Financial Instruments and Markets

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Topic?
Financial Instruments and Markets
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Financial Instruments
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Global Investment Choices

• Fixed-Income Investments

• Equities

• Derivatives

• Indirect, Managed Investments

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Fixed Income Investments

• Most fixed income instruments specify a number of
  features including the following
• The maturity date
• The coupon
• The par value

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Money Market Instruments

• Treasury Bills
• Certificate of Deposits(CD)
• Commercial Paper(CP)
• Bankers Acceptances(BA)
• Eurodollars
• Repos and Reverses Repos
• Brokers Calls
• Federal Funds
• the LIBOR Market

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Fixed Income Securities-Capital Market
(I)

• Government Bonds

• Treasury notes
• Treasury bonds
• Government agency bonds

• Municipal Bonds

• General obligation bonds (GOs)
• Revenue bonds

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Fixed Income Securities-Capital Market
(II)

• Corporate Bonds

• Debentures
• Senior secured bonds
• Subordinated debentures
• Income bonds
• Convertible bonds
• Callable bonds
• Bonds with Warrants

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Fixed Income Securities-Capital Market
(?)

• International Bond Investment

• Eurobond market
• Yankee bonds, Bulldog market, Samurai Market
• International domestic bonds

• Other Fixed Income Instruments

• Asset backed securities

CMOs
CARs

• Zero coupon bonds

• Preferred Stocks

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Equity Securities

• Common Stock

• Foreign Equities

• American Depository Receipts(ADRs)
• American Shares
• Direct purchase
• International or global mutual funds

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American Depository Receipts

• Easiest way to acquire foreign shares
• Certificates issued by a U.S. bank
• Buy and sell in U.S. dollars
• Dividends in U.S. dollars
• May represent multiple shares
• Very popular, over 1500 ADR programs available
  in 2002

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Derivative Securities
There are many types of derivative investments,
including financial derivative securities whose
payoffs are tied to various financial assets.

• Options
• Warrants
• Puts and calls
• Futures contracts

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Derivatives Options

• Warrants
• Puts and calls

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Derivatives Futures

• Standardized contracts to make or take delivery
  of some financial (or other) asset in exchange a
  specified payment at a future date.

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Managed Investments

• Closed-end investment companies
• Open-end investment companies (Mutual funds)

• Hedge Funds
• Venture capital pools
• Real Estate Investment Trusts (REITs)

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Historic Return and Risk
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Exhibit 3.1
Exhibit 3.2
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Return/Risk Characteristics

• Major classes of assets

• large company common stocks
• small capitalization common stocks
• long-term U.S. government bonds
• long-term corporate bonds
• Intermediate-term U.S. T-bonds
• U.S. T-bills
• consumer goods (measure inflation)

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Return/Risk focuses

• Consider

Exhibit 3.15
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Summarizing the Historic Data

• Average premiums earned
• Equity risk premium
• Small-stock premium
• Horizon premium
• Default premium

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Exhibit3.10
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World Portfolio Performance
Exhibit3.16
Exhibit3.17
Exhibit3.18
Exhibit3.11
Exhibit3.12
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Financial Markets and Market Structures
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Types of markets

• Direct Search Markets
• Brokered Markets
• Dealer Markets
• Auction Markets

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Characteristics of A Good Market

• Availability of info (timely accurate)
• Liquidity
• Low TCs (Internal efficiency)
• External efficiency

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Primary Capital Markets

• Underwriting Functions

• Relationships with Investment Bankers

• Negotiated
• Competitive bids
• Best-efforts

Exhibit6.1
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Primary MarketsCommon Stock

• Types of new issues
• Forms of Underwriting

• Negotiated
• Competitive bids
• Best efforts

• Introduction of Rule 415 (Shelf Registration)
• Private Placement and Rule 144A

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Rule 415 Shelf Regis tration
Allows firms to register securities and sell them
piecemeal over the next two years

• Pros

• Cons

• Used for straight debentures rather than CS or CB

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Private Placements and Rule 144A

• Firms sells to a small group of

institutional investors, with some assistance of
an investment banker
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Primary MarketsGovernment Bond

• Federal Reserve System Auction
• Competitive bids vs. non-competitive bids
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• 1.????(??)?
• 2.????(??)?,????

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Primary Markets Corporate Bond

• Negotiated arrangement

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Secondary Markets

• Provide liquidity to investors who acquire
• securities in the primary market
• An active secondary market

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Secondary Bond Markets

• Stock Exchanges (First Market)
• Over-the-counter market (Second Market)
• Third Market
• Fourth Market

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Secondary Market Trading Systems

• Pure auction market
• Dealer market

p.190??Dealer Bid Ask
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Call Versus Continuous Markets

• Call markets(????)
• Continuous markets(???? )

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Exchange Membership

• Four categories of membership
• Specialists
• Commission brokers
• Floor brokers
• Registered traders

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Major Types of Orders

• Market orders

• Limit orders

• Special Orders

• Stop loss

• MIT (Market-if-touched)

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Margin Trading Example (I)
P050,200 shares, IM50 ?I05000
? leverage factor1/0.52
P1 R R(100commission,6 on loan)
60 (?20)
40 (?20)
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Margin Trading Example (II)

• If MM25

• If P 30
• Investors Margin

Margin call for
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Short Sales Example (I)
Suppose bearish on Xerox when P 100 Short
1,000 shares IM 50, MM 30
Assets Assets Liabilities and Owners Equity Liabilities and Owners Equity
Cash 100,000 Short position in Xerox stock(1,000 shared owed) 100,000
T-bills 50,000 Equity 50,000
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Short Sales Example II
Purchase of Stock Purchase of Stock Purchase of Stock
Time Action Cash flow
0 Buy share -Initial price
1 receive dividend, sell share Ending price dividend
Short Sale of Stock Short Sale of Stock Short Sale of Stock
Time Action Cash flow
0 Borrow share sell it Initial price
1 Repay dividend and buy share to replace the share originally borrowed -(Ending price Dividend)
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Changes in the Securities Markets

• In recent years, major changes in securities
  markets have largely been driven by the influence
  of large financial (institutional) investors.
• Among the impacts
• Negotiated (competitive) commission rates
• Influence of block trades
• Impact on stock price volatility
• Development of National Market System (NMS)

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New Trading Systems

• Super DOT

• Display Book
• Opening Automated Report Service (OARS)

• Market Order Processing
• Limit Order Processing

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Global Market Changes (I)

• NYSE Off-hours trading
• Listing foreign stocks on the NYSE

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Global Market Changes (II)

• London Stock Exchange Big Bang
• Tokyo Stock Exchange Big Bang

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Future Developments

• Creation and consolidation of stock exchanges
• More specialized investment companies
• Changes in the financial services industry
• Trading in Cybermarkets

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SECURITY MARKET INDICATOR SERIES
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What is an indicator series?
It is an index that answers the question What
happened in the market today?
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Uses of Security Market Index

• Performance benchmark
• Develop an index portfolio
• Measure(or examine factors of) market movements
• Technical Analysis,to predict future price move
• Proxy for mkt portfolio to compute

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Factors in Constructing Market Indicator Series

• Sample

• Weighting

• price weighted

• value-weighted

• unweighted

• Computational procedure

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Stock-Market Indicator Series

• Price-Weighted Series
• Value-Weighted Series
• Equal-Weighted Series

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DIJA Computation
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Exhibit b7.2
Exhibit 7.1
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Value Weighted Series
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(????)
Exhibit 7.3
Exhibit7.4
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???,?????????????? ?
?????????????????????????? ???????(??????????)
,??????? ??????? ??????
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Taiwan TAIEX Example
A A B B C C D D
?? ?? ?? ?? ?? ?? ?? ??
20 5 30 2 40 6 50 2
40 5 50 2 50 6 100 2
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Unweighted Price Indicator Series

• Arithmetic and Geometric Means

GM Index
AM Index
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Exhibit7.8
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Unweighed IndexExample
ex A B C ??
t0 80 40 16 100
t1 100 50 20 150
t2 104 57 21 161.5
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Value Line Index
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A 10 250 2500 2500 2500 (50)
B 50 30 1500 1500 1500 (30)
C 100 10 1000 1000 1000 (20)
160 5000 5000 5000
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Stock Split
Prices Prices Prices
Stocks 4/1 4/2
A 20
B 35 37
C 50 51
If Stock A splits 21 on 4/1
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Price
A
40
20
B
35
37
C
50
51
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Style Indexes

• Measure the performance of various investment
  styles or sectors
• Size indexes
• type indexes

• Small-cap

growth
midcap
growth
Large-cap
growth
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Global Equity Indexes

• FT/SP Actuaries World Indexes
• Morgan Stanley Capital International (MSCI) World
  Indexes
• Dow Jones World Stock Index

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Exhibit7.9
Exhibit7.10
Exhibit7.12
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Comparison of World Stock Indexes
Exhibit7.13
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Bond-Market Indicator Series

• Relatively new and not widely published
• Growth in fixed-income mutual funds increase
  need for reliable benchmarks for evaluating
  performance
• Increasing interest in bond index funds, which
  requires an index to emulate

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Difficulties in Creating a Bond-Market Index

• bond quality
• Bond market changes
• Bond prices are affected differently
• without current and continuous transaction
• prices

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Bond Market Index Series

• Investment-Grade Bond Indexes
• High-Yield Bond Indexes
• Global Government Bond Market Indexes
• Composite Stock-Bond Indexes

• Merrill Lynch-Wilshire U.S. Capital Markets
  Index
• (ML-WCMI)
• Brinson Partners Global Security Market Index
  (GSMI)

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Comparison of Indexes Over Time
Exhibit7.15
Exhibit7.16