This document discusses various types of financial assets and instruments. It begins by defining real assets as tangible items and financial assets as promises to distribute future cash flows. It then lists and describes various short-term and long-term debt instruments, as well as equity instruments like preferred and common stock. Derivatives, which derive their value from underlying assets, are also covered. The document considers factors in choosing different financial instruments from both issuer and investor perspectives.

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)