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Chapter 2

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

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Chapter 2

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  1. Financial Instruments Chapter 2

  2. Major Types of 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

  5. Money Market Instruments (Cont.) • Repurchase Agreements (RPs) and Reverse RPs • Federal Funds • Brokers’ Calls • LIBOR Market

  6. Bond Markets • US Treasury Bonds and Notes • Agency Issues (Fed Gov) • International Bonds • Municipal Bonds • Corporate Bonds • Mortgage-Backed Securities

  7. Municipal Bond Yields • Interest income on most municipals is not subject to tax • To compare the yields on municipals to other bonds use equivalent taxable yield (municipal return) / (1 – tax rate) • Or solve for the tax rate that equates the two yields Tax rate = 1 – (municipal rate/taxable rate)

  8. Capital Market - Equity • Common stock • Residual claim • Limited liability • Preferred stock • Fixed dividends - limited • Priority over common • Tax treatment

  9. Stock Market 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?

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

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

  12. Bond Indexes • Lehman Brothers • Merrill Lynch • Salomon Brothers • Specialized Indexes • Merrill Lynch Mortgage

  13. 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)

  14. 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%

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

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