chap002

McGraw-Hill/Irwin Copyright © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

Asset Classes and Asset Classes and Financial Financial InstrumentsInstruments

Lecture 2

2-2

Major Classes of Financial Assets

or Securities

• Money market• Bond market• Equity markets• Indexes• Derivative markets

2-3

2-4

Money Market Instruments

• Treasury bills• Certificates of deposits • Commercial Paper• Bankers Acceptances

2-5

Money Market Instruments

• Eurodollars• Repurchase Agreements (RPs) and

Reverse RPs• Brokers’ Calls• Federal Funds• LIBOR Market

2-6

Figure 2.1 Money Rates

2-7

Table 2.2 Components of Table 2.2 Components of the Money Marketthe Money Market

2-8

Figure 2.2 Treasury Bills

2-9

Figure 2.3 Spreads on CDs and Figure 2.3 Spreads on CDs and Treasury BillsTreasury Bills

2-10

An investor in a T-bill earns interest by

a. Receiving interest payments every 90 days

b. Receiving dividend payments every 30 days

c. Converting the T-bill at maturity into a higher valued T-note

d. Buying the bill at a discount from the face value received at maturity

2-11

2.2BOND MARKET

2-12

Bond Market

• Treasury Notes and Bonds• Federal Agency Debt• International Bonds• Inflation-Protected Bonds• Municipal Bonds• Corporate Bonds• Mortgages and Mortgage-Backed

Securities

2-13

Treasury Notes and Bonds

• Maturities– Notes – maturities up to 10 years– Bonds – maturities in excess of 10 years

• Par Value - $1,000• Quotes – percentage of par

2-14

Figure 2.4 Treasury Notes Figure 2.4 Treasury Notes and Bondsand Bonds

2-15

Federal Agency Debt

• Major issuers– Federal Home Loan Bank– Federal National Mortgage Association

(Fannie Mae)– Government National Mortgage

Association (Ginnie Mae)– Federal Home Loan Mortgage

Corporation (Freddie Mae)

2-16

Municipal BondsMunicipal Bonds

• Issued by state and local governments

• Types– General obligation bonds– Revenue bonds

• Industrial revenue bonds

• Maturities – range up to 30 years

2-17

Municipal Bond Yields

• Interest income on municipal bonds is not subject to federal and sometimes state and local tax

• To compare yields on taxable securities a Taxable Equivalent Yield is constructed

2-18

Corporate Bonds

• Issued by private firms • Semi-annual interest payments• Subject to larger default risk than

government securities• Options in corporate bonds

– Callable– Convertible

2-19

Figure 2.7 Investment Grade Bond Listings

2-20

• Developed in the 1970s to help liquidity of financial institutions

• Proportional ownership of a pool or a specified obligation secured by a pool

• Market has experienced very high rates of growth

Mortgages and Mortgage-backed Securities

2-21

Figure 2.8 Mortgage-Backed Figure 2.8 Mortgage-Backed Securities OutstandingSecurities Outstanding

2-22

__________ is not a money market instrument. 

a. A certificate of depositb. A treasury billc. A treasury bondd. Commercial paper

2-23

EQUITY SECURITIES

2-24

Equity Markets

• Common stock– Residual claim– Limited liability

• Preferred stock– Fixed dividends - limited– Priority over common– Tax treatment

• Depository receipts

2-25

Figure 2.9 Stock Market Listings

2-26

DiscussionA. If you buy 100 shares of HSBC common stock, to what are you

entitled?B. What is the maximum gain?C. If you pay $85 per share, what is the

maximum loss?

2-27

STOCK AND BOND MARKET INDEXES

2-28

• There are several indexes worldwide such as:– Dow Jones Industrial Average (DJIA)– Nikkei Average– Hang Seng Index

• Offer ways of comparing performance of managers

Stock Market Indexes

2-29

• Representative?• Broad or narrow?• How is it weighted?

– Price weighted (DJIA)– Market weighted (S&P 500, NASDAQ)– Equal (Value Line Index)

Factors for Construction of Factors for Construction of Stock IndexesStock Indexes

2-30

Table 2.4 Data to Construct Table 2.4 Data to Construct Stock Price IndexesStock Price Indexes

2-31

DJIADJIA Price-Weighted Average Price-Weighted Average

• Using data from Table 2.4; example 2.2Initial value = $25 + $100 = $125Final value = $30 + $ 90 = $120Percentage change in portfolio value =Initial index value = (25 + 100)/2 = 62.5Final index value = (30 + 90)/2 = 60

Percentage change in index = -2.5/62.5 = -.04 = -4%

2-32

S&P’s Composite 500S&P’s Composite 500 Market Value-Weighted Index Market Value-Weighted Index

• Using data from Table 2.4:Using data from Table 2.4:– ABC would have five times the weight ABC would have five times the weight

given to XYZgiven to XYZ

• Initial Value = 25*20 + 100*1 = 600Initial Value = 25*20 + 100*1 = 600• Final Value = 30*20 + 90*1 = 690Final Value = 30*20 + 90*1 = 690• Index Value = 100 X (690/600) = 115Index Value = 100 X (690/600) = 115• Percentage change in index = 15%Percentage change in index = 15%

2-33

Value LineValue LineEqually Weighted IndexEqually Weighted Index

• Places equal weight on each return• Using data from Table 2.4

Start with equal dollars in each investmentABC increases in value by 20%XYZ decreases by 10%Need to rebalance to keep equal weights

2-34

Examples of Other Indexes - Domestic

• Dow Jones Industrial Average (30 Stocks)

• Standard & Poor’s 500 Composite• NASDAQ Composite• NYSE Composite• Wilshire 5000

2-35

Figure 2-10 Comparative Performance of Several Stock

Market Indexes

2-36

Examples of Indexes - International

• Nikkei 225 & Nikkei 300• FTSE (Financial Times of London)• Dax• Region and Country Indexes

– EAFE– Far East– United Kingdom

2-37

Table 2.6 Sample of MSCI Stock Table 2.6 Sample of MSCI Stock IndexesIndexes

2-38

The Hang Seng Index is a(n) __________ weighted index. 

a. Equallyb. Pricec. Valued. Share

2-39

DERIVATIVE MARKETS

2-40

Derivative Securities

Options• Basic Positions

– Call – Put

• Terms– Exercise Price– Expiration Date– Assets

Futures • Basic Positions

– Long – Short

• Terms– Delivery Date– Assets

2-41

References • Bodie, Kane, and Marcus, Essentials

of Investments, 7th Edition, McGraw-Hill, pp 24-54

• http://www.hsi.com.hk/HSI-Net/