Financial Assets (Instruments)

1. Financial Assets (Instruments) Chapter 2

2. Assets • Tangible asset • a physically observable, or touchable, item

3. Promissory Note Assets • Financial asset • an asset that represents a promise to distribute cash flows some time in the future

4. Treasury notes/bonds Municipal bonds Term loans Mortgages Corporate bonds Preferred stock Common stock Major Financial Instruments • Treasury bills • Repurchase agreements • Federal funds • Bankers’ acceptances • Commercial paper • Negotiable CDs • Eurodollars • Money market funds

5. Financial Instruments and the Firm’s Balance Sheet • Firm issues financial instruments so it can purchase the tangible assets necessary to produce income

6. Balance Sheet - Equity • Common equity • stockholder’s total investment in the firm • Par value • nominal or face value of a stock or bond • Retained earnings • earnings the firm has not paid out as dividends throughout its history • Additional paid-in capital • difference between the value of newly issued stock and its par value

7. Debt • A loan to an individual, company, or government • Debt features • Principal value • Face value • Maturity value • Par value

8. More Debt Features • Interest payments or discounted securities • Maturity date • Priority to assets and earnings • Control of the firm (voting rights)

9. Short-Term Debt • Treasury Bills (T-bills) • Repurchase Agreement (Repo) • Federal Funds • Banker’s Acceptance • Commercial Paper • Certificate of Deposit • Eurodollar Deposit • Money Market Mutual Funds

10. Long-Term Debt • Term Loans • Bonds • Government bonds • Treasury bonds • Municipal bonds • Revenue bonds • General obligation bonds • Corporate bonds • Mortgage bonds

11. Bonds • Debenture • Subordinated debenture • Income bond • Putable bond • Indexed (purchasing power) bond • Floating rate bond • Zero coupon bond • Junk bond

12. Bond Contract Features • Bond Indenture • Trustee • Restrictive covenant • Call provision • Sinking fund • call for redemption by annual lottery • buy bonds on the open market • Convertible

13. Bond Ratings • Moody’s Investors Service (Moody’s) • Standard & Poor’s Corporation (S&P) • Investment grade bonds • triple B or better • Criteria for rating bonds • Importance of bond ratings • Changes in ratings

14. 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, dividend participation, sinking funds, call provisions, and even maturity

15. 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

16. Stock (Equity) • Classified stock • special purpose stock • Closely held corporations • Publicly owned corporations

17. 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

18. Derivatives • Covertibles - 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 at a set price

19. Derivatives • Swaps - an agreement to exchange cash flows or assets at a set time in the future

20. 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 • Differences in popularity through time

21. 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

22. 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

23. Which Financial Instrument is Best? • Common Stock • no obligation of dividend payments • no maturity date for “repayment” • sales 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

24. 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

25. 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

26. 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 for foreign companies that is traded in the United States

27. End of Chapter 2 Financial Assets(Instruments)