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Investments. Lecture Notes 2

The document discusses different asset classes including fixed income, equity, and derivatives. It provides details on money markets, capital markets, and various fixed income and equity securities.

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Oona Niall
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© © All Rights Reserved
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287 views34 pages

Investments. Lecture Notes 2

The document discusses different asset classes including fixed income, equity, and derivatives. It provides details on money markets, capital markets, and various fixed income and equity securities.

Uploaded by

Oona Niall
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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Chapter Two

Asset Classes and


Financial Instruments

INVESTMENTS | BODIE, KANE, MARCUS


©2018 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom.
No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.
Chapter Overview

Fixed Income

Asset Classes Equity

Derivatives

INVESTMENTS | BODIE, KANE, MARCUS


©2018 McGraw-Hill Education 2-2
Fixed Income

Money Markets
Fixed Income
Capital Markets
Asset Classes Equity

Derivatives

INVESTMENTS | BODIE, KANE, MARCUS


©2018 McGraw-Hill Education 2-3
The Money Market

• Subsector of the fixed-income market


• Short-term
• Liquid
• Low risk
• Often have large denominations

INVESTMENTS | BODIE, KANE, MARCUS


©2018 McGraw-Hill Education 2-4
Major Components of
the Money Market

INVESTMENTS | BODIE, KANE, MARCUS


©2018 McGraw-Hill Education 2-5
Money Market Securities
(1 of 2)

• Treasury bills:

• Bid and asked price


• Bank discount method
• Certificates of deposit:

• Commercial paper:

INVESTMENTS | BODIE, KANE, MARCUS


©2018 McGraw-Hill Education 2-6
Money Market Securities
(2 of 2)

• Bankers’ Acceptances:

• Eurodollars:

• Repos and reverses:

• Federal funds:
INVESTMENTS | BODIE, KANE, MARCUS
©2018 McGraw-Hill Education 2-7
Yields on
Money Market Instruments
• Money market securities are not free of
default risk

• The premium on bank CDs and the TED spread


have often become greater during periods of
financial crisis

INVESTMENTS | BODIE, KANE, MARCUS


©2018 McGraw-Hill Education 2-8
Spread between 3-month CD
and Treasury Bills

INVESTMENTS | BODIE, KANE, MARCUS


©2018 McGraw-Hill Education 2-9
The Capital Market
(1 of 2)

Treasury
Notes

Corporate Treasury
Bonds Bonds

Capital
Municipal
Markets Inflation-
Protected
Bonds
Securities

Federal
International
Bonds Agency
Debt

INVESTMENTS | BODIE, KANE, MARCUS


©2018 McGraw-Hill Education 2-10
The Capital Market
(2 of 2)

• Subsector of the fixed-income market


• Long-Term
• Liquid
• Low risk (but not as low as the Money Market)

INVESTMENTS | BODIE, KANE, MARCUS


©2018 McGraw-Hill Education 2-11
Capital Market:
Treasury Notes and Bonds
• Treasury Notes and Bonds
• Maturities
• Notes –
• Bonds –
• Par Value — $1,000
• Interest paid semiannually
• Quotes — Percentage of par

INVESTMENTS | BODIE, KANE, MARCUS


©2018 McGraw-Hill Education 2-12
Capital Market Securities

• Inflation-Protected Treasury Bonds


• TIPS:
• Federal Agency Debt
• Fannie Mae
• Freddie Mac
• Others
• International Bonds
• Eurobonds and Yankee bonds

INVESTMENTS | BODIE, KANE, MARCUS


©2018 McGraw-Hill Education 2-13
Capital Market:
Municipal Bonds
• Municipal Bonds
• Issued by state and local governments
• Interest is exempt from federal income tax and
sometimes from state and local tax
• Types
• General obligation bonds:

• Revenue bonds:

INVESTMENTS | BODIE, KANE, MARCUS


©2018 McGraw-Hill Education 2-14
Tax-Exempt Debt
Outstanding

INVESTMENTS | BODIE, KANE, MARCUS


©2018 McGraw-Hill Education 2-15
Municipal Bond Yields
Taxable vs. Tax-Exempt Bonds
• Compare after-tax returns on each bond
• Let t = investor’s marginal tax bracket
• Let r = the before-tax return on the taxable bond
• Let rm = the municipal bond rate
• If
r  (1  t )  rm
then the taxable bond gives a higher return;
otherwise, the municipal bond is preferred

INVESTMENTS | BODIE, KANE, MARCUS


©2018 McGraw-Hill Education 2-16
Tax-Exempt Yield Table

INVESTMENTS | BODIE, KANE, MARCUS


©2018 McGraw-Hill Education 2-17
Capital Market:
Corporate Bonds
• Corporate Bonds
• Issued by private firms
• Semi-annual interest payments
• Larger default risk than government securities
• Options in corporate bonds
• Callable
• Convertible

INVESTMENTS | BODIE, KANE, MARCUS


©2018 McGraw-Hill Education 2-18
Capital Markets:
Mortgage Backed Securities
• Mortgage-Backed Securities
• Proportional ownership of a mortgage pool or a
specified obligation secured by a pool
• Produced by securitizing mortgages
• Most were issued by Fannie Mae and Freddie Mac

INVESTMENTS | BODIE, KANE, MARCUS


©2018 McGraw-Hill Education 2-19
Bond Market Securities

• Mortgage-Backed Securities
• Traditionally conforming mortgages

• Later, “private-label” issuers securitized large


amounts of subprime mortgages

• Fannie and Freddie were allowed and even


encouraged to buy subprime mortgage securities

INVESTMENTS | BODIE, KANE, MARCUS


©2018 McGraw-Hill Education 2-20
Mortgage-Backed Securities
Outstanding

INVESTMENTS | BODIE, KANE, MARCUS


©2018 McGraw-Hill Education 2-21
U.S. Fixed-Income Market

INVESTMENTS | BODIE, KANE, MARCUS


©2018 McGraw-Hill Education 2-22
Equity

Fixed Income Common Stock

Asset Classes Equity Preferred Stock

Derivatives ADRs

INVESTMENTS | BODIE, KANE, MARCUS


©2018 McGraw-Hill Education 2-23
Equity Securities:
Common Stock
• Common stock
• Ownership
• Residual claim
• Limited liability

INVESTMENTS | BODIE, KANE, MARCUS


©2018 McGraw-Hill Education 2-24
Equity Securities:
Preferred Stock
• Preferred stock:
• Perpetuity
• Fixed dividends
• Priority over common
• Tax treatment

INVESTMENTS | BODIE, KANE, MARCUS


©2018 McGraw-Hill Education 2-25
Equity Securities:
ADR

• American Depository Receipts (ADR)


• Certificates traded in U.S. markets that represent
ownership in shares of a foreign company

INVESTMENTS | BODIE, KANE, MARCUS


©2018 McGraw-Hill Education 2-26
Stock Basics

• Dividend Yield:

• Capital Gains:

• P/E Ratio:

INVESTMENTS | BODIE, KANE, MARCUS


©2018 McGraw-Hill Education 2-27
Stock Market Indices

• Dow Jones Industrial Average


• Includes 30 large blue-chip corporations
• Computed since 1896
• Price-Weighted Index
• S&P 500
• Broad based index of 500 firms
• Market-Value-Weighted Index

INVESTMENTS | BODIE, KANE, MARCUS


©2018 McGraw-Hill Education 2-28
Stock Market Indexes

• Investors can base their portfolios on an index


• Buy an index mutual fund
• Buy exchange-traded funds (ETFs)

INVESTMENTS | BODIE, KANE, MARCUS


©2018 McGraw-Hill Education 2-29
Other Indices

U.S. Indexes Foreign Indexes


• NYSE Composite • Nikkei (Japan)
• NASDAQ Composite • FTSE (U.K.; pronounced
• Wilshire 5000 “footsie”)
• DAX (Germany),
• Hang Seng (Hong Kong)
• TSX (Canada)

INVESTMENTS | BODIE, KANE, MARCUS


©2018 McGraw-Hill Education 2-30
Derivatives

Fixed Income

Asset Classes Equity


Options
Derivatives
Futures
• A derivative is a security that gets its value from the
value of another asset, such as commodity prices,
bond and stock prices, or market index values
INVESTMENTS | BODIE, KANE, MARCUS
©2018 McGraw-Hill Education 2-31
Derivatives Markets:
Options
• Call Option:
• Right to buy underlying asset at the strike price
• Value of calls decreases as strike price increases
• Put Option:
• Right to sell underlying asset at the strike price
• Value of puts increase with strike price
• Both calls and puts increases with time until
expiration

INVESTMENTS | BODIE, KANE, MARCUS


©2018 McGraw-Hill Education 2-32
Derivatives Markets:
Futures
• Futures Contracts:

• Long position:
• Short position:

INVESTMENTS | BODIE, KANE, MARCUS


©2018 McGraw-Hill Education 2-33
Comparison

Option Futures Contract


• Right, but not obligation, • Obliged to make or take
to buy or sell delivery
• Option is exercised only • Long (short) position
when it is profitable must buy (sell) at the
futures price
• Options must be • Futures contracts are
purchased entered into without cost
• The premium is the price
of the option itself
INVESTMENTS | BODIE, KANE, MARCUS
©2018 McGraw-Hill Education 2-34

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