Ch3

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Anonymous
ID:
141440
Filename:
Ch3
Updated:
2012-03-13 18:51:17
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equity
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equity
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  1. money market instruments
    • Interest bearing money market instruments are short-term debt obligations of largecorporations and governments.–These securities promise to make one futurepayment.–When they are issued, their lives are less than one year.
    • -very liquid
    • -treasury bill
    • •Potential gains/losses: A known future
    • payment, except when the borrower defaults (i.e., does not pay).
    • •Price quotations: Usually, the
    • instruments are sold on a discount basis, and only the interest rates are quoted.
    • •Therefore, investors
    • must be able to calculate prices from the quoted rates.
  2. Fixed Income Securities
    • Fixed-income securities are longer-term debt
    • obligations of corporations and governments.
    • These securities promise to make fixed payments according to a pre-set schedule.
    • When they are issued, their lives exceed one year.
    • •Examples: U.S. Treasury notes,corporate bonds, car loans, student loans.
    • •Potential gains/losses:–Fixed coupon payments and final payment at maturity, except when the borrower defaults.
    • –Possibility of gain (loss) from fall (rise) in interest rates
    • –Depending on the debt issue, illiquidity can be a problem.
    • Current yield =annual coupon/price and changes with price of bond
    • while coupon rate=semiannual rate usually. always stays the same.
  3. Equities 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.
    • –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.
  4. Prefered 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.
    • -harder to find
    • –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.
  5. Primary asset
    Security sold by a business or government to raise money
  6. Derivative Asset
    •Derivativeasset: A financial asset that is derived from an existing traded asset, rather than issued by a business or government to raise capital. More generally, any financial asset that is not a primary asset.
  7. Derivatives- Futures
    • •Futures contract: An agreement made today regarding the
    • terms of a trade that will take place later.
    • •Examples: financial futures
    • (i.e., S&P 500, T-bonds, foreign currencies, and others), commodity futures
    • (i.e., wheat, crude oil, cattle, and others).


    • •Potential
    • gains/losses:
    • –At maturity, you gain if your contracted price is better than the market price of the underlying asset, and vice versa.
    • –If you sell your contract before its maturity, you may gain or lose depending on the market price for the contract.
    • –Note that enormous gains and losses are possible.
  8. Options
    • •A call option gives the owner the right, but not the obligation, to buy something, while a put option gives the owner the right, but not the obligation, to sell something.
    • •The “something” can be an asset, a commodity, or an index.
    • •The price you pay today to buy an option is 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
    • •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 differ from futures in two main ways:
    • –Holders of call options have no obligation to buy the underlying asset.
    • –Holders of put options have no obligation to sell the underlying asset.
    • –To avoid this obligation, buyers of calls and puts must pay a price today. Holders of futures contracts do not pay for
    • the contract today.
    • •Potential gains and losses
    • from call options:

    • –Buyers:
    • •Profit when the market price minus the strike price is
    • greater than the option premium.
    • •Best case, theoretically unlimited profits.
    • •Worst case, the call buyer loses the entire premium.
    • –Sellers:
    • •Profit when the market price minus the strike price is less
    • than the option premium.
    • •Best case, the call seller collects the entire premium.
    • •Worst case, theoretically unlimited losses.
    • –Note that, for buyers, losses are limited, but gains are not.
  9. Strike price
    price specified in an option contract at which the underlying asset can be bought(call) or sold (put).

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