Fourth
Edition
1
Chapter 2
Financial Securities
Fourth
Edition
2
Outline
• Major assets traded. (ttp://finance.yahoo.com/?u)
– Fixed income
• Money market instruments
• Bonds
– Equity securities
– Derivatives
• Understanding Index
– Different index
– Construction of index
Fourth
Edition
3
Markets and Instruments
Money
Market(<=1
year)
Fixed-income
Equity
Capital
Market(>1year)
T-bill CD, Federal Bonds (T-notes,
Funds..
T-bonds, Muni,
Corporate bonds)
NA
Common stock,
Preferred stock
Fourth
Edition
4
Money Market Instruments
•
T(Treasury) bills:
–
–
•
Short-term government debt security
Issued at discount from face value and returning the face
value at maturity
Certificates of deposit
–
–
•
Time deposit with a bank
CD issued in denominations larger than
$100,000 are usually negotiable-sellable in the
secondary market
Commercial Paper
–
Short term unsecured debt issued by large
corp directly to the public.
Fourth
Edition
5
Money Market Instruments
Bankers Acceptances
•
An order to a bank by a customer to pay a sum of money at
a future date.
•
Like postdated check, with bank endorsement
•
Widely used in foreign trade
•
Sell at discount in secondary market
Eurodollars
•
$ denominated deposits at foreign bank or foreign branches
of US bank
•
Can be traded in secondary market like CD before its
maturity
Federal Funds
•
Deposits of banks at Fed
•
Used for reserve requirements and transaction
•
Banks with surplus lend to those with shortage
•
Not directly sold to investors
Fourth
Edition
6
Money market instruments
Repurchases agreements and reverses
•
Def. Short-term sales of government
securities with an agreement of repurchase
at a higher price Reverse repo: mirror
image of a repo. Buys government
securities with an agreement to resell them
at a prespecified higher price
•
Q: Who is who? A: Seller of security
(borrower of funds) vs. Buyer (lender)
•
Price increase is interest
•
Security is collateral
Fourth
Edition
7
Bonds
Publicly Issued Instruments
• US Treasury Bonds and Notes
• Agency Issues (Fed Gov)
• Municipal Bonds
Privately Issued Instruments
• Corporate Bonds
• Mortgage-Backed Securities
Fourth
Edition
8
Equity
• Common stock
– Residual claim
– Limited liability
• Preferred stock
– Fixed dividends - limited
– Priority over common
Fourth
Edition
9
Derivatives Securities
Options
• Basic Positions
– Call (Buy)
– Put (Sell)
• Terms
– Exercise Price
– Expiration Date
– Assets
Futures
• Basic Positions
– Long (Buy)
– Short (Sell)
• Terms
– Delivery Date
– Assets
Fourth
Edition
10
Define option
• Option is the right to buy or sell an
asset at a specified exercise price on
or before a specified expiration date.
• Call Option:
• Put Option:
• Check:
Fourth
Edition
11
Market and Exercise Price
Relationships
In the Money - exercise of the option would be
profitable (without considering the
cost/premium of the option)
Call: market price>exercise price
Put: exercise price>market price
Out of the Money - exercise of the option would
not be profitable
Call: market price<exercise price
Put: exercise price<market price
At the Money - exercise price and asset price
are equal
Fourth
Edition
12
Stock Indexes
Uses
• Track average returns
• Comparing performance of managers
• Base of derivatives
Fourth
Edition
13
Examples of Indexes - Domestic
• Dow Jones Industrial Average (30
Stocks)
• Standard & Poor’s 500 Composite
• NASDAQ Composite
• NYSE Composite
• Dow Jones Wilshire 5000
– Included all stocks(over 5,000) traded in
US with available data
Fourth
Edition
14
Construction of Indexes
• How are stocks weighted?
– Price weighted (DJIA)
– Market-value weighted (S&P500,
NASDAQ)
– Equally weighted (Value Line Index)
Fourth
Edition
15
Construction of Indexes
• Price weighted
Initial P
Final P
Shares (M)
Yahoo
$25
$30
20
MSN
100
80
1
Fourth
Edition
16
Construction of Indexes
• Price-weighted average
– Adding the price and divided by a divisor (#
of stocks or adjusted divisor)
– Index0=(25+100)/2=62.5
– Index1=(30+80)/2=55
Fourth
Edition
17
Construction of Indexes
• Price weighted-adjusting for splits
P0
#0
P1
#1
(M)
Yahoo
$25
20
$30
20
MSFT
100
1
$50
2
Fourth
Edition
18
Construction of Indexes
• Price-weighted :adjusting for splits
– Calculate new index value without split
effect( from time 0 to 1, stock prices can
change without split effects)
•
index1=(30+100)/2=65
– With split, index1 should also equal 65
• (30+50)/d=65 d=1.23
• (30+50)/1.23=65
• d is divisor
Fourth
Edition
19
Construction of Indexes
• Market value-weighted
– The weight is based on the market value of
each component stock
– Set initial level to an arbitrarily chosen
starting value (e.t. 100)
– New level: 100*(new market value 700/old
initial market value 600)=116.67
Fourth
Edition
20
Construction of Indexes
• Equal weighted
– Each stock has the same weight
– Set initial level to an arbitrarily chosen
starting value (e.t. 100)
– The %change of the index=the simple
average of the %change of each
component stock
• % change of Yahoo=(30-25)/25=20%
• % change of MSFT=(50-50)/50=0%
• % change of index=(20%+0%)/2=10%
– New level: 100*(1+% change of the index)
• =100*(1+10%)=110