Essentials of Investments: Chapter 2 - Financial Markets and Instruments presents Major Classes of Financial Assets or Securities, Markets and Instruments, Money Market Instrument Yields, Bank Discount Rate, Bond Equivalent Yield.
1 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Chapter Financial Markets and Instruments Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc All rights reserved 2 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Major Classes of Financial Assets or Securities • Debt – Money market instruments – Bonds • Common stock • Preferred stock Derivative securities Irwin / McGraw-Hill â 2001 The McGraw-Hill Companies, Inc All rights reserved 3 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Markets and Instruments • Money Market – Debt Instruments – Derivatives • Capital Market – Bonds – Equity – Derivatives Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc All rights reserved 4 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Money Market Instruments • • • • • • Treasury bills Certificates of deposit Commercial Paper Bankers Acceptances Eurodollars Repurchase Agreements (RPs) and Reverse RPs • Federal Funds Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc All rights reserved 5 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Money Market Instrument Yields • Yields on Money Market Instruments are not always directly comparable Factors influencing yields • Par value vs investment value • 360 vs 365 days assumed in a year (366 leap year) • Bond equivalent yield Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc All rights reserved 6 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Interest rates that arise in connection with money market securities Bank discount rate (rBD ) This is a rate that is used solely for determining the price of a MM security for trading purposes .Bond equivalent yield (rBEY ) In general, a yield is an interest rate that (under very specific, sometimes unrealistic, assumptions) represents a rate of return .rBEY is such a rate of return It is an annual percentage rate (APR) For comparing different MM instruments, we often use the effective annual rate (EAR) of the rBEY Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc All rights reserved 7 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Bank Discount Rate (T-Bills) 10,000 - P 360 r BD = x n 10,000 rBD = bank discount rate P = market price of the T-bill n = number of days to maturity Example 90-day T-bill, P = $9,875 10,000 - 9,875 360 r BD = = 5% x 10,000 90 Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc All rights reserved 8 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Bond Equivalent Yield • Can’t compare T-bill directly to bond – 360 vs 365 days – Return is figured on par vs price paid • Adjust the bank discounted rate to make it comparable Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc All rights reserved 9 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Bond Equivalent Yield r BEY 10,000 = P -P 365 x n P = price of the T-bill n = number of days to maturity Example Using Sample T-Bill 10,000 - 9,875 365 r BEY = x 9,875 90 rBEY = 0127 x 4.0556 = 0513 = 5.13% Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc All rights reserved 10 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Capital Market - Fixed Income Instruments Publicly Issued Instruments • US Treasury Bonds and Notes • Agency Issues (Fed Gov) • Municipal Bonds Privately Issued Instruments • Corporate Bonds • Mortgage-Backed Securities Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc All rights reserved 11 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Capital Market - Equity • Common stock – Residual claim – Limited liability • Preferred stock – Fixed dividends - limited – Priority over common – Tax treatment Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc All rights reserved 12 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Stock Indexes 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? Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc All rights reserved 13 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Examples of Indexes - Domestic • Dow Jones Industrial Average (30 Stocks) • Standard & Poor’s 500 Composite • NASDAQ Composite • NYSE Composite • Wilshire 5000 Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc All rights reserved 14 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Examples of Indexes - Int’l • • • • Nikkei 225 & Nikkei 300 FTSE (Financial Times of London) Dax Region and Country Indexes – EAFE – Far East – United Kingdom Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc All rights reserved 15 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Construction of Indexes • How are stocks weighted? – Price weighted (DJIA) – Market-value weighted (S&P500, NASDAQ) – Equally weighted (Value Line Index) Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc All rights reserved 16 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Example Suppose we have two stocks #Shares Stock Pr 9/19/01 Pr 9/20/01 Return Outstand A 100 120 20% 10M B 10 –10% 500M Computation of a price-weighted index (like the Dow) Index on 9/19/01 (100+10)/2 = 55 Index on 9/20/01 (120+9)/2 = 64.5 Return on index 17.27% This is called a price-weighted index because the index return is the price-weighted average of the component (100/110) x 20% + (10/110) x –10% = 17.27% Portfolio: one share in each stock Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc All rights reserved 17 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Market-value weighted index A market-value weighted average (like the S&P) .Index on 9/19/01 = “100” (an arbitary base level) Market value of A = $100 x 10M = $1,000M Market value of B = $10 x 500M = $5,000M Return on index is (1,000/6,000) x 20% + (5,000/6000) x –10% = –5% Index on 9/20/01 = 100 x (1–5%) = 95 Portfolio: 1/6 in A; 5/6 in B An equally-weighted index (like the Wilshire 5000) Index on 9/19/01 = “100” (an arbitary base level) Return on index is (20% + –10%)/2 = +5% Index on 9/20/01 = 100 x (1+5%) = 105 Portfolio: equal amounts in A and B Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc All rights reserved ... 9/19/01 Pr 9 /20 /01 Return Outstand A 100 120 20 % 10M B 10 –10% 500M Computation of a price-weighted index (like the Dow) Index on 9/19/01 (100+10) /2 = 55 Index on 9 /20 /01 ( 120 +9) /2 = 64.5 Return... / McGraw-Hill © 20 01 The McGraw-Hill Companies, Inc All rights reserved 14 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Examples of Indexes - Int’l • • • • Nikkei 22 5 & Nikkei... / McGraw-Hill â 20 01 The McGraw-Hill Companies, Inc All rights reserved 3 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Markets and Instruments • Money Market – Debt Instruments