Investment Alternatives

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various alternatives available for individuals for investment

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Investment Alternatives

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

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