asset at a specified price for a set period of time.
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Futures Contracts
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Examples: financial futures (i.e., S&P/TSX 60, S&P 500,
T-bonds, foreign currencies, and others), commodity
futures (i.e., wheat, crude oil, cattle, and others).
Potential gains/losses:
At maturity, you gain if your contracted price is better than
the market price of the underlying asset, and vice versa.
If you sell your contract before its maturity, you may gain
or lose depending on the market price for the contract.
Note that enormous gains and losses are possible.
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4- 12
Futures Contracts: Price Quotes
Source: www.cmegroup.com
Ayşe Yüce
Copyright © 2012
McGraw-Hill Ryerson
Option Contracts
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A call option gives the owner the right, but not the obligation, to
buy an asset, while a put option gives the owner the right, but
not the obligation, to sell an asset.
The price you pay today to buy an option is called the option
premium.
The specified price at which the underlying asset can be bought
or sold is called the strike price, or exercise price.
An American option can be exercised anytime up to and
including the expiration date, while a European option can be
exercised only on the expiration date.
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Option Contracts
Options differ from futures in two main ways:
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Holders of call options have no obligation to buy the underlying asset.
Holders of put options have no obligation to sell the underlying asset.
To avoid this obligation, buyers of calls and puts must pay a price
today. Holders of futures contracts do not pay for the contract today.
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Potential gains and losses:
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Buyers of options profit if the strike price is better than the market price,
and if the difference is greater than the option premium. In the worst
case, buyers lose the entire premium.
Sellers of options gain the premium if the market price is better than
strike price. Here, the gain is limited but the loss is not.
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© 2009 McGraw-Hill Ryerson
Limited
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Online Price Quotes for Nike (NKE) options
Source: www.finance.yahoo.com
Investing in Stocks versus Options, I.
Stocks:
Suppose you have $10,000 for investments. Macron
Technology is selling at $50 per share.
Number of shares bought = $10,000 / $50 = 200
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If Macron is selling for $55 per share 3 months later, gain
= ($55  200) - $10,000 = $1,000
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If Macron is selling for $45 per share 3 months later, gain
= ($45  200) - $10,000 = -$1,000
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Investing in Stocks versus Options, II.
Options:
A call option with a $50 strike price and 3 months to
maturity is also available at a premium of $4.
Traded option contracts are on a bundle of 100 shares.
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A call contract costs $4  100 = $400, so number of
contracts bought = $10,000 / $400 = 25 (for 25  100 =
2500 shares)
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If Macron is selling for $55 per share 3 months later,
gain = {($55 – $50)  2500} - $10,000 = $2,500
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If Macron is selling for $45 per share 3 months later,
gain = ($0  2500) – $10,000 = -$10,000
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Useful Internet Sites
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www.m-x.ca (Montreal Exchange)
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www.nasdbondinfo.com (current corporate bond prices)
www.investinginbonds.com (bond basics)
www.finra.com (learn more about TRACE)
www.fool.com (Are you a “Foolish investor”?)
www.stocktickercompany.com (reproduction stock tickers)
www.cmegroup.com (CME Group)
www.cboe.com (Chicago Board Options Exchange)
finance.yahoo.com (prices for option chains)
www.wsj.com (online version of The Wall Street Journal)
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Ayşe Yüce
Copyright © 2012
McGraw-Hill Ryerson