McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Asset Classes and Financial Instruments CHAPTER 2

THE MONEY MARKET

2-3 Major Classes of Financial Assets or Securities Money market Bond market Equity markets Indexes Derivative markets

2-4 Money Market Instruments Treasury bills: Short-term government securities issued at a discount from face value and returning the face amount at maturity. Certificates of deposits (CDs): A bank time deposit. The bank pays interest and principal only at the end of the fixed term of the CD.

2-5 Money Market Instruments Commercial Paper: Short-term unsecured debt issued by corporations. Bankers Acceptances: An order to a bank by a customer to pay a sum of money at a future date.

2-6 Money Market Instruments Eurodollars: Dollar-denominated deposits at foreign banks or foreign branches of American banks Repurchase Agreements (RPs) and Reverse RPs: RPs are the short-term sales of the government securities with an agreement to repurchase the securities at a higher price.

2-7 Money Market Instruments Brokers’ Calls: Individuals who buy stocks on margin borrow part of the funds from the broker. The broker in turn may borrow the funds from a bank, agreeing to repay the bank immediately (on call) if the bank requests it. Federal Funds: Funds in the accounts of commercial banks at the Federal Reserve Bank. LIBOR Market: The London Interbank Offer Rate (LIBOR) is the rate at which large banks in London are willing to lend money among themselves.

2-8 Figure 2.1 Money Rates

2-9 Table 2.2 Components of the Money Market

2-10 Figure 2.2 Treasury Bills

2-11 Figure 2.3 Spreads on CDs and Treasury Bills

THE BOND MARKET

2-13 Bond Market Treasury Notes and Bonds Federal Agency Debt Municipal Bonds Municipal Bonds Corporate Bonds Corporate Bonds Mortgages and Mortgage-Backed Securities Inflation-Protected Bonds (TIPs) International Bonds

2-14 Treasury Notes and Bonds Debt obligations of the Federal government with original maturities of one year or more. Maturities –Treasury Notes (T-Notes – maturities up to 10 years –Treasury Bonds (T-Bonds – maturities in excess of 10 years Par Value - $1,000 Quotes – percentage of par

2-15 Figure 2.4 Treasury Notes and Bonds

2-16 Federal Agency Debt Some government agencies issue their own securities to finance their activities. Major issuers –Federal Home Loan Bank –Federal National Mortgage Association –Government National Mortgage Association –Federal Home Loan Mortgage Corporation

2-17 Municipal Bonds Tax-exempt bonds issued by state and local governments. Types –General obligation bonds –Revenue bonds Industrial revenue bonds Maturities – range up to 30 years

2-18 Figure 2.5 Outstanding Tax-exempt Debt

2-19 Municipal Bond Yields Interest income on municipal bonds is not subject to federal and sometimes state and local tax To compare yields on taxable securities a Taxable Equivalent Yield is constructed

2-20 Table 2.3 Equivalent Taxable Yields

2-21 Figure 2.6 Ratio of Yields on Tax-exempts to Taxables,

2-22 Corporate Bonds Long-term debt instruments Issued by private firms Semi-annual interest payments Returning the face value of the bond at maturity Subject to larger default risk than government securities Options in corporate bonds –Callable –Convertible

2-23 Figure 2.7 Investment Grade Bond Listings

2-24 Developed in the 1970s to help liquidity of financial institutions Proportional ownership of a pool or a specified obligation secured by a pool Market has experienced very high rates of growth Mortgages and Mortgage-backed Securities

2-25 Figure 2.8 Mortgage-Backed Securities Outstanding

2-26 Inflation-Protected Bonds (TIPs): Many countries have issued bonds that are linked to an index (inflation rate). International Bonds: Many firms borrow abroad and many investors buy bonds from foreign issuers

EQUITY SECURITIES

2-28 Equity Markets Common stock: Ownership shares in a publicly held corporation. Shareholders have voting rights and may receive dividends. –Residual claim –Limited liability Preferred stock: It has features similar to both equity and debt. –Non-voting shares –Fixed dividends - limited –Priority over common –Tax treatment Depository receipts: American Depository Receipts (ADRs) are certificates traded in US markets that represent ownership in shares of a foreign company

2-29 Figure 2.9 Stock Market Listings

STOCK AND BOND MARKET INDEXES

2-31 There are several indexes worldwide such as: –Dow Jones Industrial Average (DJIA) –Nikkei Average Offer ways of comparing performance of managers Base of derivatives Stock Market Indexes

2-32 Examples of Other Indexes - Domestic Dow Jones Industrial Average (30 Stocks) Standard & Poor’s 500 Composite NASDAQ Composite NYSE Composite

2-33 Figure 2-10 Comparative Performance of Several Stock Market Indexes

2-34 Examples of Indexes - International Nikkei 225 & Nikkei 300 FTSE (Financial Times of London) Dax Region and Country Indexes –EAFE –Far East –United Kingdom

2-35 Table 2.6 Sample of MSCI Stock Indexes

DERIVATIVE MARKETS

2-37 Derivative 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

2-38 OPTIONS Call Option; gives its holder the right to purchase an asset for a specified price on or before a specified expiration date. Put Option; gives its holder the right to sell an asset for a specified price on or before a specified expiration date.

2-39 FUTURES Obligates traders to purchase or sell an asset at an agreed-upon price at a specified future date.