Financial Instruments

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Presentation transcript:

Financial Instruments Chapter 2

Major Types of Securities Debt Money market instruments Bonds Common stock Preferred stock Derivative securities

Markets and Instruments Money Market Debt Instruments Derivatives Capital Market Bonds Equity

Money Market Instruments Treasury bills Certificates of deposit Commercial Paper Bankers Acceptances Eurodollars

Money Market Instruments (Cont.) Repurchase Agreements (RPs) and Reverse RPs Federal Funds Brokers’ Calls LIBOR Market

Bond Markets US Treasury Bonds and Notes Agency Issues (Fed Gov) International Bonds Municipal Bonds Corporate Bonds Mortgage-Backed Securities

Municipal Bond Yields Interest income on most municipals is not subject to tax To compare the yields on municipals to other bonds use equivalent taxable yield (municipal return) / (1 – tax rate) Or solve for the tax rate that equates the two yields Tax rate = 1 – (municipal rate/taxable rate)

Capital Market - Equity Common stock Residual claim Limited liability Preferred stock Fixed dividends - limited Priority over common Tax treatment

Stock Market Indexes Uses Factors in constructing or using an Index 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?

Examples of Indexes - Domestic Dow Jones Industrial Average (30 Stocks) Standard & Poor’s 500 Composite NASDAQ Composite NYSE Composite Wilshire 5000

Examples of Indexes - International Nikkei 225 & Nikkei 300 FTSE (Financial Times of London) Dax Region and Country Indexes EAFE Far East United Kingdom

Bond Indexes Lehman Brothers Merrill Lynch Salomon Brothers Specialized Indexes Merrill Lynch Mortgage

Construction of Indexes How are stocks weighted? Price weighted (DJIA) Market-value weighted (S&P500, NASDAQ) Equally weighted (Value Line Index) How returns are averaged? Arithmetic (DJIA and S&P500) Geometric (Value Line Index)

Averaging Methods Component Return A=10% B= (-5%) C = 20% Arithmetic Average [.10 + (-.05) + .2] / 3 = 8.33% Geometric Average [(1.1) (.95) (1.2)]1/3 - 1 = 7.84%

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