Financial Assets Instruments

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Financial Assets (Instruments)
Chapter 2
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Assets

• Real asset
• a physically observable, or touchable, item

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Assets

• Financial asset
• an asset that represents a promise to distribute
  cash flows some time in the future

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Major Financial Instruments

• Treasury bills
• Repurchase agreements
• Federal funds
• Bankers acceptances
• Commercial paper
• Negotiable CDs
• Eurodollars
• Money market funds

• Treasury notes/bonds
• Municipal bonds
• Term loans
• Mortgages
• Corporate bonds
• Preferred stock
• Common stock

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Financial Instruments and the Firms Balance Sheet

• Firm issues financial instruments so it can
  purchase the tangible assets necessary to produce
  income

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Balance Sheet - Equity

• Common equity
• stockholders total investment in the firm
• Par value
• nominal or face value of a stock or bond
• Retained earnings
• earnings the firm has not paid out as dividends
  throughout its history
• Additional paid-in capital
• difference between the value of newly issued
  stock and its par value

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Debt - A loan to an individual, company, or
government

• Debt features
• Priority to assets and earnings
• Principal value, Face value, Maturity value, and
  Par value
• Interest payments or discounted securities
• Maturity date
• Control of the firm (voting rights)

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Short-Term Debt

• Treasury Bill (T-bill)
• Repurchase Agreement (Repo)
• Federal Funds
• Bankers Acceptance
• Commercial Paper
• Certificate of Deposit
• Eurodollar Deposit
• Money Market Mutual Fund

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Long-Term Debt

• Term Loans
• Bonds

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Government Bonds

• Treasury notes or bonds - issued by US government
• Municipal bonds - issued by state or local
  governments
• Revenue bonds
• General obligation bonds

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Corporate Bonds

• Mortgage bonds
• Debenture
• Subordinated debenture
• Income bond
• Putable bond
• Indexed (purchasing power) bond
• Floating rate bond
• Zero coupon bond
• Junk bond

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Bond Contract Features

• Bond Indenture
• Trustee
• Restrictive covenant
• Call provision
• Sinking fund
• call for redemption by annual lottery
• buy bonds on the open market
• Convertible

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Bond Ratings

• Moodys Investors Service (Moodys)
• Standard Poors Corporation (SP)
• Investment grade bonds
• triple B or better
• Criteria for rating bonds
• Importance of bond ratings
• Changes in ratings

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Yields on Selected Long-Term Bonds, 1965-2005
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Stock (Equity)

• Preferred stock has preference over common stock
  in distribution of dividends and assets dividend
  payments are fixed
• Preferred stock may provide for cumulative
  dividends, conversion into common stock, voting
  rights, dividend participation, sinking funds,
  call provisions, and even maturity

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Stock (Equity)

• Common stock
• represents ownership in a corporation
• common stockholders vote for members of the board
  of directors
• has last claim on distribution of earnings and
  assets
• may have preemptive rights to purchase any
  additional shares sold by the firm

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Stock (Equity)

• Classified stock
• special purpose stock
• Closely held corporations
• Publicly owned corporations

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Derivatives

• Value depends on some underlying asset such as a
  stock or bond
• Option - contract that gives the right to buy or
  sell an asset at a set price within a specified
  period of time
• Call holder has the right to buy
• Put holder has the right to sell
• Striking price exercise price of the option

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Derivatives

• Convertibles - bonds or preferred stocks that can
  be exchanged for common stock at the option of
  the holder
• Conversion ratio defines the number of shares of
  stock the convertible holder receives upon
  conversion
• Futures - arrangement for delivery of an item at
  a set future date at a set price

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Derivatives

• Swaps - an agreement to exchange cash flows or
  assets at a set time in the future

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Rationale for Using Different Types of Securities

• Differences in trade-off between risk and
  expected after tax return
• Appeal to broad market and different investment
  needs
• Differences in popularity through time

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Which Financial Instrument is Best?

• Issuers or investors viewpoint ?
• Bonds
• fixed interest payments
• does not represent ownership
• may have restrictions on dividends
• interest expense is deductible

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Which Financial Instrument is Best?

• Preferred stock
• fixed payment - but not obligated
• no voting rights
• higher after-tax cost since dividends are not
  deductible expenses

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Which Financial Instrument is Best?

• Common Stock
• no obligation of dividend payments
• no maturity date for repayment
• sales increases creditworthiness
• prospects affect terms
• gives control to stockholders
• shares the income of the firm
• higher costs of distribution than debt
• dividends are not deductible

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Risk Returns on Different Classes of Financial
Instruments
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Financial Instruments in International Markets

• American Depository Receipts (ADRs)
• represent ownership in stocks of foreign
  countries that are held in trust by a bank
  located in the country the stock is traded
• Foreign debt
• sold by a foreign borrower but denominated in the
  currency of the country in which it is sold

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Financial Instruments in International Markets

• Eurodebt
• debt sold in a country other than the one in
  whose currency the debt is denominated
• Eurobonds
• Eurocredits usually tied to London InterBank
  Offer Rate (LIBOR)
• Euro-commercial paper (Euro-CP)
• Euronotes

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Financial Instruments in International Markets

• Equity instruments
• Euro stock is traded in countries other than the
  home country of the company, not including the
  United States
• Yankee stock is stock issued for foreign
  companies that is traded in the United States

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End of Chapter 2

• Financial Assets (Instruments)