CHAPTER TWO Investment Alternatives

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CHAPTER TWO Investment Alternatives

• Cleary / Jones
• Investments Analysis and Management

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Learning Objectives

• To describe the major types of financial assets
  and how they are organized
• To explain what non-marketable financial assets
  are
• To describe the important features of money
  market and capital market securities

3
Learning Objectives

• To distinguish between preferred stock and common
  stock
• To understand the basics of options and futures

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Non-Marketable Financial Assets

• Examples Savings accounts, Canada Savings Bonds
  (CSBs), Guaranteed Investment Certificates (GICs)
• Commonly owned by individuals
• Represent direct exchange of claims between
  issuer and investor
• Usually safe investments which are easy to
  convert to cash without loss of value

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Money Market Securities

• Examples Treasury bills, commercial paper,
  Eurodollars, repurchase agreement, bankers
  acceptance (B/A)
• Marketable claims are negotiable or saleable in
  the marketplace
• Short-term, liquid, relatively low risk debt
  instruments
• Issued by governments and private firms

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Fixed-Income Securities

• Marketable debt with maturity greater than one
  year
• More risky than money market securities
• Fixed-income securities have a specified payment
  schedule
• Dates and amount of interest and principal
  payments known in advance

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Fixed-Income Securities

• Major bond types
• Government of Canada bonds
• U.S. Treasury bonds
• Provincial bonds
• Provincially-guaranteed bonds - Ontario Hydro
• U.S. federal agency securities - GNMAs (Ginnie
  Maes), FNMAs (Fannie Maes)

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Fixed-Income Securities

• Major bond types (continued)
• Corporate bonds
• Usually pay semi-annual interest, are callable,
  carry a sinking fund provision, and have a par
  value of 1,000
• Convertible bonds may be exchanged for another
  asset
• Risk that issuer may default on payments
• Securitized assets Mortgage-backed

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Equity Securities

• Represent an ownership interest
• Preferred stockholders paid after bondholders but
  before common stockholders
• Dividend known, fixed in advance
• May be cumulative if dividend omitted
• Common stockholders are residual claimants on
  income and assets
• Voting rights important

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Derivative Securities

• Securities whose value is derived from some
  underlying security
• Futures and options contracts are standardized
  and performance is guaranteed by a third party
• Risk management tools
• Warrants are options issued by firms

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Options

• Exchange-traded options are created by investors,
  not corporations
• Call (Put) Buyer has the right but not the
  obligation to purchase (sell) a fixed quantity
  from (to) the seller at a fixed price before a
  certain date
• Options can be sold in the market at a price
• Increases return possibilities

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Futures

• Futures contract A standardized agreement
  between a buyer and seller to make future
  delivery of a fixed asset at a fixed price
• A good faith deposit, called margin, is
  required of both the buyer and seller to reduce
  default risk
• Used to hedge the risk of price changes