Financial Securities

1
Chapter 2

• Financial Securities

2
Outline

• Major assets traded. (ttp//finance.yahoo.com/?u)
• Fixed income
• Money market instruments
• Bonds
• Equity securities
• Derivatives
• Understanding Index
• Different index
• Construction of index

3
Markets and Instruments
4
Money Market Instruments

• T(Treasury) bills
• Short-term government debt security
• Issued at discount from face value and returning
  the face value at maturity
• Certificates of deposit
• Time deposit with a bank
• CD issued in denominations larger than 100,000
  are usually negotiable-sellable in the secondary
  market
• Commercial Paper
• Short term unsecured debt issued by large corp
  directly to the public.

5
Money Market Instruments

• Bankers Acceptances
• An order to a bank by a customer to pay a sum of
  money at a future date.
• Like postdated check, with bank endorsement
• Widely used in foreign trade
• Sell at discount in secondary market
• Eurodollars
• denominated deposits at foreign bank or foreign
  branches of US bank
• Can be traded in secondary market like CD before
  its maturity
• Federal Funds
• Deposits of banks at Fed
• Used for reserve requirements and transaction
• Banks with surplus lend to those with shortage
• Not directly sold to investors

6
Money market instruments

• Repurchases agreements and reverses
• Def. Short-term sales of government securities
  with an agreement of repurchase at a higher price
  Reverse repo mirror image of a repo. Buys
  government securities with an agreement to resell
  them at a prespecified higher price
• Q Who is who? A Seller of security (borrower of
  funds) vs. Buyer (lender)
• Price increase is interest
• Security is collateral

7
Bonds

• Publicly Issued Instruments
• US Treasury Bonds and Notes
• Agency Issues (Fed Gov)
• Municipal Bonds
• Privately Issued Instruments
• Corporate Bonds
• Mortgage-Backed Securities

8
Equity

• Common stock
• Residual claim
• Limited liability
• Preferred stock
• Fixed dividends - limited
• Priority over common

9
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

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Define option

• Option is the right to buy or sell an asset at a
  specified exercise price on or before a specified
  expiration date.
• Call Option
• Put Option
• Check

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Market and Exercise Price Relationships

• In the Money - exercise of the option would be
  profitable (without considering the cost/premium
  of the option)
• Call market pricegtexercise price
• Put exercise pricegtmarket price
• Out of the Money - exercise of the option would
  not be profitable
• Call market priceltexercise price
• Put exercise priceltmarket price
• At the Money - exercise price and asset price are
  equal

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Stock Indexes

• Uses
• Track average returns
• Comparing performance of managers
• Base of derivatives

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Examples of Indexes - Domestic

• Dow Jones Industrial Average (30 Stocks)
• Standard Poors 500 Composite
• NASDAQ Composite
• NYSE Composite
• Dow Jones Wilshire 5000
• Included all stocks(over 5,000) traded in US with
  available data

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Construction of Indexes

• How are stocks weighted?
• Price weighted (DJIA)
• Market-value weighted (SP500, NASDAQ)
• Equally weighted (Value Line Index)

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Construction of Indexes

• Price weighted

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Construction of Indexes

• Price-weighted average
• Adding the price and divided by a divisor ( of
  stocks or adjusted divisor)
• Index0(25100)/262.5
• Index1(3080)/255

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Construction of Indexes

• Price weighted-adjusting for splits

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Construction of Indexes

• Price-weighted adjusting for splits
• Calculate new index value without split effect(
  from time 0 to 1, stock prices can change without
  split effects)
• index1(30100)/265
• With split, index1 should also equal 65
• (3050)/d65 d1.23
• (3050)/1.2365
• d is divisor

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Construction of Indexes

• Market value-weighted
• The weight is based on the market value of each
  component stock
• Set initial level to an arbitrarily chosen
  starting value (e.t. 100)
• New level 100(new market value 700/old initial
  market value 600)116.67

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Construction of Indexes

• Equal weighted
• Each stock has the same weight
• Set initial level to an arbitrarily chosen
  starting value (e.t. 100)
• The change of the indexthe simple average of
  the change of each component stock
• change of Yahoo(30-25)/2520
• change of MSFT(50-50)/500
• change of index(200)/210
• New level 100(1 change of the index)
• 100(110)110