Bodie Essentials of Investments 12e Chapter 02 PPT PDF

2.1 The Money Market: Instruments Bankers’ Acceptances Purchaser authorizes a bank to pay a seller for goods at later date (time draft) When purchaser’s bank “accepts” draft, it becomes contingent liability of the bank (and marketable)...

2.1 The Money Market: Instruments Bankers’ Acceptances Purchaser authorizes a bank to pay a seller for goods at later date (time draft) When purchaser’s bank “accepts” draft, it becomes contingent liability of the bank (and marketable) Eurodollars Dollar-denominated time deposits held outside U.S. Pay higher interest rate than U.S. deposits Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill. 7  2.1 The Money Market: Repurchase Agreements Repurchase Agreements (RPs) Short-term sale of securities + promise to repurchase at higher price RP is a collateralized loan Many RPs are overnight “Term” RPs may have a 1-month maturity Reverse RPs Lending money; obtaining security title as collateral Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill. 8  2.1 The Money Market: Brokers’ Calls Brokers’ Calls Call money rate applies for investors buying stock on margin Loan may be “called in” by broker Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill. 9  2.1 The Money Market: Instruments Federal Funds Trading in reserves held at the Federal Reserve * Key interest rate for economy LIBOR (London Interbank Offer Rate) Rate at which large banks in London (and elsewhere) lend to each other Base rate for many loans and derivatives * Depository institutions must maintain deposits with Federal Reserve Bank Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill. 10  Figure 2.2 Funds rate and T-bill rate Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill. 11  2.1 The Money Market: Instrument Yields Yields on money market instruments Not always directly comparable Factors influencing “quoted” yields Par value vs. investment value 360 vs. 365 days assumed in a year (366 leap year) Simple vs. compound interest Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill. 12  2.1 The Money Market: Bond Equivalent Yield Bond Equivalent Yield Can’t compare T-bill directly to bond 360 vs. 365 days Return is figured in par vs. price paid Adjust bank discount rate to make it comparable Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill. 13  2.1 The Money Market: Bond Equivalent Yield Bond Equivalent Yield P = price of the T-bill n = number of days to maturity $10, 000 − P 365 rBEY =  P n Example Using Sample T-Bill $10, 000 − $9,875 365 rBEY =  =.0513 = 5.13% $9,875 90 Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill. 14  2.1 The Money Market: Effective Annual Yield Effective Annual Yield 365  $10, 000 − P  n rEAY = 1 +  −1  P  Compare: P = price of the T-bill rBD = 5% n = number of days to maturity rBEY = 5.13% rEAY = 5.23% Example Using Sample T-Bill 365  $10, 000 − $9,875  90 rEAY = 1 +  − 1 =.0523 = 5.23%  $9,875  Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill. 15  2.1 The Money Market: Instrument Yield Money Market Instrument Instrument Yield Treasury Bills Discount Certificates of Deposit Bond Equivalent Yield Commercial Paper Discount Bankers’ Acceptances Discount Eurodollars Bond Equivalent Yield Federal Funds Bond Equivalent Yield Repurchase Agreements Discount Reverse RPs Discount Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill. 16  2.2 The Bond Market Capital Market—Fixed-Income Instruments Government Issues—U.S. Treasury Bonds and Notes Bonds vs. notes Denomination Interest type Treasury Inflation Protected Securities (TIPS) Principal adjusted for changes in the Consumer Price Index Marked with a trailing “i” in quote sheets Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill. 17  2.2 The Bond Market: Municipal Bonds Municipal bonds Issuer? Differ from treasuries and agencies? Risk? G.O. vs. revenue Industrial development Taxation? rtax exempt = rtaxable  (1 − tax rate) Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill. 18  Table 2.2 Equivalent Taxable Yields rtax exempt = rtaxable  (1 − tax rate) Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill. 19 Figure 2.5 Yield Ratio: Tax-Exempt to Taxable Bonds Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill. 20  2.2 The Bond Market: Private Issue Corporate Bonds Investment grade vs. speculative grade Mortgage-Backed Securities Backed by pool of mortgages with “pass-through” of monthly payments; covers defaults Collateral Traditionally all mortgages conform, since 2006 Alt-A and subprime mortgages are included in pools Private banks purchased and sold pools of subprime mortgages Issuers assumed housing prices would continue to rise Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill. 21 Figure 2.6 Mortgage-Backed Securities Outstanding Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill. 22 Figure 2.7 Asset-Backed Securities Outstanding Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill. 23  Figure 2.9 The U.S. Fixed-Income Market Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill. 24  2.3 Equity Securities: Instruments Equity Securities Common stock Residual claim Limited liability Preferred stock Priority over common Fixed dividends: Limited gains Nonvoting Tax treatment: Corporate tax exclusions on 70% of dividends earned Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill. 25  2.3 Equity Securities: Instruments Depository receipts American Depositary Receipts (ADRs), also called American Depositary Shares (ADSs) Certificates traded in the U.S. representing ownership in foreign security Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill. 26  2.3 Equity Securities: Returns Capital gains and dividend yields Buy a share of stock for $50, hold for 1 year, collect $1 dividend, and sell stock for $54 What were dividend yield, capital gain yield, and total return? PSell − PBuy + Div $54 − 50 + 1 Total Return = = = 10% PBuy $50 Div $1 Dividend Yield = = = 2% PBuy $50 PSell − PBuy $54 − 50 Capital Gains Yield = = = 8% PBuy $50 Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill. 27  Figure 2.8 Listing of stocks traded on NYSE Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill. 28  2.4 Stock and Bond Market Indexes Constructing Market Indexes Weighting schemes Price-weighted average: Add prices and divide by “divisor” Market value-weighted index: Return = weighted average of returns of each security proportional to market value Equally weighted index: Computed from simple average of returns Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill. 29  2.4 Stock and Bond Market Indexes Construction of Indexes How are stocks weighted? Price weighted (DJIA) Market value weighted (S&P 500, NASDAQ) Equally weighted (Value Line Index) How much money do you put in each stock in the index? Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill. 30  2.5 Derivative Markets Derivative Asset/Contingent Claim Security with payoff that depends on the price of other securities Call Option Right to buy an asset at a specified price on or before a specified expiration date Put Option Right to sell an asset at a specified exercise price on or before a specified expiration date Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill. 31  Figure 2.10 Stock Options on Microsoft Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill. 32  2.5 Derivative Markets: Call Option Call Options on Microsoft The right to buy 100 shares at a strike price of $140 using the September contract costs: Cost call = 100  $1.99 = $199 Is this contract “in the money”? When should you buy this contract? When should you write it? Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill. 33  2.5 Derivative Markets: Put Option Put Options on Microsoft The right to buy 100 shares at a strike price of $140 using the September contract costs: Cost put = 100  $4.35 = $435 Is this contract “in the money?” Why do the two option prices (Call and Put) differ? Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill. 34  2.5 Derivative Markets Futures Contracts Purchaser (long) buys specified quantity at contract expiration for set price Contract seller (short) delivers underlying commodity at contract expiration for agreed- upon price Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill. 35