CHAPTER 2CHAPTER 2

InvestmentsInvestments

Asset Classes and Asset Classes and Financial Financial

InstrumentsInstruments

Slides bySlides by

Richard D. JohnsonRichard D. Johnson

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reservedCopyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/IrwinMcGraw-Hill/Irwin

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Major Classes of Financial Assets or Securities

Money marketBond marketEquity marketsIndexesDerivative markets

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Money Market Instruments

Treasury billsCertificates of deposits Commercial PaperBankers Acceptances

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Money Market Instruments cont.

EurodollarsRepurchase Agreements (RPs) and

Reverse RPsBrokers’ CallsFederal FundsLIBOR Market

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Figure 2.1 Rates on Money Market Securities

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Table 2.1 Major Components of the Money Market

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Figure 2.2 Treasury Bill Listing

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Figure 2.3 Spread between 3-month CDs and Treasury Bill Rates

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Bond Market

Treasury Notes and BondsInflation-Protected Treasury BondsFederal Agency DebtInternational BondsMunicipal BondsCorporate BondsMortgages and Mortgage-Backed

Securities

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Treasury Notes and Bonds

Maturities– Notes – maturities up to 10 years

– Bonds – maturities in excess of 10 years

– 30-year bond• 2001 Treasury suspended sales

• 2006 Treasury resume sales

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

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Figure 2.4 Treasury Bonds and Notes

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Federal Agency Debt

Major issuers– Federal Home Loan Bank

– Federal National Mortgage Association

– Government National Mortgage Association

– Federal Home Loan Mortgage Corporation

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Figure 2.5 Government Agency Issues

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Municipal Bonds

Issued by state and local governmentsTypes

– General obligation bonds

– Revenue bonds• Industrial revenue bonds

Maturities – range up to 30 years

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Figure 2.6 Tax-exempt Debt Outstanding

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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

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Table 2.2 Equivalent Taxable Yields

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Figure 2.7 Ratio of Yields on Tax-exempts to Taxables

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Corporate Bonds

Issued by private firms Semi-annual interest paymentsSubject to larger default risk than

government securitiesOptions in corporate bonds

– Callable

– Convertible

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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

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Figure 2.8 Mortgage-backed Securities Outstanding

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Equity Markets

Common stock– Residual claim

– Limited liability

Preferred stock– Fixed dividends - limited

– Priority over common

– Tax treatment

Depository receipts

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Figure 2.9 Stock Market Listings

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Track average returnsComparing performance of managersBase of derivatives

Uses of Stock Indexes

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Representative? Broad or narrow? How is it weighted?

Factors for Construction of Stock Indexes

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Examples of Indexes - Domestic

Dow Jones Industrial Average (30 Stocks)Standard & Poor’s 500 CompositeNASDAQ CompositeNYSE CompositeWilshire 5000

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Figure 2.10 Performance of Major Stock Indexes

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Examples of Indexes - Int’l

Nikkei 225 & Nikkei 300FTSE (Financial Times of London)DaxRegion and Country Indexes

– EAFE

– Far East

– United Kingdom

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Construction of Indexes

How are stocks weighted?– Price weighted (DJIA)

– Market-value weighted (S&P500, NASDAQ)

– Equally weighted (Value Line Index)

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Derivatives Securities

Options Basic Positions

– Call (Buy)

– Put (Sell)

Terms– Exercise Price

– Expiration Date

– Assets

Futures Basic Positions

– Long (Buy)

– Short (Sell)

Terms– Delivery Date

– Assets