Slides_Fundamentals of Investments - Chapter 3 doc

3 3 C h a p t e r Security TypesSecurity Types second edition Fundamentals of Investments Valuation & Management Charles J. Corrado Bradford D.Jordan McGraw Hill / Irwin Slides by Yee-Tien (Ted) Fu © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin 3 - 2 Security Types Our goal in this chapter is to introduce the different types of securities that are routinely bought and sold in financial markets around the world. Goal  For each security type, we will examine: c its distinguishing characteristics, d the potential gains and losses from owning it, and e how its prices are quoted in the financial press. © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin 3 - 3 Classifying Securities Basic Types Major Subtypes Interest-bearing Money market instruments Fixed-income securities Equities Common stock Preferred stock Derivatives Options Futures © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin 3 - 4 Interest-Bearing Assets Fixed-income securities Longer-term debt obligations, often of corporations or governments, that promise to make fixed payments according to a preset schedule. Money market instruments Short-term debt obligations of large corporations and governments that mature in a year or less. © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin 3 - 5 Money Market Instruments  Examples: U.S. Treasury bills (T-bills), bank certificates of deposit (CDs), corporate and municipal money market instruments.  Potential gains/losses: Fixed future payment, except when the borrower defaults.  Price quotations: Usually, the instruments are sold on a discount basis, and only the interest rates are quoted. So, some calculation is necessary to convert the rates to prices. © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin 3 - 6 Fixed-Income Securities  Examples: U.S. Treasury notes, corporate bonds, car loans, student loans.  Potential gains/losses: Î Fixed coupon payments and final payment at maturity, except when the borrower defaults. Î Possibility of gain/loss from fall/rise in interest rates. Î Can be quite illiquid. © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin 3 - 7 Fixed-Income Securities  Price quotations: CUR NET BONDS YLD. VOL CLOSE CHG. NEW YORK BONDS Corporation Bonds ATT 7 3 / 4 07 …… 7.8 56 100 + 1 / 4 ATT 8 1 / 8 22 …… 8.6 433 94 1 / 8 + 5 / 8 ATT 8 1 / 8 24 …… 8.7 453 93 3 / 4 – AT&T, the issuer of the bond. ATT The bond’s annual coupon rate. You will receive 8 1 / 8 % of the bond’s face value each year in 2 semiannual coupon payments. 8 1 / 8 The bond will mature in the year 2022. 22 © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin 3 - 8 Fixed-Income Securities  Price quotations: CUR NET BONDS YLD. VOL CLOSE CHG. NEW YORK BONDS Corporation Bonds ATT 7 3 / 4 07 …… 7.8 56 100 + 1 / 4 ATT 8 1 / 8 22 …… 8.6 433 94 1 / 8 + 5 / 8 ATT 8 1 / 8 24 …… 8.7 453 93 3 / 4 – 8.6 Current yield = annual coupon current price 433 The actual number of bonds traded that day. 94 1 / 8 The closing price for the day is 94.125% of face value. The closing price is up by 5 / 8 of 1% from the previous closing price. + 5 / 8 © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin 3 - 9 Work the Web  Check out bond basics at: http://www.investinginbonds.com © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin 3 - 10 Equities Preferred stock The dividend is usually fixed and must be paid before any dividends for the common shareholders. In the event of a liquidation, preferred shares have a particular face value. Common stock Represents ownership in a corporation. A part owner receives a pro rated share of whatever is left over after all obligations have been met in the event of a liquidation. [...]... 2002 by The McGraw-Hill Companies, Inc All rights reserved 3 - 18 Futures Contracts Price quotations: McGraw Hill / Irwin @2002 by the McGraw- Hill Companies Inc.All rights reserved 3 - 19 Work the Web You can download lots of basic futures information from the Knowledge Center at: http://www.cbot.com McGraw Hill / Irwin © 2002 by The McGraw-Hill Companies, Inc All rights reserved 3 - 20 Option Contracts... McGraw-Hill Companies, Inc All rights reserved 3 - 23 Option Contracts Price quotations: McGraw Hill / Irwin @2002 by the McGraw- Hill Companies Inc.All rights reserved 3 - 24 Investing in Stocks versus Options Example: Suppose you have $10,000 for investments Macron Technology is selling at $50 per share Number of shares bought = $10,000 / $50 = 200 If Macron is selling for $55 per share 3 months... Hill / Irwin 3 - 13 @2002 by the McGraw- Hill Companies Inc.All rights reserved 3 - 14 Work the Web Are you a Foolish investor? Go to “Fool School” at: http://www.fool.com You can also learn more about the “ticker tape” at: http://www.stocktickercompany.com and create your own ticker at: http://www.cnbc.com McGraw Hill / Irwin © 2002 by The McGraw-Hill Companies, Inc All rights reserved 3 - 15 Derivatives... Macron is selling for $55 per share 3 months later, gain = {($55 – $50) × 2500} – $10,000 = $2,500 If Macron is selling for $45 per share 3 months later, gain = ($0 × 2500) – $10,000 = – $10,000 McGraw Hill / Irwin © 2002 by The McGraw-Hill Companies, Inc All rights reserved 3 - 26 Chapter Review Classifying Securities Interest-Bearing Assets Money Market Instruments Fixed-Income Securities Equities Common... selling for $45 per share 3 months later, gain = ($45 × 200) – $10,000 = – $1,000 McGraw Hill / Irwin © 2002 by The McGraw-Hill Companies, Inc All rights reserved 3 - 25 Investing in Stocks versus Options Example: …continued A call option with a $50 strike price and 3 months to maturity is also available at a premium of $4 A call contract costs $4 × 100 = $400, so number of contracts bought = $10,000.. .3 - 11 Common Stock Examples: IBM shares, Microsoft shares, etc Potential gains/losses: Many companies pay cash dividends to their shareholders However, neither the timing nor the amount of any dividend is guaranteed The stock value may rise or fall depending on the prospects for the company and market-wide circumstances McGraw Hill / Irwin © 2002 by The McGraw-Hill Companies, Inc... © 2002 by The McGraw-Hill Companies, Inc All rights reserved 3 - 16 Derivatives Futures contract An agreement made today regarding the terms of a trade that will take place later Option contract An agreement that gives the owner the right, but not the obligation, to buy or sell a specific asset at a specified price for a set period of time McGraw Hill / Irwin © 2002 by The McGraw-Hill Companies, Inc... / Irwin © 2002 by The McGraw-Hill Companies, Inc All rights reserved 3 - 27 Chapter Review Derivatives Futures Contracts Futures Price Quotes Gains and Losses on Futures Contracts Option Contracts Option Terminology Options versus Futures Option Price Quotes Gains and Losses on Option Contracts Investing in Stocks versus Options McGraw Hill / Irwin © 2002 by The McGraw-Hill Companies, Inc All rights... rights reserved 3 - 12 Preferred Stock Example: Citigroup preferred stock Potential gains/losses: Dividends are “promised.” However, there is no legal requirement that the dividends be paid, as long as no common dividends are distributed The stock value may rise or fall depending on the prospects for the company and market-wide circumstances McGraw Hill / Irwin © 2002 by The McGraw-Hill Companies,... called the option premium The specified price at which the underlying asset can be bought or sold is called the strike price, or exercise price McGraw Hill / Irwin © 2002 by The McGraw-Hill Companies, Inc All rights reserved 3 - 21 Option Contracts An American option can be exercised anytime up to and including the expiration date, while a European option can be exercised only on the expiration date Options . stock Derivatives Options Futures © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin 3 - 4 Interest-Bearing Assets Fixed-income securities Longer-term debt obligations, often of corporations or. 3 3 C h a p t e r Security TypesSecurity Types second edition Fundamentals of Investments Valuation & Management Charles J. Corrado Bradford D.Jordan McGraw Hill / Irwin Slides by Yee-Tien . BONDS Corporation Bonds ATT 7 3 / 4 07 …… 7.8 56 100 + 1 / 4 ATT 8 1 / 8 22 …… 8.6 433 94 1 / 8 + 5 / 8 ATT 8 1 / 8 24 …… 8.7 4 53 93 3 / 4 – AT&T, the issuer of the bond. ATT The bond’s