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Chapter 2

Chapter 2. Financial Markets and Instruments. Major Classes of Financial Assets or Securities. Debt Money market instruments Bonds Common stock Preferred stock Derivative securities. Markets and Instruments. Money Market Debt Instruments Derivatives Capital Market Bonds Equity

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Chapter 2

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  1. Chapter 2 Financial Marketsand Instruments

  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. - P 10,000 360 x r = BD n 10,000 rBD = bank discount rate P = market price of the T-bill n = number of days to maturity Example 90-day T-bill, P = $9,800 - 10,000 9,800 360 x r = = 8% BD 90 10,000 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. Bond Equivalent Yield P 10,000 - 365 x r = BEY n P P = price of the T-bill n = number of days to maturity Example Using Sample T-Bill 10,000 - 9,800 365 x r = BEY 9,800 90 rBEY = .0204 x 4.0556 = .0828 = 8.28%

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

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