33C h a p t e r
Security TypesSecurity Types
second edition
Fundamentals
of InvestmentsValuation & Management
Charles J. Corrado Bradford D. Jordan
McGraw Hill / Irwin Slides by Yee-Tien (Ted) Fu
2002 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
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Security Types
Our goal in this chapter is to introduce the different types of securities that are routinely bought and sold in financial markets around the world.
Goal
For each security type, we will examine: its distinguishing characteristics, the potential gains and losses from owning it, and how its prices are quoted in the financial press.
2002 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
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Classifying Securities
Basic Types Major Subtypes
Interest-bearing Money market instruments
Fixed-income securities
Equities Common stock Preferred stock
Derivatives Options Futures
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Interest-Bearing Assets
Fixed-income securitiesLonger-term debt obligations, often of corporations or governments, that promise to make fixed payments according to a preset schedule.
Money market instrumentsShort-term debt obligations of large corporations and governments that mature in a year or less.
2002 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
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Money Market Instruments
Examples: U.S. Treasury bills (T-bills), bank certificates of deposit (CDs), corporate and municipal money market instruments.
Potential gains/losses: Fixed future payment, except when the borrower defaults.
Price quotations: Usually, the instruments are sold on a discount basis, and only the interest rates are quoted. So, some calculation is necessary to convert the rates to prices.
2002 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
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Fixed-Income Securities
Examples: U.S. Treasury notes, corporate bonds, car loans, student loans.
Potential gains/losses: Fixed coupon payments and final payment at
maturity, except when the borrower defaults. Possibility of gain/loss from fall/rise in interest
rates. Can be quite illiquid.
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Fixed-Income Securities Price quotations:
CUR NETBONDS YLD. VOL CLOSE CHG.
NEW YORK BONDSCorporation Bonds
ATT 73/407 …… 7.8 56 100 + 1/4
ATT 81/822 …… 8.6 433 94 1/8 + 5/8
ATT 81/824 …… 8.7 453 93 3/4 –
AT&T, the issuer of the bond.
ATT
The bond’s annual coupon rate. You will receive 81/8% of the bond’s face value each year in 2 semiannual coupon payments.
81/8
The bond will mature in the year 2022.
22
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Fixed-Income Securities Price quotations:
CUR NETBONDS YLD. VOL CLOSE CHG.
NEW YORK BONDSCorporation Bonds
ATT 73/407 …… 7.8 56 100 + 1/4
ATT 81/822 …… 8.6 433 94 1/8 + 5/8
ATT 81/824 …… 8.7 453 93 3/4 –
8.6
Current yield = annual coupon current price
433
The actual number of bonds traded that day.
94 1/8
The closing price for the day is 94.125% of
face value.
The closing price is up by 5/8 of1% from the previous closing price.
+ 5/8
2002 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
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Work the Web
Check out bond basics at:http://www.investinginbonds.com
2002 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
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Equities
Preferred stockThe dividend is usually fixed and must be paid before any dividends for the common shareholders. In the event of a liquidation, preferred shares have a particular face value.
Common stockRepresents ownership in a corporation. A part owner receives a pro rated share of whatever is left over after all obligations have been met in the event of a liquidation.
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Common Stock
Examples: IBM shares, Microsoft shares, etc. Potential gains/losses:
Many companies pay cash dividends to their shareholders. However, neither the timing nor the amount of any dividend is guaranteed.
The stock value may rise or fall depending on the prospects for the company and market-wide circumstances.
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Preferred Stock
Example: Citigroup preferred stock. Potential gains/losses:
Dividends are “promised.” However, there is no legal requirement that the dividends be paid, as long as no common dividends are distributed.
The stock value may rise or fall depending on the prospects for the company and market-wide circumstances.
Equities : Price quotations3 - 13
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Work the Web
Are you a Foolish investor? Go to “Fool School” at:http://www.fool.com
You can also learn more about the “ticker tape” at:http://www.stocktickercompany.com
and create your own ticker at:http://www.cnbc.com
2002 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
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Derivatives
Primary assetSecurity originally sold by a business or government to raise money.
Derivative assetA financial asset that is derived from an existing traded asset rather than issued by a business or government to raise capital. More generally, any financial asset that is not a primary asset.
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Derivatives
Futures contractAn agreement made today regarding the terms of a trade that will take place later.
Option contractAn agreement that gives the owner the right, but not the obligation, to buy or sell a specific asset at a specified price for a set period of time.
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Futures Contracts
Examples: financial futures, commodity futures.
Potential gains/losses: At maturity, you gain if your contracted price is
better than the market price of the underlying asset, and vice versa.
If you sell your contract before its maturity, you may gain or lose depending on the market price for the contract.
Note that enormous gains/losses are possible.
Futures Contracts Price quotations:
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2002 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
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Work the Web
You can download lots of basic futures information from the Knowledge Center at:http://www.cbot.com
2002 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
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Option Contracts
A call option gives the owner the right, but not the obligation, to buy an asset, while a put option gives the owner the right, but not the obligation, to sell an asset.
The price you pay to buy an option is called the option premium.
The specified price at which the underlying asset can be bought or sold is called the strike price, or exercise price.
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Option Contracts
An American option can be exercised anytime up to and including the expiration date, while a European option can be exercised only on the expiration date.
Options differ from futures in two main ways: There is no obligation to buy/sell the underlying
asset. There is a premium associated with the contract.
2002 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
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Option Contracts
Potential gains/losses: Buyers gain if the strike price is better than the
market price, and if the difference is greater than the option premium. In the worst case, buyers lose the entire premium.
Sellers gain the premium if the market price is better than strike price. Here, the gain is limited but the loss is not.
Option Contracts
Price quotations:
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Investing in Stocks versus Options
Example: Suppose you have $10,000 for investments. Macron
Technology is selling at $50 per share. Number of shares bought = $10,000 / $50 = 200 If Macron is selling for $55 per share 3 months later,
gain = ($55 200) – $10,000 = $1,000 If Macron is selling for $45 per share 3 months later,
gain = ($45 200) – $10,000 = – $1,000
2002 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
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Investing in Stocks versus Options
Example: …continued A call option with a $50 strike price and 3 months to
maturity is also available at a premium of $4. A call contract costs $4 100 = $400, so number of
contracts bought = $10,000 / $400 = 25 (for 25 100 = 2500 shares)
If Macron is selling for $55 per share 3 months later, gain = {($55 – $50) 2500} – $10,000 = $2,500
If Macron is selling for $45 per share 3 months later, gain = ($0 2500) – $10,000 = – $10,000
2002 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
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Chapter Review
Classifying Securities Interest-Bearing Assets
Money Market Instruments Fixed-Income Securities
Equities Common Stock Preferred Stock Common and Preferred Stock Price Quotes
2002 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
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Chapter Review
Derivatives Futures Contracts Futures Price Quotes Gains and Losses on Futures Contracts
Option Contracts Option Terminology Options versus Futures Option Price Quotes Gains and Losses on Option Contracts Investing in Stocks versus Options
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