Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 2-1 Chapter 2

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 2-2 Chapter Summary  Objective: To introduce the features of various security types, necessary for the understanding of the coming material Money markets and how yields are measured Fixed Income Stocks and Indexes Derivative Securities

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 2-3 Major Classes of Financial Assets or Securities  Debt Money market instruments Bonds  Common stock  Preferred stock  Derivative securities

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 2-4 Markets and Instruments  Money Market Debt Instruments Derivatives  Capital Market Bonds Equity Derivatives

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 2-5 Summary Reminder  Objective: To introduce the features of various security types, necessary for the understanding of the coming material Money markets and how yields are measured Fixed Income Stocks and Indexes Derivative Securities

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 2-6 Money Market Instruments  Treasury bills  Certificates of Deposit and Bearer Deposit Notes (BDNs)  Commercial Paper  Bankers Acceptances  Eurodollars  Repurchase Agreements (REPOs) and Reverse REPOs

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 2-7 Money Market Instrument Yields  Yields on Money Market Instruments are not always directly comparable  Factors influencing yields Par value vs. investment value 360 vs. 365 days assumed in a year (366 leap year) Bond equivalent yield

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 2-8 P = price of the T-bill n = number of days to maturity Example: Using Sample T-Bill r BEY =.0204 x =.0828 = 8.28% Bond Equivalent Yield

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 2-9 r BD = bank discount rate P= market price of the T-bill n= number of days to maturity Example 90-day T-bill, P = $980 Bank Discount Rate (T- Bills)

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 2-10 Bond Equivalent Yield  Impossible to compare T-bill directly to bond 360 vs 365 days Return is figured on par vs. price paid  Adjust the bank discount rate to make it comparable

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 2-11 Equivalence of yields  US T-bills are quoted in bank discount yields  Canadian T-bills are quoted in bond equivalent yields  Equivalence formula:  Also note that the effective annual yield is:

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 2-12 Summary Reminder  Objective: To introduce the features of various security types, necessary for the understanding of the coming material Money markets and how yields are measured Fixed Income Stocks and Indexes Derivative Securities

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 2-13 Capital Market - Fixed Income Instruments  Publicly Issued Instruments Canada Bonds Provincial Government Bonds Municipal Bonds  Privately Issued Instruments Corporate Bonds Mortgage-Backed Securities

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 2-14 Summary Reminder  Objective: To introduce the features of various security types, necessary for the understanding of the coming material Money markets and how yields are measured Fixed Income Stocks and Indexes Derivative Securities

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 2-15 Capital Market - Equity  Common stock Residual claim Limited liability Corporate governance and restricted shares  Preferred stock Fixed dividends - limited Priority over common Tax treatment

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 2-16 Stock Indexes  Uses Track average returns Comparing performance of managers Base of derivatives  Factors in constructing or using an Index Representative? Broad or narrow? How is it constructed?

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 2-17 Examples of Indexes – Canadian  TSE 300 Composite Index  TSE 35 (also known as Toronto 35 or T35)  TSE 100  S&P/TSE 60

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 2-18 Examples of Indexes - US  Dow Jones Industrial Average (30 Stocks)  Standard & Poor’s 500 Composite  NASDAQ Composite  NYSE Composite  Wilshire 5000

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 2-19 Examples of Indexes - International  TSE (Tokyo) - Nikkei 225 & Nikkei 300  FTSE (Financial Times of London)  Dax  Region and Country Indexes EAFE Far East United Kingdom

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 2-20 Construction of Indexes  How are stocks weighted? Price weighted (DJIA) Market-value weighted (S&P500, NASDAQ, TSE 300) Equally weighted (Value Line Index)  How returns are averaged? Arithmetic (DJIA and S&P500) Geometric (Value Line Index)

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 2-21 Averaging Methods Component Return r A =10% r B = (-5%) r C = 20% Arithmetic Average: Geometric Average:

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 2-22 Bond Indexes  Lehman Brothers  Merrill Lynch  Salomon Brothers  Scotia Capital (Canada)  Specialized Indexes Merrill Lynch Mortgage

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 2-23 Summary Reminder  Objective: To introduce the features of various security types, necessary for the understanding of the coming material Money markets and how yields are measured Fixed Income Stocks and Indexes Derivative Securities

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 2-24 Derivatives Securities Options  Basic Positions Call (Buy) Put (Sell)  Terms Exercise Price Expiration Date Underlying Assets Futures  Basic Positions Long (Buy) Short (Sell)  Terms Delivery Date Underlying Assets

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 2-25 Derivative Securities- Quotes Options  Bid price  Ask price  Last price  Open interest  Underlying asset price  Cash settlement  Physical delivery Futures  Settlement price  Change  Open interest  Underlying asset price  Cash settlement  Physical delivery