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Investment Alternatives

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various alternatives available for individuals for investment

various alternatives available for individuals for investment


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  • 1. INVESTMENT ALTERNATIVES
  • 2.
    • Describe the major types of financial assets and how they are organized.
    • Explain what non-marketable financial assets are.
    • Describe the important features of money market and capital market securities.
    • Distinguish among preferred stock, income trusts, and common stock.
    • Understand the basics of options and futures.
    Learning Objectives
  • 3.
    • Examples: Savings deposits , Canada Savings Bonds (CSBs) , Guaranteed Investment Certificates (GICs)
    • Commonly owned by individuals
    • Represent direct exchange of claims between issuer and investor
    • Usually “safe” investments which are easy to convert to cash without loss of value
    Non-Marketable Financial Assets
  • 4.
    • Examples: Treasury bills , commercial paper , Eurodollars , repurchase agreements , banker’s acceptances (B/As)
    • Marketable: claims are negotiable or saleable in the marketplace
    • Short-term, liquid, relatively low-risk debt instruments
    • Issued by governments and private firms
    Money Market Securities
  • 5.
    • Treasury Bills:
      • Short-term promissory notes issued by governments
      • T-bills accounted for about one-half of all outstanding money market securities.
      • Sold at a discount from face value in denominations of $5,000, $25,000, 100,000, and $1 million
      • Typical maturities are 91, 182, and 364 days although shorter maturities are also offered
    Treasury Bills (T-bills)
  • 6.
    • Treasury Bills:
      • Due to government backing, there is a very low risk of default
      • Widely distributed and actively traded – high liquidity
      • In subsequent chapters we will use government T-bill rates as a measure of the “riskless rate” available to investors, commonly referred to as the risk-free rate
    Treasury Bills (T-bills)
  • 7.
    • Commercial Paper:
      • Short-term unsecured promissory notes issued by large, well-known, and financially strong corporations (including finance companies)
      • Denominations start at $100,000 with maturities of 30 to 365 days, and it is sold either directly by the issuer or indirectly through a dealer, with rates slightly above T-bill rates.
    Commercial Paper
  • 8.
    • Eurodollars:
      • Dollar-denominated deposits held in foreign banks or in offices of Canadian banks located abroad
      • Although this market originally developed in Europe, dollar-denominated deposits can now be made in many countries, such as those of Asia
      • Consist of both time deposits and certificates of deposit (CDs), with the latter constituting the largest component of the Eurodollar markets
      • Maturities are mostly short-term, often less than six months
    Eurodollars
  • 9.
    • Repurchase Agreements (RPs):
      • agreements between a borrower and lender (typically institutions) to sell and repurchase money market securities
      • borrower initiates an RP by contracting to sell securities to a lender and agreeing to repurchase these securities at a pre-specified (higher) price on a stated future date
      • maturity is generally very short, from 3 to 14 days, and sometimes overnight
      • minimum denomination is typically $100,000
    Repurchase Agreements
  • 10.
    • Bankers Acceptances (B/As):
      • Time drafts drawn on a bank by a customer, whereby the bank agrees to guarantee payment of a particular amount at a specified future date
      • Differ from commercial paper because the associated payments are guaranteed by a bank, and thus possess the credit risk associated with that bank
      • Issued in minimum denominations of $100,000
      • Typical maturities range from 30 to 180 days, with 90 days being the most common
    Bankers Acceptances
  • 11.
    • Marketable debt with maturity greater than one year
    • More risky than money market securities
    • Fixed-income securities have a specified payment schedule
      • Dates and amount of interest and principal payments known in advance
    Fixed-Income Securities
  • 12.
    • Bonds – long-term debt instruments
    • Major bond types:
      • Government of Canada bonds
      • U.S. Treasury bonds
      • Provincial bonds
      • Provincially-guaranteed bonds – Ontario Hydro
      • U.S. federal agency securities – GNMAs (Ginnie Maes), FNMAs (Fannie Maes)
    Fixed-Income Securities
  • 13.
    • Major bond types (cont’d):
      • Corporate bonds
        • Usually pay semi-annual interest, are callable, carry a sinking fund provision, and have a par value of $1,000
        • Convertible bonds may be exchanged for another asset
        • Risk that issuer may default on payments
    Fixed-Income Securities
  • 14.
    • Callable bonds give the issuer the option to “ call ” or repurchase outstanding bonds at predetermined “call” prices (generally at a premium over par) at specified times
    • This feature is detrimental to the bondholders who are willing to pay less for them (i.e., they demand a higher return) than for similar non-callable bonds.
    • Generally, the issuer agrees to give 30 or more days notice that the issue will be redeemed
    Bond Characteristics
  • 15.
    • Extendible Bonds: gives the investor an option to extend the maturity date
    • Retractable Bonds: gives the investor an option to redeem the bond at par prior to maturity
    • Issuers are able to sell bonds with these features at higher prices than straight issues
    • When bond prices rise (yields fall):
      • they are attractive long-term investments
    • When bond prices fall (yields rise):
      • they can trade as short-term debt
    Bond Characteristics
  • 16.
    • Convertible Bonds may be converted into common shares at predetermined prices.
    • This feature makes the issue more saleable and lowers the interest rate that must be offered
    • Permits the holding of a two-way security:
      • The safety of a bond
      • The capital gains potential of a share
    • If the common shares of the company are split, the convertible debt provides protection against dilution by adjusting the conversion privilege
    • Convertibles are normally callable
    Bond Characteristics
  • 17.
    • The market price of convertible debt depends on the value of the underlying common stock
      • When the stock is selling well below the conversion price, the convertible debt is more like straight debt
      • When the stock approaches conversion price, a premium appears
      • When the stock rises above the conversion price, the debt will rise accordingly, and will then be selling off the stock
    Bond Characteristics Convertible Bonds (cont’d)
  • 18.
    • Asset-backed securities are “securitized” assets
    • E.g. mortgage-backed securities
      • I nvestors assume little default risk as most mortgages are guaranteed by a federal government agency
    Asset-Backed Securities
  • 19.
    • Represent an ownership interest
    • Preferred stock
      • Preferred shareholders are paid after bondholders but before common shareholders
      • Dividend known, fixed in advance
      • May be cumulative if dividend omitted
    Equity Securities
  • 20.
    • Income trusts
      • Pay out a portion of cash flows generated from underlying assets
      • E.g. royalty trusts and real estate investment trusts (REITs)
    • Common stock
      • Common shareholders are residual claimants on income and assets
      • Common shareholders can elect board of directors and vote on important issues
    Equity Securities
  • 21.
    • Securities whose value is derived from some underlying security
    • Futures and options contracts are standardized and performance is guaranteed by a third party
      • Risk management tools
    • Warrants are options issued by firms
    Derivative Securities
  • 22.
    • Exchange-traded options are created by investors, not corporations
    • Call (Put) gives the buyer the right but not the obligation to purchase (sell) a fixed quantity of shares at a a fixed price before a certain date
    • Options can be sold in the market at a price
    • Increases return possibilities
    Options
  • 23.
    • Futures contract: A standardized agreement between a buyer and seller to make future delivery of a fixed asset at a fixed price
      • A “good faith deposit” called margin, is required of both the buyer and seller to reduce default risk
      • Used to hedge the risk of price changes
    Futures