Investment Choices in investment portflio

1. Global Investment
Choices

2. Short Term Investment Vehicles
•Certificates of deposit
• Treasury bills
• Commercial paper
• Bankers’ acceptances
• Repurchase agreements
•Eurodollar CD
•Federal Funds

3. Certificate of Deposit
•Certificate of deposit is debt instrument issued by a bank that
indicates a specified sum of money has been deposited at the
issuing depository institution.
•Most certificates of deposit cannot be traded and they incur
penalties for early withdrawal.
• For large money-market investors financial institutions allow
their large-denomination certificates of deposits to be traded as
negotiable certificates of deposits.

4. Treasury bills
•Treasury bills (T-bills) are securities representing financial
obligations of the government. Treasury bills have maturities of
less than one year.
•They have the unique feature of being issued at a discount.
• The other important feature of T-bills is that they are treated as
risk-free securities ignoring inflation and default of a
government

5. Commercial paper
•Commercial paper is a short-term unsecured promissory notes
issued by a corporation.
•Commercial paper is a means of short-term borrowing by large
corporations. Large, well-established corporations have found
that borrowing directly from investors through commercial paper
is cheaper than relying only on bank loans.
•Commercial paper, like T-bills is issued at a discount. The most
common maturity range of commercial paper is 30 to 60 days or
less.
•Commercial paper is riskier than T-bills.
•Not bought and sold after it is issued, because the issues are
relatively small compared with T-bills and hence their market is
not liquid.

6. Banker‘s acceptance
• A banker’s acceptance is a bank draft (a promise of payment
similar to a cheque) issued by a firm, payable at some future date,
and guaranteed for a fee by the bank that stamps it “accepted.”
• The firm issuing the instrument is required to deposit the required
funds into its account to cover the draft. If the firm fails to do so, the
bank’s guarantee means that it is obligated to make good on the
draft.

7. Banker‘s acceptance(Cont.)
•The advantage to the firm is that the draft is more likely to be
accepted when purchasing goods abroad, because the foreign
exporter knows that even if the company purchasing the goods goes
bankrupt, the bank draft will still be paid off.
• These “accepted” drafts are often resold in a secondary market at a
discount.. Typically The interest rate is higher than similar short term
securities to compensate for the default risk.
•Bankers’ acceptances are not standardized, there is no active trading
of these securities.

8. Repurchase agreement
•Repurchase agreement (repo) is the sale of security with a
commitment by the seller to buy the security back from the
purchaser at a specified price on a designated future date.
•A repo is a collateralized short-term loan, where collateral is a
security. The collateral in a repo may be a Treasury security or other
money-market security.
•The maturity of repo is usually very short. If the agreement is for
one day, it is called overnight repo; if the term of the agreement is
for more than one day, it is called a term repo.
•A reverse repo is the opposite of a repo. In this transaction a
corporation buys the securities with an agreement to sell them at a
specified price and time.
•Repos help to increase the liquidity in the money market.

9. Example:
•Assume General Motors, may have some idle funds in its bank
account, say $1 million, which it would like to lend for a week.
GM uses this excess $1 million to buy treasury bills from a bank,
which agrees to repurchase them the next week at a price slightly
above GM’s purchase price.
•The effect of this agreement is that GM makes a loan of $1
million to the bank and holds $1 million of the bank’s treasury
bills until the bank repurchases the bills to pay off the loan.
• Repurchase agreements are a fairly recent innovation in financial
markets, introduced in 1969.
•They are now an important source of bank funds (over $400
billion). The most important lenders in this market are large
corporations.

10. Eurodollar CDs:
•Eurodollar CDs are certificates of deposit issued by a bank
outside the U.S. and denominated in U.S. dollars.
•Technically, any certificate of deposit that is denominated in a
currency outside the bank of origin can be called a Eurodollar
CD.
•However, the great majority are in U.S. dollars. They are
short-term CDs (less than 12 months maturity) and typically
yield a higher interest rate than the domestic CDs of U.S. banks.

11. Federal Funds:
•These are typically overnight loans by banks to other banks.
•Reason why a bank might borrow in the overnight funds market is
that it might find it does not have enough settlement deposits at the
Central Bank .It can then borrow these balances from another bank
with excess settlement balances.
•The interest rate on overnight loans(Federal funds rate), is a closely
watched barometer of the tightness of credit market conditions in the
banking system and the stance of monetary policy. When it is high, it
indicates that the banks are strapped for funds, whereas when it is
low, banks’ credit needs are low.

12. Pricing Issuer Characteristic
Treasury
Bills
Discount
Paper
US Treasury
“Full Faith and Credit” of the US
Government
Commercial
Paper
Corporations
Short term corporate debt
Bankers
Acceptance
Banks
Finances self-liquidating
transaction involving non-US
entity
Certificate of
Deposit
Interest
at
Maturity
Borrowing by banks from
investors
Federal
Funds
Borrowing by Banks from other
banks
Repurchase
Agreement
Money Market
Dealers
Borrowing with financial assets as
collateral in order to lend at a
higher rate: “Pawnshop Model”
Money Market Instruments

13. Fixed Income Securities
Treasury Securities :
•All government securities issued by the Treasury are fixed
income instruments. They may be bills, notes, or bonds
depending on their initial times to maturity.
•Bills mature in one year or less, notes in over one to 10 years,
and bonds in more than 10 years from time of issue.
•Government obligations are essentially free of credit risk
because there is little chance of default and they are highly
liquid.

14. Government Agency Securities:
•Government Agency securities are sold by various agencies of the
government to support specific programs, but they are not direct
obligations of the Treasury.

15. Municipal Bonds :
•Municipal bonds are issued by local government entities as either
general obligation or revenue bonds.
•General obligation bonds (GOs) are backed by the full taxing
power of the municipality.
•Revenue bonds pay the interest from revenue generated by
specific projects.

16. Municipal Bonds(Cont.):
•Municipal bonds differ from other fixed-income securities because
they are tax-exempt.
•The interest earned is exempt from taxation by the federal
government and historically by some states that issued the bond,
provided the investor is a resident of that state.
• For this reason, municipal bonds are popular with investors in high
tax brackets

17. Corporate Bonds:
•Corporate bonds are fixed-income securities issued by corporations to
raise funds to invest in plant, equipment, or working capital.
•Sinking Fund provisions
•Categories of Corporate bonds based on their contractual promises to
investors.
Secured bonds:
•These are the most senior bonds in a firm’s capital structure and have
the lowest risk of default. They include various secured issues that
differ based on the assets that are pledged

18. Mortgage bonds:
These are backed by liens on specific assets, such as land and
buildings. In the case of default, the proceeds from the sale of these
assets are used to pay off the mortgage bondholders.
Collateral trust bonds:
These are also a form of mortgage bond except that the assets
backing the bonds are financial assets, such as stocks, notes, and
other high-quality bonds.

19. Equipment trust Certificates:
ETCs are mortgage bonds that are secured by specific pieces of
transportation equipment, such as locomotives for a railroad and
airplanes for an airline.
Debentures:
•Debentures are promises to pay interest and principal, but they
pledge no specific assets ( collateral) in case the firm does not fulfill
its promise.
•Bondholder depends on the success of the borrower to make the
promised payment

20. Subordinated bonds
•:Subordinated bonds are similar to debentures but in the case of
default, subordinated bondholders have claim to the assets of the firm
only after the firm has satisfied the claims of all senior secured and
debenture bondholders.
•The claims of subordinated bondholders are secondary to those of
other bondholders.

21. Income bonds:
• Income bonds make interest payment only if the issuers earn the
income to make the payment by stipulated dates.
• If the company does not earn the required amount, it does not
have to make the interest payment and it cannot be declared in
default.
• The interest payment is considered in arrears and, if
subsequently earned, it must be paid off.

22. Callable and Putable bonds:
Callable bonds can be redeemed at the issuer’s discretion prior to
the specified maturity (redemption) date. Putable bonds can be sold
back to the issuer on specified dates, prior to the redemption date.
Convertible bonds:
These are usually corporate bonds, issued with the option for holders
to convert into some other asset on specified terms at a future date.
Conversion is usually into equities in the firm, though it may
sometimes be into floating rate notes.

23. Floating Rate Notes (FRNs):
•These are corporate bonds where the coupon can be adjusted at
pre-determined intervals.
•The adjustment will be made by reference to some benchmark rate,
specified when the bond is first issued.
•An FRN might specify, for example, that its coupon should be fifty
basis points above six-month treasury bill rate, or six-month
LIBOR, adjusted every six months.
•FRNs are, in part, a response to high and variable inflation rates.

24. Index-linked bonds:
These are corporate bonds where the coupon can be adjusted to high
and variable rates of inflation. While other bonds have a maturity
(redemption) value fixed in nominal terms and therefore suffer a
decline in real value as a result of inflation, both the value and the
coupon of an index-linked bond are up rated each year in line with
lagged changes in a specified price index.
Junk bonds:
Junk bonds are corporate bonds whose issuers are regarded by bond
credit rating agencies as being of high risk. They will carry a rate of
interest at least 200 basis points above that for the corresponding
bonds issued by high-quality borrowers.

25. Strips:
• Stripping refers to the breaking up of a bond into its component
coupon payments and its maturity (redemption) value.
•A ten-year bond, paying semi-annual coupons, would make twenty-
one strips. Each strip is then sold as a zero-coupon bond.
•It pays no interest but is sold at a discount to the payment that will
eventually be received.
•It is like a long-dated bill. The strips are created from conventional
bonds.

26. Warrants:
•Warrants are instruments that give the bond holders the right to
purchase a certain number of shares of the issuer’s common stock at
a specified price over a certain period of time.
•Enables the issuer to pay a slightly lower coupon rate than would
otherwise be required.
Zero coupon bond:
It promises no interest payments during the life of the bond but only
the payment of the principal at maturity.

27. Preferred Stock:
Preferred stock is an equity security, which has infinitive life and pay
dividends. But preferred stock is attributed to the type of fixed-
income securities, because the dividend for preferred stock is fixed in
amount and known in advance.
•Hybrid security
•Preferred stock is an attractive source of financing for highly
leveraged companies.

28. Eurobonds
An international bond denominated in a currency other than the
country where it is issued .
Example: A US company issues bond and raises capital in Japan
denominated in US Dollar. This will be an example Euro Bond. If the
US company issues bond in Pound sterling in Japan, it will also be
considered as Euro Bond
Foreign Bond:
Foreign Bond is a bond where foreign company issues bond
denominated in the currency denomination of the foreign country.
Example: A US company issues bond and raises capital in Japan
denominated in Japanese Yen. Japanese investors are not exposed to
foreign exchange risk while investing in a foreign bond.

29. Interesting Names of Foreign Bonds.
Yankee Bonds Foreign Bonds sold in U.S.
Samurai Bonds Foreign Bonds sold in Japan.
Bulldog Bonds Foreign Bonds sold in U.K.
Rembrandt Bond Foreign Bonds sold in Netherland.
Matador Bond Foreign Bonds sold in Spain.

30. Dual Currency Bonds:
•In a dual currency bond, the principal and coupon rate denominated
in two different currencies.
•Dual currency bonds are different from the dual trench Eurobonds
issued. In a dual trench bond issue, a company simultaneously offers
bonds in two different currencies, say, USD and Yen. But interest
and principal is denominated in a single currency.

31. Common Stock
•Represents ownership of a firm Investor’s return tied to the
performance of the company and may result in loss or gain.
•Residual claimants
•Voting right
Acquiring Foreign Equities
•Investors may invest into foreign shares by purchasing shares
directly, purchasing American Depository Receipts (ADRs),
Global Depository Receipts (GDRs).
•Alternatively, investments can be made by investing into
international funds or purchasing exchange traded funds (ETFs).

32. American Depository Receipts (ADR)
•American Depository Receipts (ADR) is an arrangement under
which foreign shares are deposited within a US bank, which in
turn issues ADRs in the name of foreign company.
•Dividends are also paid in US dollars, even if the underlying
security’s cash flows are denominated in terms of foreign issuer’s
home currency.

33. Global Depository Receipts (GDRs)
•Global Depository Receipts (GDRs) are negotiable receipts issued
by financial institutions in developed countries against shares of
foreign companies.
•Financial institution collects and distributes dividends paid by the
foreign firm to the GDR (also ADR) investor.
•Financial institutions facilitate access to world equity markets by
intermediating between world investors and companies in
developing and transition countries.

34. Direct purchases of foreign shares
•Direct purchases of foreign shares can be limited due to limited
access to the stock exchanges.
•Limited available set of shares, high transaction costs through
specialized brokerage companies.
Exchange traded funds (ETFs)
•Exchange traded funds (ETFs) are passive funds, that track specific
index. Thus investor can invest into a specific index, representing a
country’s (e.g. foreign) stock market.
• ETFs are denominated in US dollars as a rule, the net asset value of
an international ETF is determined by translating foreign currency
value of the foreign securities into dollars.

35. ETFs Contd.
•The price of each international ETF is denominated in US dollars,
the underlying securities that make up the index are denominated
in non-US currencies.
•The return on ETF will be influenced by the movement of the
country’s currency against dollar. If the country’s currency
appreciates, this will increase the value of the index as measured in
dollars.
•On the other hand, if the foreign currency depreciates, this will
reduce the value of the index as measured in dollars.

36. Purchase or Sale of Global Mutual Funds
•It possible for investors to indirectly acquire the stocks of firms
from foreign countries.
•The alternatives range from global funds, which invest in both
domestic stocks and foreign stocks, to international funds, which
invest almost totally outside the Domestic.
•International funds can (1) diversify across many countries,(2)
concentrate in a segment of the world (for example, Europe, South
America, the Pacific basin), (3) concentrate in a specific country
(for example, the Japan Fund, the Germany Fund, the Italy Fund,
or the Korea Fund), or (4) concentrate in types of markets (for
example, emerging markets, which would include stocks from
countries such as Thailand, Indonesia, India, and China).

37. Speculative investment vehicles
•Using these investment vehicles speculators try to buy low and
to sell high, their primary concern is with anticipating and
profiting from the expected market fluctuations.
•The only gain from such investments is the positive difference
between selling and purchasing prices.
• Options
• Futures

38. Options
•An options contract gives its owner the right, but not the
obligation, to buy or to sell a financial asset at a specified price
from or to another party.
•The buyer of the contract must pay a fee (option price) for the
seller.
•There is a big uncertainty about if the buyer of the option will
take the advantage of it and what option price would be relevant,
as it depends not only on demand and supply in the options
market, but on the changes in the other market where the financial
asset included in the option contract are traded.
•Option are risky financial instruments for those investors who use
for speculations instead of hedging.

39. Futures
•A future contract is an agreement between two parties to
exchange some financial asset at a predetermined price at a
specified future date.
• One party agree to buy the financial asset, the other agrees to
sell the financial asset.
•In futures contract case both parties are obligated to perform and
neither party charges the fee.

40. Investment companies/ investment funds
•They receive money from investors with the common objective
of pooling the funds and then investing them in securities
according to a stated set of investment objectives.
Two types of funds:
• open-end funds
• closed-end funds

41. Open -End Fund
Open End Funds are Portfolios of Securities, mainly stocks,bonds,and
money market instruments.
Important Aspects:
i. Investors in mutual funds own a pro rata share of the overall
portfolio
ii. The Fund is managed by Investment managers
iii. The Value or Price each share of the portfolio is called Net Asset
Value(NAV):
NAV=Market value of portfolio – Expenses/No. of shares
iv. The NAV is determined only once each day at close
v. All new investments into the fund or withdrawals from the fund during
a day are priced at the closing NAV.
vi. Investments after the end of the day or on a non- business day are
priced at the next day's closing NAV.

42. Open-end Fund
•Investors can contribute to an open-end fund at any time. The fund
simply increases the number of shares outstanding.
•Another feature of open-end funds is that the fund agrees to buy back
shares from investors at any time.
•Each day the fund’s net asset value is computed based on the number of
shares outstanding and the net assets of the fund. All shares bought and
sold that day are traded at the same net asset value.

43. Closed-End Funds
•Closed-end funds have a fixed number of nonredeemable shares sold at
an initial offering and are then traded in the market like common stocks.
•The market price of these shares fluctuates with the value of the assets
held by the funds.
•The market value of the shares may be above or below the NAV,
depending on the market’s assessment of how likely managers are to pick
stocks that will increase fund value.

44. Advantage and Disadvantage of Closed-End Funds
•The problem with closed-end funds is that once shares have
been sold, the fund cannot take in any more investment dollars.
Thus, to grow the fund managers must start a whole new fund.
•The advantage of closed-end funds to managers is that investors
cannot make withdrawals. The only way investors have of
getting money out of their investment in the fund is to sell
shares.