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Chapter 2

Chapter 2. Markets and Instruments. Chapter Summary. Objective: To introduce the features of various security types, necessary for the understanding of the coming material Money markets and how yields are measured Fixed Income Stocks and Indexes Derivative Securities.

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Chapter 2

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  1. Chapter 2 Markets and Instruments

  2. Chapter Summary • Objective: To introduce the features of various security types, necessary for the understanding of the coming material • Money markets and how yields are measured • Fixed Income • Stocks and Indexes • Derivative Securities

  3. Major Classes of Financial Assets or Securities • Debt • Money market instruments • Bonds • Common stock • Preferred stock • Derivative securities

  4. Markets and Instruments • Money Market • Debt Instruments • Derivatives • Capital Market • Bonds • Equity • Derivatives

  5. Summary Reminder • Objective: To introduce the features of various security types, necessary for the understanding of the coming material • Money markets and how yields are measured • Fixed Income • Stocks and Indexes • Derivative Securities

  6. Money Market Instruments • Treasury bills • Certificates of Deposit and Bearer Deposit Notes (BDNs) • Commercial Paper • Bankers Acceptances • Eurodollars • Repurchase Agreements (REPOs) and Reverse REPOs

  7. 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

  8. 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%

  9. 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

  10. 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

  11. Equivalence of yields • US T-bills are quoted in bank discount yields • Canadian T-bills are quoted in bond equivalent yields • Equivalence formula: Also note that the effective annual yield is:

  12. Summary Reminder • Objective: To introduce the features of various security types, necessary for the understanding of the coming material • Money markets and how yields are measured • Fixed Income • Stocks and Indexes • Derivative Securities

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

  14. Summary Reminder • Objective: To introduce the features of various security types, necessary for the understanding of the coming material • Money markets and how yields are measured • Fixed Income • Stocks and Indexes • Derivative Securities

  15. Capital Market - Equity • Common stock • Residual claim • Limited liability • Corporate governance and restricted shares • Preferred stock • Fixed dividends - limited • Priority over common • Tax treatment

  16. 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?

  17. Examples of Indexes – Canadian • TSE 300 Composite Index • TSE 35 (also known as Toronto 35 or T35) • TSE 100 • S&P/TSE 60

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

  19. Examples of Indexes - International • TSE (Tokyo) - Nikkei 225 & Nikkei 300 • FTSE (Financial Times of London) • Dax • Region and Country Indexes • EAFE • Far East • United Kingdom

  20. 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 and S&P500) • Geometric (Value Line Index)

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

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

  23. Summary Reminder • Objective: To introduce the features of various security types, necessary for the understanding of the coming material • Money markets and how yields are measured • Fixed Income • Stocks and Indexes • Derivative Securities

  24. 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

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

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