Security Types

1
Chapter 3

• Security Types

2
Goals

• To examine constraints and strategies for
  investors
• To become familiar with different types of
  securities
• Distinguishing characteristics
• Potential gains and losses

3
Investor Objectives

• Constraints
• Resources
• Horizon
• Liquidity
• Taxes

• Strategies
• Management
• Market Timing
• Asset Allocation
• Security Selection

4
Classifying Securities

• There are three broad types
• Interest bearing
• Money market instruments
• Fixed income securities
• Equities
• Common stock
• Preferred stock
• Derivatives
• Options
• Futures

5
Interest Bearing Securities

• Money market instruments
• Short term debt obligations of corporations and
  governments
• Provide one future payment
• Lives are less than one year
• Fixed-income securities
• Long term debt
• Provide pre-determined fixed payments
• Lives exceed one year

6
Money Market Instruments

• Examples
• U.S. T-bills, bank CDs, corporate and municipal
  money market instruments
• Potential Gains/Losses
• A known future payment unless the borrower
  defaults
• Price quotations
• Usually sold on a discount basis, only interest
  rates are quoted

7
Fixed Income Securities

• Examples
• U.S. T-notes, corporate bonds
• Potential Gains/Losses
• Fixed payment of coupons and principal unless
  borrower defaults
• Gain or loss from fall or rise in interest rates
• Illiquidity may be a problem

8
Equities

• Common Stock
• Voting rights
• Paid last in case of liquidation
• Optional and adjustable dividends

• Preferred Stock
• No voting rights
• Paid before common stockholders in case of
  liquidation
• Typically fixed dividends

9
Common Preferred Quotes

• Examples Apple, The Cheesecake Factory, Dell
• Gains/Losses
• Dividend income
• Price appreciation or depreciation

• Examples Citigroup
• Gains/Losses
• Fixed dividend income
• Price appreciation or depreciation

10
Common vs. Preferred Stock
11
CITIGROUP INC (NYSEC)

• Last Trade 24.34
• Change 0.78 (-3.11)
• Prev Close 25.12
• Open 24.65
• Day's Range 24.25 - 24.99
• 52wk Range 22.36 - 55.55
• Volume 55,678,669
• Avg Vol (3m) 98,984,100
• Market Cap 121.57B
• P/E (ttm) 33.98
• EPS (ttm) 0.717
• Div Yield 1.28 (5.10)

12
Derivatives

• Primary asset security originally sold by a
  business or government to raise money
• Derivative asset a financial asset that is
  derived from an existing traded asset, rather
  than issued by a business or government

13
How derivatives work

• Two parties take opposing sides of a trade
  concerning
• A specific asset
• A specific time frame
• A specific price
• Whatever is gained by one party is lost by the
  other party.

14
Futures and Options

• A futures contract is an agreement made today
  regarding the terms of a trade that will take
  place later
• An options contract is an agreement that gives
  the owner the right, but not the obligation, to
  buy or sell a specific asset at a specified price
  over a set period of time

15
Futures Contracts

• Examples
• Financial futures, commodity futures
• Potential gains/losses
• At maturity, you gain if the contracted price is
  better than the market price of the underlying
  asset
• If you sell prior to maturity, you may gain or
  lose depending on the market price
• Enormous gains and losses are possible

16
Futures Buyers Sellers

• Buyers
• Said to take the long position
• Take delivery of the asset upon expiration of the
  futures agreement

• Sellers
• Said to take the short position
• Makes delivery of the asset upon expiration of
  the futures agreement

Approximately 98 of futures are terminated
before expiration.
17
Futures Gold

• Upon graduation, you take a part-time job with
  Kay Jewelers. You convince management to explore
  hedging their risk against price movements in the
  gold market.
• You purchase contracts on 100 ounces of gold at
  350 per ounce
• The total value of your contract is
• 100 ounces x 350/oz. 35,000

What needs to happen for this deal to be a
profitable one?
18
What happens

• If
• the price of gold rises to 360 per ounce, your
  contract is worth 36,000
• 1,000 profit (360 350) x 100 ounces
• the price of gold drops to 340 per ounce, your
  contract is worth 34,000
• 1,000 loss (340 - 350) x 100 ounces

19
Futures Settlement

• Delivery
• Short position holder delivers commodity to long
  position holder
• Long position holders cash is delivered to short
  position holders account through clearinghouse

• Cash
• Commodities do not move
• Cash paid from trade loser to trade winner

20
Options Contracts

• A call option gives the owner the right to buy an
  asset, whereas a put option gives the owner the
  right to sell an asset
• The price paid to buy an option is the option
  premium
• The specified price of purchasing the underlying
  asset is the strike price

21
Options

• Potential Gains/Losses
• Buyers profit if the strike price is better than
  the market price, AND if the difference is
  greater than the option premium
• Sellers gain the premium unless the market price
  is better than the strike price

22
Options Terminology

• American option
• European option
• In the money
• Out of the money
• At the money

23
Options chain Dell Computer
Current price per share 19.99
24
Options vs. Futures

• Holders of call options have no obligation to buy
  the asset and holders of put options have no
  obligation to sell the asset
• To avoid the obligation, option holders pay a
  price today. Futures contract holders do not pay
  for the contract until execution

25
Investing in Stocks vs. Options

• Stocks
• You invest 10,000 in Aramark (RMK) at 25.00 per
  share
• Shares bought 400
• If Aramark is selling for 27.50 in 3 months, you
  gain 1,000.00
• If Aramark is selling for 22.50 in 3 months you
  lose 1,000.00

26
Investing in Stocks vs. Options

• Options
• A call option with a strike price of 25 and 3
  months to maturity has a premium of 2
• Contracts bought 50 (100 shares/con)
• If Aramark is selling for 27.50 in 3 months, you
  gain 2,500
• If Aramark is selling for 22.50 in 3 months you
  lose 10,000

27
Quick Quiz

• What are the 3 broad asset types?
• What are some differences between common stock
  and preferred stock?
• What is the difference between an options
  contract and a futures contract?