4030 Chap 002

Embed Size (px)

Citation preview

  • 8/2/2019 4030 Chap 002

    1/42

    Chapter 2

    Asset Classesand FinancialInstruments

    Copyright 2010 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

  • 8/2/2019 4030 Chap 002

    2/42

    Money Market Instruments

    Treasury Bills

    Certificates of Deposits

    Commercial Paper

    Bankers Acceptances

    Eurodollars Repurchase Agreements (RPs) and Reverse RPs

    Federal Funds

    LIBOR Market

  • 8/2/2019 4030 Chap 002

    3/42

    Table 2.2 Major Components of theMoney Market

    2-3

  • 8/2/2019 4030 Chap 002

    4/42

    Figure 2.2 Treasury Bills (T-bills)

    2-4

  • 8/2/2019 4030 Chap 002

    5/42

    Figure 2.3 Spreads on CDs andTreasury Bills

    2-5

  • 8/2/2019 4030 Chap 002

    6/42

    MMMFs in 2008 Between 2005 and 2008 money market mutual funds

    (MMMFs) grew by 88%. Why?

    MMMFs had their own crisis in 2008 when LehmanBrothers filed for bankruptcy on September 15.

    Some funds had invested heavily in Lehmanscommercial paper.

    On Sept. 16, Reserve Primary fund broke the buck.What does this mean?

    A run on money market funds ensued.

    The U.S. Treasury temporarily offered to insure allmoney funds to stop the run

    - (up to $3.4 trillion in these funds.)

    2-6

  • 8/2/2019 4030 Chap 002

    7/42

    Money Market Instrument Yields

    Yields on money market instrumentsare not always directly comparable

    Factors influencing quoted yields Par value vs. investment value

    360 vs. 365 days assumed in a year

    (366 leap year) Simple vs. Compound Interest

    2-7

  • 8/2/2019 4030 Chap 002

    8/42

    Bank Discount Rate (T-Bill quotes)

    rrBDBD = bank discount rate= bank discount rate

    FF = Face Value= Face Value

    PP = Market Price= Market Price

    nn = number of days to maturity= number of days to maturity

    rrBDBD == FF -- PP

    FFxx360360

    nn

    90-day T-bill, P = $9,87590-day T-bill, P = $9,875ExampleExample

    rrBDBD == $10,000$10,000--$9,875$9,875

    $10,000$10,000xx

    360360

    9090== 5%5%

    $10,000 = Face

    2-8

  • 8/2/2019 4030 Chap 002

    9/42

    Bond Equivalent Yield

    Cant compare T-bill directly to bond

    360 vs 365 days

    Return is figured on par vs. price paid

    Adjust the bank discount rate to make itcomparable

    2-9

  • 8/2/2019 4030 Chap 002

    10/42

    Bond Equivalent Yield

    P = price of the T-billP = price of the T-bill

    n = number of days to maturityn = number of days to maturity

    rrBEYBEY == 10,00010,000 -- PP

    PPxx

    365365nn

    rrBEYBEY == 10,00010,000 -- 9,8759,8759,8759,875

    xx 3653659090

    rrBEYBEY = .0127 x 4.0556 = .0513 = 5.13%= .0127 x 4.0556 = .0513 = 5.13%

    Example Using Sample T-BillExample Using Sample T-Bill

    2-10

  • 8/2/2019 4030 Chap 002

    11/42

    Effective Annual Yield

    P = price of the T-billP = price of the T-bill

    n = number of days to maturityn = number of days to maturity

    rEAY = 5.23%

    Example Using Sample T-BillExample Using Sample T-Bill

    rBD=5%

    rBEY

    =5.13%

    rEAY

    =5.23%

    1111,11$

    1

    111

    +=n

    EAYP

    Pr

    1111,1$

    111,1$111,11$1 11

    111

    +=EAYr

    2-11

  • 8/2/2019 4030 Chap 002

    12/42

    Money Market Instruments

    Treasury bills Certificates of deposit

    Commercial Paper

    Bankers Acceptances

    Eurodollars

    Federal Funds Repurchase Agreements (RPs)and Reverse RPs

    Discount

    BEY*

    Discount

    Discount

    BEY*

    BEY*

    Discount

    2-12

  • 8/2/2019 4030 Chap 002

    13/42

    Bond Market

    Corporate Bonds GE

    Government Treasury Notes and Bonds

    Federal Agency Debt GMNA

    Municipal Bonds

    Colorado E470 International Bonds

    Mortgages and Mortgage-Backed Securities

  • 8/2/2019 4030 Chap 002

    14/42

    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 2005 discussion to possibly resume sales

    Sales have resumed

    Par Value - $1,000

    Quotes percentage of par Not Subject to State and Local Tax

    One Arm of the Government cant tax the other

  • 8/2/2019 4030 Chap 002

    15/42

    Capital Market - Fixed IncomeInstruments

    2-15

  • 8/2/2019 4030 Chap 002

    16/42

    Federal Agency Debt

    Major issuers Government National Mortgage Association (GNMA)-

    Ginnie Mae

    Federal Home Loan Bank (FHLB)

    Federal National Mortgage Association (FNMA)-Fannie Mae

    Federal Home Loan Mortgage Corporation (FHLMC)-

    Freddie MacAlso Student Loan Marketing Association (SLM)- SallieMae

  • 8/2/2019 4030 Chap 002

    17/42

    Municipal Bonds

    Issued by state and local governments Types

    General obligation bonds Ad Valorem- backed by unlimited taxing power

    Revenue bonds Industrial revenue bonds- backed revenue from project

    Maturities range up to 30 years

    Not Subject to Federal Tax

    Not subject to State and Local tax when investoris resident of State Colorado Residents investing in E470 Muni

    Fi 2 5 O t t di T

  • 8/2/2019 4030 Chap 002

    18/42

    Figure 2.5 Outstanding TaxExempt Debt

    2-18

  • 8/2/2019 4030 Chap 002

    19/42

    Municipal Bond Yields

    To compare yields on taxable securities aTaxable Equivalent Yield is calculated

    TEY= Tax Free Yield/(1- Tax Bracket) Colorado E470 Bond yielding 3.5%

    GE Bond yielding 5.0%

    Your Tax Bracket is 28% TEY of E470 Bond = 3.5/.72 = 4.86%

    Equivalent Tax Free Yield Finding the tipping point between taxable and tax free

    = Taxable Yield x (1- Tax Bracket)

    = 5.0 x .72 = 3.6%

  • 8/2/2019 4030 Chap 002

    20/42

    Yields onTax-exempts to Taxables

    All about Tax Brackets

    Tax Brackets are 10%,15%, 25%, 28%, 35%

    The market determines

    the tipping point Recent history has

    this ratio at .75

    Meaning that thosein the 25% Bracketand above wouldinvest

    T bl 2 3 E i l t T bl

  • 8/2/2019 4030 Chap 002

    21/42

    Table 2.3 Equivalent TaxableYields

    Rate)Tax(1

    rr TaxableExemptTax =2-21

  • 8/2/2019 4030 Chap 002

    22/42

    Corporate Bonds

    Issued by private firms

    Semi-annual interest payments

    Accruing interest at buy and sell

    Subject to larger default risk thangovernment securities

    Options in corporate bonds

    Callable

    Convertible

  • 8/2/2019 4030 Chap 002

    23/42

    Figure 2.7 Investment Grade BondListings

  • 8/2/2019 4030 Chap 002

    24/42

    Capital Market - Fixed IncomeInstruments

    Mortgage-Backed Securities Pass-through

    A security backed by a pool of mortgages. Thepool backer passes through monthly mortgagepayments made by homeowners and coverspayments from any homeowners that default.

    Collateral: Traditionally all mortgages were conforming

    mortgages but since 2006, Alt-A and subprimemortgages were included in pools

    2-24

    C i l M k Fi d I

  • 8/2/2019 4030 Chap 002

    25/42

    Capital Market - Fixed IncomeInstruments

    Mortgage-Backed Securities Political encouragement to spur affordable

    housing led to increase in subprime lending

    Private banks began to purchase and sell poolsof subprime mortgages

    Pool issuers assumed housing prices wouldcontinue to rise, but they began to fall as farback as 2006 with disastrous results for themarkets.

    2-25

    Fi 2 7 M t B k d

  • 8/2/2019 4030 Chap 002

    26/42

    Figure 2.7 Mortgage BackedSecurities Outstanding

    2-26

  • 8/2/2019 4030 Chap 002

    27/42

    The U.S. Bond Market

    2-27

  • 8/2/2019 4030 Chap 002

    28/42

    Equity Markets

    Common stock Residual claim

    Limited liability

    Preferred stock Fixed dividends - limited

    Priority over common

    Tax treatment

    Depository receipts

  • 8/2/2019 4030 Chap 002

    29/42

    Capital Market - Equity

    2-29

  • 8/2/2019 4030 Chap 002

    30/42

    Capital Market - Equity

    Capital Gains and Dividend Yields You buy a share of stock for $50, hold it for one

    year, collect a $1.00 dividend and sell the stock for

    $54. What were your dividend yield, capital gainyield and total return? (Ignore taxes)

    Dividend yield: = Dividend / Pbuy

    $1.00 / $50 = 2%

    Capital gain yield: = (Psell Pbuy)/ Pbuy($54 - $50) / $50 = 8%

    Total return: = Dividend yield + Capital gain yield

    2% + 8% = 10%

    2-30

  • 8/2/2019 4030 Chap 002

    31/42

    Uses

    Track average returns

    Comparing performance of managers

    Base of derivatives

    Factors in constructing or using an index

    Representative? Broad or narrow?

    How is it constructed?

    2.4 Stock and Bond Indexes

    2-31

  • 8/2/2019 4030 Chap 002

    32/42

    Examples of Indexes - Domestic

    Dow Jones Industrial Average (30 Stocks)

    Standard & Poors 500 Composite

    NASDAQ Composite

    Russell 2000

    Wilshire 5000

    Figure 2 9 Comparative

  • 8/2/2019 4030 Chap 002

    33/42

    Figure 2.9 ComparativePerformance of Several Stock

    Market Indices, 2001-2008

    Why has performance differed for the

    indices? 2-33

  • 8/2/2019 4030 Chap 002

    34/42

    Construction of Indexes

    How are stocks weighted? Price weighted (DJIA)

    Market-value weighted (S&P 500, NASDAQ)

    Equally weighted (Value Line Index)

  • 8/2/2019 4030 Chap 002

    35/42

    Table 2.4 Data to Construct StockPrice Indexes

  • 8/2/2019 4030 Chap 002

    36/42

    DJIAPrice-Weighted Average

    Using data from Table 2.4; example 2.2Initial value = $25 + $100 = $125

    Final 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%

  • 8/2/2019 4030 Chap 002

    37/42

    S&Ps Composite 500Market Value-Weighted Index

    Using data from Table 2.4:

    ABC would have five times the weight given toXYZ

  • 8/2/2019 4030 Chap 002

    38/42

    Value LineEqually 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

    Table 2 6 Companies in the

  • 8/2/2019 4030 Chap 002

    39/42

    Table 2.6 Companies in theDow Then & Now

    2-39

  • 8/2/2019 4030 Chap 002

    40/42

    Examples of International Indices

    2-40

    D i ti S iti

  • 8/2/2019 4030 Chap 002

    41/42

    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

  • 8/2/2019 4030 Chap 002

    42/42

    Figure 2.10 Stock Options on Apple

    What does the term strike or exercise price refer to?