Asset Classes and Financial Instruments PDF

Asset classes and financial instruments 1  Process of building investment Asset allocation: how much money to allocate to each type of assets of assets (bank accounts, financial markets, real estate) Security selection: within each type of assets the...

Asset classes and financial instruments 1  Process of building investment Asset allocation: how much money to allocate to each type of assets of assets (bank accounts, financial markets, real estate) Security selection: within each type of assets the investor chooses specific assets 2  Financial Markets Money Market Capital Market Bond/Sukuk markets Equity markets Derivative markets 3  Money Market Subsector of the fixed-income market (debt) Short-term debts Highly liquid Low risk Often have large denominations 4  Money Market Treasury bills Certificates of deposit Commercial paper 5  Treasury bills The government raises money by selling Treasury bills to the public Short-term government securities issued at a discount from face value and returning the face amount at maturity Short maturity up to 52 weeks High liquidity Low transaction costs Low risk 6  Certificates of deposit A certificate of deposit (CD) is a time deposit with a bank Time deposits may not be withdrawn on demand The bank pays the depositor only at the end of the fixed term 7  Commercial paper Large firms often issue their own short-term debt directly to the public, rather than borrowing from banks These notes are called commercial paper 8  Money Market: Interbank Rate The Fed funds rate is the rate on very short-term loans among financial institutions in US The London Interbank Offer Rate (LIBOR) is the rate at which banks in London lend to each other The LIBOR is published by the British Bankers’ Association (BBA) between 11:00 a.m and 11:10 a.m (London time) LIBOR rates are widely quoted for transactions denominated in several currencies such as GBP, yen, euros EURIBOR, EONIA and ESTER are the main rated at which banks in the euro zone lend euros among themselves Saudi Arabian Interbank Offered Rate (SAIBOR) 9  Capital Markets Bond/Sukuk markets Equity markets Derivative markets 10  Bond/Sukuk market The bond market is composed of longer-term borrowing or debt instruments than those that trade in the money market Issued by firms (corporate bonds) or governments (treasury bonds) Fixed-income Cash flows are called coupon payments 11  Bond/Sukuk market Like bonds, sukuks provide fixed returns Like bonds, sukuks have the priority of repayment in case of bankruptcy According to the Saudi stock market “Sukuk are Sharia-compliant financial certificates through which investors gain partial ownership on an issuer’s assets until maturity. While Bonds are financial certificates through which investors lend money to the issuer, indicating an obligation for repayment at maturity” Bondholders receive regular interest payments, while Sukuk holders receive a share of the profit generated by the underlying asset 12  Stocks Stocks or equities represent ownership shares in a firm Shareholders have voting rights and receive dividends (common stocks versus preferred stocks) Residual claim: in case of bankruptcy the firm’s assets, the shareholders have claim to what is left after paying all other claimants (tax authorities, employees, suppliers, bondholders, and other creditors) Limited liability: in case of bankruptcy, corporate stockholders at worst have worthless stock. They are not personally liable for the firm’s obligations 13  Derivative markets Futures and options provide payoffs that depend on the values of other assets (stocks, bonds, exchange rate, commodities) These instruments are called derivative assets, as their values derive from the values of other assets Main Derivatives: Options Futures Swaps 14  Call option A call option gives its holder the right to purchase an asset for a specified price, called the exercise or strike price, on or before some specified expiration date. 15  Put option Put option gives its holder the right to sell an asset for a specified exercise price on or before a specified expiration date. 16  PROFITS AND LOSSES BUYER CALL The trader who wants to hedge against rising prices must buy call options. Example: the spot underlying price of an asset is 150 SAR and the strike price is set at 160 SAR. The premium (purchase price of the call) amount is assumed to be 5 SAR. Profits 15 160 165 180 -5 Spot price of the underlying asset Losses 17  PROFITS AND LOSSES SELLER CALL Profits 5 160 165 180 -15 Spot price of the underlying asset Losses 18  PROFITS AND LOSSES BUYER PUT The trader who wants to protect hedge against falling prices must buy put options. Example: The spot underlying price of an asset A is 170 SAR and the strike price is set at 160 SAR. The amount of the premium (purchase price of the put) is assumed to be 5 SAR. Profits 10 145 155 160 -5 Spot price of the underlying asset Losses 19  PROFITS AND LOSSES SELLER PUT Profits 5 145 155 160 -10 Spot price of the underlying asset Losses 20  Futures contracts Contrary to options, futures contract obliges traders to buy or sell an asset at an agreed upon price at a specified future date The call (put) provide the trader right to buy (sell) an asset at an agreed-upon price, however future contract obliges the trader to buy (sell) the asset Options must be purchased (premium), however future contract does not have cost 21  Swaps A swap is a contract in which a trader swaps the values or cash flows of one asset for another For example, a swap rate allows to swap fixed rate against variable rate 22 Thank you for your attention 23