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Financial Markets and Instruments Chapter 2. Major Classes of Financial Assets or Securities Debt - Money market instruments - Bonds Common stock Preferred.

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Presentation on theme: "Financial Markets and Instruments Chapter 2. Major Classes of Financial Assets or Securities Debt - Money market instruments - Bonds Common stock Preferred."— Presentation transcript:

1 Financial Markets and Instruments Chapter 2

2 Major Classes of Financial Assets or Securities Debt - Money market instruments - Bonds Common stock Preferred stock Derivative securities

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

4 Money Market Instruments Treasury bills Certificates of deposit Commercial Paper Bankers Acceptances Eurodollars Repurchase Agreements (RPs) and Reverse RPs Federal Funds

5 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

6 r BD = bank discount rate P= market price of the T-bill n= number of days to maturity r BD = 10,000 - P x 360 n 90-day T-bill, P = $9,800 r BD = 10,000 - 9,800 10,000 x 360 90 =8% Example Bank Discount Rate (T-Bills)

7 Bond Equivalent Yield Can’t compare T-bill directly to bond - 360 vs 365 days - Return is figured on par vs. price paid Adjust the bank discounted rate to make it comparable

8 P = price of the T-bill n = number of days to maturity r BEY = 10,000 - P P x 365 n r BEY = 10,000 - 9,800 x 365 90 r BEY =.0204 x 4.0556 =.0828 = 8.28% Example Using Sample T-Bill Bond Equivalent Yield

9 Capital Market - Fixed Income Instruments Publicly Issued Instruments - US Treasury Bonds and Notes - Agency Issues (Fed Gov) - Municipal Bonds Privately Issued Instruments - Corporate Bonds - Mortgage-Backed Securities

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

11 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?

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

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

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

15 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)

16 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%

17 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


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