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INVESTMENTS | BODIE, KANE, MARCUS
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill/Irwin
CHAPTER 2
Asset Classes and Financial
Instruments
INVESTMENTS | BODIE, KANE, MARCUS
2-2
Asset Classes
• Money market instruments
• Capital market instruments
– Bonds
– Equity Securities
– Derivative Securities
INVESTMENTS | BODIE, KANE, MARCUS
2-3
The Money Market
• Subsector of the fixed-income market:
Securities are short-term, liquid, low
risk, and often have large
denominations
• Money market mutual funds allow
individuals to access the money
market.
INVESTMENTS | BODIE, KANE, MARCUS
2-4
Table 2.1 Major Components of
the Money Market
INVESTMENTS | BODIE, KANE, MARCUS
2-5
Money Market Securities
• Treasury bills: Short-term debt of U.S.
government
– Bid and asked price
• Certificates of Deposit: Time deposit with a
bank
• Commercial Paper: Short-term, unsecured
debt of a company
INVESTMENTS | BODIE, KANE, MARCUS
2-6
Money Market Securities
• Bankers’ Acceptances: An order to a bank
by a bank’s customer to pay a sum of
money on a future date
• Eurodollars: dollar-denominated time
deposits in banks outside the U.S.
• Repos and Reverses: Short-term loan
backed by government securities.
• Fed Funds: Very short-term loans between
banks
INVESTMENTS | BODIE, KANE, MARCUS
2-7
Yields on Money Market Instruments
• Except for Treasury bills, money market
securities are not free of default risk
• Both the premium on bank CDs and the
TED spread (T-bill and Euro Deposit) have
often become greater during periods of
financial crisis
• During the credit crisis of 2008, the federal
government offered insurance to money
market mutual funds after some funds
experienced losses
INVESTMENTS | BODIE, KANE, MARCUS
2-8
The Bond Market
• Treasury Notes and Bonds
• Inflation-Protected Treasury
Bonds
• Federal Agency Debt
• International Bonds
INVESTMENTS | BODIE, KANE, MARCUS
2-9
The Bond Market
• Municipal Bonds
• Corporate Bonds
• Mortgages and Mortgage-Backed
Securities
INVESTMENTS | BODIE, KANE, MARCUS
2-10
Treasury Notes and Bonds
• Maturities
– Notes – maturities up to 10 years
– Bonds – maturities from 10 to 30
years
• Par Value - $1,000
• Interest paid semiannually
• Quotes – percentage of par
INVESTMENTS | BODIE, KANE, MARCUS
2-11
The Bond Market
• Inflation-Protected Treasury Bonds
– TIPS: Provide inflation protection
• Federal Agency Debt
– Debt of mortgage-related agencies such as
Fannie Mae and Freddie Mac
• International Bonds
– Eurobonds and Yankee bonds (dollar
denominated bond issued in the US by a
foreign company or government)
INVESTMENTS | BODIE, KANE, MARCUS
2-12
Municipal Bonds
• Issued by state and local governments
• Interest is exempt from federal income
tax and sometimes from state and local
tax
INVESTMENTS | BODIE, KANE, MARCUS
2-13
Municipal Bonds
• Types
– General obligation bonds: Backed by taxing
power of issuer
– Revenue bonds: backed by project’s
revenues or by the municipal agency
operating the project.
INVESTMENTS | BODIE, KANE, MARCUS
2-14
Municipal Bond Yields
• To choose between taxable and tax-exempt
bonds, compare after-tax returns on each
bond.
• Let t equal the investor’s marginal tax
bracket
• Let r equal the before-tax return on the
taxable bond and r m denote the municipal
bond rate.
• If r (1 - t ) > r m then the taxable bond gives
a higher return; otherwise, the municipal
bond is preferred.
INVESTMENTS | BODIE, KANE, MARCUS
2-15
Table 2.2 Tax-Exempt Yield Table
The equivalent taxable yield is simply the tax-free
rate, rm , divided by (1-t).
INVESTMENTS | BODIE, KANE, MARCUS
2-16
Corporate Bonds
• Issued by private firms
• Semi-annual interest payments
• Subject to larger default risk than
government securities
• Options in corporate bonds
– Callable
– Convertible
INVESTMENTS | BODIE, KANE, MARCUS
2-17
• Proportional ownership of a mortgage
pool or a specified obligation secured by
a pool
• Produced by securitizing mortgages
– Mortgage-backed securities are called
pass-throughs because the cash flows
produced by homeowners paying off their
mortgages are passed through to
investors.
Mortgage-Backed Securities
INVESTMENTS | BODIE, KANE, MARCUS
2-18
Mortgage-Backed Securities
• Most mortgage-backed securities were
issued by Fannie Mae and Freddie Mac.
• Traditionally, pass-throughs were
comprised of conforming mortgages,
which met standards of credit worthiness.
INVESTMENTS | BODIE, KANE, MARCUS
2-19
Mortgage-Backed Securities
• Eventually, “Private-label” issuers
securitized large amounts of subprime
mortgages, made to financially weak
borrowers.
• Finally, Fannie and Freddie were allowed
and even encouraged to buy subprime
mortgage pools.
• September, 2008: Fannie and Freddie got
taken over by the federal government.
INVESTMENTS | BODIE, KANE, MARCUS
2-20
Figure 2.6 Mortgage-backed securities
outstanding
INVESTMENTS | BODIE, KANE, MARCUS
2-21
Equity Securities
• Common stock: Ownership
– Residual claim
– Limited liability
• Preferred stock: Perpetuity
– Fixed dividends
– Priority over common
– Tax treatment
INVESTMENTS | BODIE, KANE, MARCUS
2-22
Stock Market Indexes
• Dow Jones Industrial Average
– Includes 30 large blue-chip
corporations
– Computed since 1896
– Price-weighted average
INVESTMENTS | BODIE, KANE, MARCUS
2-23
Example 2.2 Price-Weighted Average
Portfolio: Initial value $25 + $100 = $125
Final value $30 + $ 90 = $120
Percentage change in portfolio value
= 5/125 = -.04 = -4%
Index: Initial index value (25+100)/2 = 62.5
Final index value (30 + 90)/2 = 60
Percentage change in index -2.5/62.5
= -.04 = -4%
INVESTMENTS | BODIE, KANE, MARCUS
2-24
• S&P 500
– Broadly based index of 500 firms
– Market-value-weighted index
• Investors can base their portfolios
on an index:
– Buy an index mutual fund
– Buy exchange traded funds (ETFs)
Standard & Poor’s Indexes
INVESTMENTS | BODIE, KANE, MARCUS
2-25
Other Indexes
U.S. Indexes
• NYSE Composite
• NASDAQ Composite
• Wilshire 5000
Foreign Indexes
• Nikkei (Japan)
• FTSE (U.K.; pronounced
“footsie”)
• DAX (Germany),
• Hang Seng (Hong Kong)
• TSX (Canada)
INVESTMENTS | BODIE, KANE, MARCUS
2-26
Derivatives Markets
• Options and futures provide payoffs that
depend on the values of other assets such
as commodity prices, bond and stock
prices, or market index values.
• A derivative is a security that gets its value
from the values of another asset.
INVESTMENTS | BODIE, KANE, MARCUS
2-27
Options
• Call: Right to buy underlying asset at the
strike or exercise price.
– Value of calls decrease as strike price
increases
• Put: Right to sell underlying asset at the
strike or exercise price.
– Value of puts increase with strike price
• Value of both calls and puts increase with
time until expiration.
INVESTMENTS | BODIE, KANE, MARCUS
2-28
Futures Contracts
• A futures contract calls for delivery of an
asset (or in some cases, its cash value) at
a specified delivery or maturity date for an
agreed-upon price, called the futures
price, to be paid at contract maturity.
• Long position: Take delivery at maturity
• Short position: Make delivery at maturity
INVESTMENTS | BODIE, KANE, MARCUS
2-29
Comparison
Option
• Right, but not obligation,
to buy or sell; option is
exercised only when it is
profitable
• Options must be
purchased
• The premium is the price
of the option itself.
Futures Contract
• Obliged to make or take
delivery. Long position
must buy at the futures
price, short position must
sell at futures price
• Futures contracts are
entered into without cost

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ch 2 asset classes and financial instrument.ppt

  • 1. INVESTMENTS | BODIE, KANE, MARCUS Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin CHAPTER 2 Asset Classes and Financial Instruments
  • 2. INVESTMENTS | BODIE, KANE, MARCUS 2-2 Asset Classes • Money market instruments • Capital market instruments – Bonds – Equity Securities – Derivative Securities
  • 3. INVESTMENTS | BODIE, KANE, MARCUS 2-3 The Money Market • Subsector of the fixed-income market: Securities are short-term, liquid, low risk, and often have large denominations • Money market mutual funds allow individuals to access the money market.
  • 4. INVESTMENTS | BODIE, KANE, MARCUS 2-4 Table 2.1 Major Components of the Money Market
  • 5. INVESTMENTS | BODIE, KANE, MARCUS 2-5 Money Market Securities • Treasury bills: Short-term debt of U.S. government – Bid and asked price • Certificates of Deposit: Time deposit with a bank • Commercial Paper: Short-term, unsecured debt of a company
  • 6. INVESTMENTS | BODIE, KANE, MARCUS 2-6 Money Market Securities • Bankers’ Acceptances: An order to a bank by a bank’s customer to pay a sum of money on a future date • Eurodollars: dollar-denominated time deposits in banks outside the U.S. • Repos and Reverses: Short-term loan backed by government securities. • Fed Funds: Very short-term loans between banks
  • 7. INVESTMENTS | BODIE, KANE, MARCUS 2-7 Yields on Money Market Instruments • Except for Treasury bills, money market securities are not free of default risk • Both the premium on bank CDs and the TED spread (T-bill and Euro Deposit) have often become greater during periods of financial crisis • During the credit crisis of 2008, the federal government offered insurance to money market mutual funds after some funds experienced losses
  • 8. INVESTMENTS | BODIE, KANE, MARCUS 2-8 The Bond Market • Treasury Notes and Bonds • Inflation-Protected Treasury Bonds • Federal Agency Debt • International Bonds
  • 9. INVESTMENTS | BODIE, KANE, MARCUS 2-9 The Bond Market • Municipal Bonds • Corporate Bonds • Mortgages and Mortgage-Backed Securities
  • 10. INVESTMENTS | BODIE, KANE, MARCUS 2-10 Treasury Notes and Bonds • Maturities – Notes – maturities up to 10 years – Bonds – maturities from 10 to 30 years • Par Value - $1,000 • Interest paid semiannually • Quotes – percentage of par
  • 11. INVESTMENTS | BODIE, KANE, MARCUS 2-11 The Bond Market • Inflation-Protected Treasury Bonds – TIPS: Provide inflation protection • Federal Agency Debt – Debt of mortgage-related agencies such as Fannie Mae and Freddie Mac • International Bonds – Eurobonds and Yankee bonds (dollar denominated bond issued in the US by a foreign company or government)
  • 12. INVESTMENTS | BODIE, KANE, MARCUS 2-12 Municipal Bonds • Issued by state and local governments • Interest is exempt from federal income tax and sometimes from state and local tax
  • 13. INVESTMENTS | BODIE, KANE, MARCUS 2-13 Municipal Bonds • Types – General obligation bonds: Backed by taxing power of issuer – Revenue bonds: backed by project’s revenues or by the municipal agency operating the project.
  • 14. INVESTMENTS | BODIE, KANE, MARCUS 2-14 Municipal Bond Yields • To choose between taxable and tax-exempt bonds, compare after-tax returns on each bond. • Let t equal the investor’s marginal tax bracket • Let r equal the before-tax return on the taxable bond and r m denote the municipal bond rate. • If r (1 - t ) > r m then the taxable bond gives a higher return; otherwise, the municipal bond is preferred.
  • 15. INVESTMENTS | BODIE, KANE, MARCUS 2-15 Table 2.2 Tax-Exempt Yield Table The equivalent taxable yield is simply the tax-free rate, rm , divided by (1-t).
  • 16. INVESTMENTS | BODIE, KANE, MARCUS 2-16 Corporate Bonds • Issued by private firms • Semi-annual interest payments • Subject to larger default risk than government securities • Options in corporate bonds – Callable – Convertible
  • 17. INVESTMENTS | BODIE, KANE, MARCUS 2-17 • Proportional ownership of a mortgage pool or a specified obligation secured by a pool • Produced by securitizing mortgages – Mortgage-backed securities are called pass-throughs because the cash flows produced by homeowners paying off their mortgages are passed through to investors. Mortgage-Backed Securities
  • 18. INVESTMENTS | BODIE, KANE, MARCUS 2-18 Mortgage-Backed Securities • Most mortgage-backed securities were issued by Fannie Mae and Freddie Mac. • Traditionally, pass-throughs were comprised of conforming mortgages, which met standards of credit worthiness.
  • 19. INVESTMENTS | BODIE, KANE, MARCUS 2-19 Mortgage-Backed Securities • Eventually, “Private-label” issuers securitized large amounts of subprime mortgages, made to financially weak borrowers. • Finally, Fannie and Freddie were allowed and even encouraged to buy subprime mortgage pools. • September, 2008: Fannie and Freddie got taken over by the federal government.
  • 20. INVESTMENTS | BODIE, KANE, MARCUS 2-20 Figure 2.6 Mortgage-backed securities outstanding
  • 21. INVESTMENTS | BODIE, KANE, MARCUS 2-21 Equity Securities • Common stock: Ownership – Residual claim – Limited liability • Preferred stock: Perpetuity – Fixed dividends – Priority over common – Tax treatment
  • 22. INVESTMENTS | BODIE, KANE, MARCUS 2-22 Stock Market Indexes • Dow Jones Industrial Average – Includes 30 large blue-chip corporations – Computed since 1896 – Price-weighted average
  • 23. INVESTMENTS | BODIE, KANE, MARCUS 2-23 Example 2.2 Price-Weighted Average Portfolio: Initial value $25 + $100 = $125 Final value $30 + $ 90 = $120 Percentage change in portfolio value = 5/125 = -.04 = -4% Index: Initial index value (25+100)/2 = 62.5 Final index value (30 + 90)/2 = 60 Percentage change in index -2.5/62.5 = -.04 = -4%
  • 24. INVESTMENTS | BODIE, KANE, MARCUS 2-24 • S&P 500 – Broadly based index of 500 firms – Market-value-weighted index • Investors can base their portfolios on an index: – Buy an index mutual fund – Buy exchange traded funds (ETFs) Standard & Poor’s Indexes
  • 25. INVESTMENTS | BODIE, KANE, MARCUS 2-25 Other Indexes U.S. Indexes • NYSE Composite • NASDAQ Composite • Wilshire 5000 Foreign Indexes • Nikkei (Japan) • FTSE (U.K.; pronounced “footsie”) • DAX (Germany), • Hang Seng (Hong Kong) • TSX (Canada)
  • 26. INVESTMENTS | BODIE, KANE, MARCUS 2-26 Derivatives Markets • Options and futures provide payoffs that depend on the values of other assets such as commodity prices, bond and stock prices, or market index values. • A derivative is a security that gets its value from the values of another asset.
  • 27. INVESTMENTS | BODIE, KANE, MARCUS 2-27 Options • Call: Right to buy underlying asset at the strike or exercise price. – Value of calls decrease as strike price increases • Put: Right to sell underlying asset at the strike or exercise price. – Value of puts increase with strike price • Value of both calls and puts increase with time until expiration.
  • 28. INVESTMENTS | BODIE, KANE, MARCUS 2-28 Futures Contracts • A futures contract calls for delivery of an asset (or in some cases, its cash value) at a specified delivery or maturity date for an agreed-upon price, called the futures price, to be paid at contract maturity. • Long position: Take delivery at maturity • Short position: Make delivery at maturity
  • 29. INVESTMENTS | BODIE, KANE, MARCUS 2-29 Comparison Option • Right, but not obligation, to buy or sell; option is exercised only when it is profitable • Options must be purchased • The premium is the price of the option itself. Futures Contract • Obliged to make or take delivery. Long position must buy at the futures price, short position must sell at futures price • Futures contracts are entered into without cost