Money Market Instrument Yields

1. 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

2. Bond Equivalent Yield P = price of the T-bill n = number of days to maturity Example: Using Sample T-Bill rBEY = .0204 x 4.0556 = .0828 = 8.28%

3. Bank Discount Rate (T-Bills) rBD = bank discount rate P = market price of the T-bill n = number of days to maturity Example 90-day T-bill, P = $980

4. Bond Equivalent Yield • Impossible to compare T-bill directly to bond • 360 vs 365 days • Return is figured on par vs. price paid • Adjust the bank discount rate to make it comparable

5. Capital Market - Fixed Income Instruments • Publicly Issued Instruments • Canada Bonds • Provincial Government Bonds • Municipal Bonds • Privately Issued Instruments • Corporate Bonds • Mortgage-Backed Securities

6. Canada Bonds • Non marketable (Sold November 1st) Canada savings bonds: can be cashed in any time Canada Premium Bonds: Can be cashed in November of succeeding years only

7. Marketable Canada Bonds Varying maturity, up to 40 years Considered part of the money market when maturity is less than 3 years Interest rate at date of issue is such that the bond can be sold at par value Coupon paid in two semiannual installments

8. Yield to maturity • Calculated by determining the semi-annual yield and doubling it • Annual Percent Rate (APR), not effective annual rate • Yield for callable bond selling at a premium is up to the first call date • For a discount bound, Yield is to maturity

9. Provincial and Municipal Bonds • Similar to Canada bonds but generally with a higher YTM • U.S. municipal bonds are exempt of taxes

10. Corporate Bonds • Riskier than government bonds • Secured bonds have collateral backing • Unsecured bonds, or debentures, have no collateral

11. Features of bonds • Callable bonds: the firm has the option to repurchase the bond before maturity at a specified price • Retractable: holder has the option to redeem the bond • Extendable: holder has the option to keep the bond after maturity date • Convertible: can be converted to a certain number of shares

12. Mortgages and MBS • Mortgage-Backed Security (MBS): Ownership claim in a pool of mortgages • The mortgage originator keeps collecting principal and interest for the but borrower but then passes the payments to the MBS holder • Ex: mortgage of $100,000 at 10% over 30 yearsmonthly payment is 877.57$833.33 interest, $44.24 principal

13. MBS • First introduced in Canada by the Canadian Mortgage and Housing Corporation (CMHC) in 1987 • MBS are guaranteed by the federal government (no risk) • Yield still higher than T-Bill due to the callable feature, depriving holder from potential capital gains

14. Equity Securities • Equities: ownership shares in a corporation • Common stock: voting share, allows to participate in directors elections • Some common stocks may have restricted voting rights, usually come with better financial benefits

15. Equity Securities • Common stocks are residual claims on the liquidation value of the firm • Financial benefits are dividends and/or capital appreciation • Listing

16. Board Lots and Odd Lots • A board lot is normally 100 shares1,000 shares if the stock price is below $525 shares if the stock price is above $100 • Odd lots are not board lots • Stock brokers may charge odd-lot differential

17. Preferred Stocks • Stocks to which a fixed amount of income is paid each year • Income is dividend, failure to pay it does not mean bankruptcy • Preferred stock holders are paid before common stock holders • No voting power

18. Preferred Stocks • Advantage for the firm: income need not be paid • Disadvantage: dividends are not tax deductible • Should yield on preferreds be greater or lower than similar bonds? Interest income is taxed more than dividends: yields on preferreds can be lower for that

19. 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?

20. Examples of Indexes – Canadian • TSE 300 Composite IndexIntroduced in 1977TSE 300 for 1975 = 1,000 • TSE 35 Introduced to stimulate index futures and options trading • TSE 100 • S&P/TSE 60Created to mimic the TSE 300TSE 60 = 100 in Jan 29, 1982

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

22. Construction of Indexes • How are stocks weighted? • Price weighted (DJIA) • Market-value weighted (S&P500, NASDAQ, TSE 300) • Equally weighted (Value Line Index) • How returns are averaged? • Arithmetic (DJIA, S&P500, Value Line) • Geometric (Value Line Index)

23. Averaging Methods (Value Line) Component Return rA=10% rB= (-5%) rC = 20% Arithmetic Average: Geometric Average:

24. Bond Indexes • Lehman Brothers • Merrill Lynch • Salomon Brothers • Scotia Capital (Canada) • Specialized Indexes • Merrill Lynch Mortgage

25. Options Basic Positions Call (Buy) Put (Sell) Terms Exercise Price Expiration Date Underlying Assets Futures Basic Positions Long (Buy) Short (Sell) Terms Delivery Date Underlying Assets Derivatives Securities

26. Options Bid price Ask price Last price Open interest Underlying asset price Futures Settlement price Change Open interest Underlying asset price Physical delivery Derivative Securities-Quotes