1. Financial Assets (Instruments)
Chapter 2
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2. Assets
Real asset
 a physically observable, or touchable, item

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

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

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
Priority to assets and earnings
Principal value, Face value, Maturity
value, and Par value
Interest payments or discounted
securities
Maturity date
Control of the firm (voting rights)

8. Short-Term Debt
 Treasury Bill (T-bill)
 Repurchase Agreement (Repo)
 Federal Funds
 Banker’s Acceptance
 Commercial Paper
 Certificate of Deposit
 Eurodollar Deposit
 Money Market Mutual Fund

9. Long-Term Debt
Term Loans
Bonds

10. Government Bonds
Treasury notes or bonds - issued by US
government
Municipal bonds - issued by state or
local governments
Revenue bonds
General obligation bonds

11. Corporate Bonds
 Mortgage 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. Yields on Selected Long-Term
Bonds, 1965-2005

15. 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

16. 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

17. Stock (Equity)
Classified stock
 special purpose stock
Closely held corporations
Publicly owned corporations

18. 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

19. Derivatives
 Convertibles - 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

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

21. 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

22. 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

23. Preferred stock
 fixed payment - but not obligated
 no voting rights
 higher after-tax cost since dividends are not
deductible expenses
Which Financial Instrument is Best?

24. 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

25. Risk & Returns on Different
Classes of Financial Instruments

26. 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

27. 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

28. 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

29. End of Chapter 2
Financial
Assets
(Instruments)