Stock (Equity) Preferred stock has preference over common stock in distribution of dividends and assets; dividend payments are fixed Preferred stock may provide for cumulative dividends, conversion into common stock, voting rights (when dividend payments are missed), dividend participation, sinking funds, and/or call provisions (provides maturity) Principles of Finance 5e, Ch. 2 Financial Assets © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 1

Stock (Equity) Common stock represents ownership in a corporation common stockholders vote for members of the board of directors has last claim on distribution of earnings and assets may have preemptive rights to purchase any additional shares sold by the firm Principles of Finance 5e, Ch. 2 Financial Assets © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 2

Common Stock Classified Closely held Publicly held Principles of Finance 5e, Ch. 2 Financial Assets © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 3

Derivatives Value depends on some underlying asset such as a stock or bond Option - contract that gives the right to buy or sell an asset at a set price within a specified period of time Call: holder has the right to buy Put: holder has the right to sell Striking price: exercise price of the option Principles of Finance 5e, Ch. 2 Financial Assets © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 4

Derivatives Convertibles - bonds or preferred stocks that can be exchanged for common stock at the option of the holder Conversion ratio defines the number of shares of stock the convertible holder receives upon conversion Futures - arrangement for delivery of an item at a set future date and at a set price Principles of Finance 5e, Ch. 2 Financial Assets © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 5

Derivatives Swaps - an agreement to exchange cash flows or assets at a set time in the future Principles of Finance 5e, Ch. 2 Financial Assets © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 6

Derivatives Hedge Funds- a private pool of funds constructed for the purpose of generating a specific range of returns, no matter what happens in the general stock market Principles of Finance 5e, Ch. 2 Financial Assets © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 7

Rationale for Using Different Types of Securities Differences in trade-off between risk and expected after tax return Appeal to broad market and different investment needs Different securities are popular during different economic conditions or at different times Principles of Finance 5e, Ch. 2 Financial Assets © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 8

Which Financial Instrument is Best? Issuer’s or investor’s viewpoint ? Bonds fixed interest payments does not represent ownership may have restrictions on dividends interest expense is deductible Principles of Finance 5e, Ch. 2 Financial Assets © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 9

Which Financial Instrument is Best? Preferred stock fixed payment - but not obligated no voting rights higher after-tax cost since dividends are not deductible expenses Principles of Finance 5e, Ch. 2 Financial Assets © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 10

Which Financial Instrument is Best? Common Stock no obligation of dividend payments no maturity date for “repayment” increases creditworthiness prospects affect terms gives control to stockholders shares the income of the firm higher costs of distribution than debt dividends are not deductible Principles of Finance 5e, Ch. 2 Financial Assets © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 11

Risk & Returns on Different Classes of Financial Instruments Principles of Finance 5e, Ch. 2 Financial Assets © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 12

Financial Instruments in International Markets American Depository Receipts (ADRs) represent ownership in stocks of foreign countries that are held in trust by a bank located in the country the stock is traded Foreign debt sold by a foreign borrower but denominated in the currency of the country in which it is sold Principles of Finance 5e, Ch. 2 Financial Assets © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 13

Financial Instruments in International Markets Eurodebt debt sold in a country other than the one in whose currency the debt is denominated Eurobonds Eurocredits: usually tied to London InterBank Offer Rate (LIBOR) Euro-commercial paper (Euro-CP) Euronotes Principles of Finance 5e, Ch. 2 Financial Assets © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 14

Financial Instruments in International Markets Equity instruments Euro stock is traded in countries other than the “home” country of the company, not including the United States Yankee stock is stock issued by foreign companies that is traded in the United States Principles of Finance 5e, Ch. 2 Financial Assets © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 15

Chapter Principles Key Financial Assets Concepts Why are there so many different types of financial institutions? Different investors have different risk/return tradeoff preferences Firms can raise funds more easily if they offer the types of securities that investors want What is debt? What types of debt exist? A debt is a loan Two classifications of debt are short-term and long-term Principles of Finance 5e, Ch. 2 Financial Assets © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 16

Chapter Principles Key Financial Assets Concepts What are bond ratings and why are they important? Bond ratings are based on both quantitative and qualitative factors; give an indication of the default risk associated with a bond What is equity? The value of the assets owned minus the amount of debt that is owed Principles of Finance 5e, Ch. 2 Financial Assets © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 17

Chapter Principles Key Financial Assets Concepts What are derivatives? Financial assets that have values based on the values of other assets such as stocks and bonds What are some of the more familiar types of derivatives? Options, futures, convertibles and swaps Principles of Finance 5e, Ch. 2 Financial Assets © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 18

End of Chapter 2 Financial Assets (Instruments) Principles of Finance 5e, Ch. 2 Financial Assets © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 19