Upcoming SlideShare
×

Thanks for flagging this SlideShare!

Oops! An error has occurred.

×
Saving this for later? Get the SlideShare app to save on your phone or tablet. Read anywhere, anytime – even offline.
Standard text messaging rates apply

# Financial Markets: Stocks and Bonds.

854
views

Published on

Published in: Business, Economy & Finance

0 Likes
Statistics
Notes
• Full Name
Comment goes here.

Are you sure you want to Yes No
• Be the first to comment

• Be the first to like this

Views
Total Views
854
On Slideshare
0
From Embeds
0
Number of Embeds
0
Actions
Shares
0
46
0
Likes
0
Embeds 0
No embeds

No notes for slide

### Transcript

• 1. Ch. 15: Financial Markets
• Financial markets
• determine interest rates, stock prices, bond prices, etc.
• Bonds
• a promise by the bond-issuer to pay some specified amount(s) in the future in exchange for some payment (the bond price) today.
• Stocks (equities)
• legal rights of ownership in an incorporated firm.
• promise the stockholder a share of the corporte profits (dividends)
• 2. The Bond Market.
• Maturity date :
• A bond's maturity date refers to the specific future date on which the maturity value will be paid to the bond holder. Bond maturity dates when issued generally range from 3 months up to 30 years.
• Coupon rate
• Between the date of issuance and the maturity date, the bond-holder receives an annual interest payment equal to the coupon rate times the maturity value.
• Yield to maturity
• represents the effective interest rate that the bond-holder earns if the bond is held to maturity.
• Bond price
• The price that the bond sells for. This fluctuates over the life of the bond.
• *If the bond price is equal to 100% of its maturity value, the bond sold at “par”.
• If the bond price is below 100% of its maturity value, the bond price sold “below par”.
• 3. The Bond Market
• 20 year bond with maturity value of \$1000 and coupon rate of 5% promises
• 20 annual payments of .05*1000=\$50
• \$1000 payment at maturity (20 years from now).
• If price is \$1000 for this bond, the bond sold for par.
• 4. The Bond Market.
• Computing yields on a bond.
• The yield on a bond is the same as the internal rate of return . To calculate the yield to maturity, define NPV as follows:
• NPV = CP1/(1+r) + CP2/(1+r) 2 + .... + CPT/(1+r) T + MV/(1+r) T - P
• where CP1, CP2, ... CPT are the interest or coupon payments in periods 1 through T
• MV is the payment received at maturity
• P is the price paid for the bond.
• The yield to maturity is the interest rate that makes the NPV on the bond purchase zero.
• 5. The Bond Market.
• One year bonds
• NPV = MV(1+cr)/(1+r) - P where cr is the coupon rate.
• setting NPV=0 and solving for r provides the yield to maturity:
• yield = [MV(1+cr)/P] - 1
• For example, suppose you buy a one-year bond for \$900. It has a maturity value of \$1000 and a coupon rate of 5%. What is the yield?
• yield = [(1000)(1.05)/900] - 1
• =1050/900 -1
• =16.67%
• As the price paid for a bond increases, the yield on the bond falls.
• 6. The Bond Market.
• Zero Coupon Bonds.
• With zero coupon bonds, no interest payments are made between the sale of the bond and its maturity. That is, there is a zero coupon rate. For such bonds, the yield calculations is straightforward.
• NPV = MV/(1+r) T - P
• setting NPV=0 and solving for r provides the yield:
• yield = (MV/P) 1/T - 1
• For example, if you buy a zero coupon bond today for \$1000 and it has a maturity value of \$1500 in 10 years:
• yield = (1500/1000) 1/10 -1 = .0414 = 4.14%
• As the price paid for a bond increases, the yield on the bond falls.
• 7. The Bond Market.
• Determinants of bond yields
• Higher expected inflation will drive up yields.
• Higher risk bonds must offer higher yields.
• Default risk.
• Debt rating agencies:
• Moody’s & Standard and Poors
• AAA=superior quality
• C=imminent default
• Diversification to reduce risk.
• Inflation risk.
• Term
• Longer term bonds have greater inflation and default risk.
• 8. The Bond Market.
• Yield curve
• Shows relationship between yield and term on government bonds
• Slope of yield curve reflects
• Expectations of future short term interest rates
• Greater risk of long term bonds
• If short term interest rates are expected to be constant in the future, yield curve will slope upward reflecting risk premia for longer term bonds.
• A steepening of the yield curve suggests that financial markets believe short term interest rates will be rising in the future.
• The bond market
• The dynamic yield curve
• 9. The Stock Market
• Stocks (equities):
• legal rights of ownership in an incorporated firm.
• promise the stockholder a share of the corporte profits (dividends)
• 10. The Stock Market
• The “fundamental value” of a stock is the expected present value of all future dividends from a stock.
• P = d 1 /(1+r) + d 2 /(1+r) 2 + d 3 /(1+r) 3 + ....d T /(1+r) T
• where T is the end of the firm’s life (which might be infinite)
• d 1 , d 2 , ... d T represent dividend payments in years 1 through T.
• r is the interest rate
• 11. The Stock Market
• Given the fundamental value theory, stock prices will rise with:
• lower interest rates.
• an increase in future expected dividends.
• A lower tax rate on dividends.
• 12. The Stock Market
• Efficient markets hypothesis:
• All stock prices represent their fundamental value at each point in time.
• When new “information” arrives about a stock, its price immediately adjusts to reflect that new information.
• It is impossible to consistently predict which way a stock price will move in the future and to consistently “beat the market”.
• 13. The Stock Market.
• If the efficient markets hypothesis is true,
• financial advisors can assist you only in evaluating the risk and tax consequences of different stocks and concerns regarding income or growth, etc.
• Financial advisors will not be able to consistently find stocks that will “beat the market”.
• The validity of the efficient markets hypothesis is controversial among economists.
• 14. The Stock Market
• Stock quotes
• Price
• PE ratio (price-earnings ratio)
• Volume (number of shares sold in previous day)
• Change (change in from previous day)
• 52 week high and low
• Beta (measures stock movements relative to market)
• 15. The Stock Market
• Performance measures
• Dow Jones Industrial Average
• Standard and Poor 500
• NASDAQ
• For stock quotes and information
• http://money.cnn.com/
• 16. Options
• Options are contracts in which the terms of the contract are standardized and give the buyer the right, but not the obligation, to buy (call) or sell (put) a particular asset at a fixed price (the strike price) for a specific period of time (until expiration).
• 17. Options Market
• Call option on a security:
• the right to call (buy) a security at the strike price up until the expiration date of the option from the person that issued the call.
• If I sell you a call option on IBM with a strike price of \$190 and an expiration date of 1/1/2009, you have the right to exercise the option until its expiration and force me to sell you IBM for \$190. You will exercise the option only if IBM rises above the strike price of \$190.
• 18. Options Market
• Put option on a security:
• the right to put (sell) a security at the strike price up until the expiration date of the option to the person that issued the put.
• If I sell you a put option on IBM with a strike price of \$150 and an expiration date of 1/1/2009, then at any time between now and 2009 you can force me to buy a share of IBM for \$150. You would exercise your put option only if the price of IBM falls below the strike price of \$150.
• 19. Options Market
• The options market can be used for:
• speculation
• reducing exposure to risk.
• 20. Futures Market
• A market for contracts that provide for future delivery of a good at some pre-specified price. Futures markets exist for commodities, bonds, and foreign currencies.
• Example: If I agree to a 1/1/2009 futures contract to buy 1000 bushels of corn at \$3.00 per bushel, I am committed to buying corn on that date at that price. The other party to the contract is committed to sell 1000 bushels at \$3.00 per bushel. The person who agrees to buy corn has “bought” a futures contract. The person who agrees to sell the corn has “sold” a futures contract.
• If the expected price of a commodity in the future rises, the futures price will rise.
• The price in futures contracts provides an indicator of what people believe about the movement of prices in the future.
• 21. Mutual Funds
• Mutual Funds: a firm that pools money from many small investors to buy and manage a portfolio of assets and pays the earnings back to the investors. Mutual funds can be categorized in several ways. For example:
• index funds (S&P 500 or Willshire 5000)
• international funds (invest in foreign securities; exchange rate risk)
• bond funds (invest in bonds)
• balanced funds (invest in bonds and stocks)
• growth funds (invest in companies viewed as having high growth potential)
• sector funds (invest in a particular sector of the economy; e.g. health, or financial services).
• tax-exempt income funds (invest in tax exempt bonds)
• money market funds (invest in short term government securities)
• The major advantage of mutual funds is that it allows a person to invest in the stock market and be diversified .