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Essentials of Investments
© 2001 The McGraw-Hill Companies, Inc. All rights reserved.
Fourth Edition
Irwin / McGraw-Hill
Bodie • Kane • Marcus1
Chapter 2
Financial Markets and Instruments
Essentials of Investments
© 2001 The McGraw-Hill Companies, Inc. All rights reserved.
Fourth Edition
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Bodie • Kane • Marcus2
Major Classes of Financial Assets or Securities
• Debt– Money market instruments– Bonds
• Common stock
• Preferred stock
• Derivative securities
• Contracts
Essentials of Investments
© 2001 The McGraw-Hill Companies, Inc. All rights reserved.
Fourth Edition
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Bodie • Kane • Marcus3
Markets and Instruments
• Money Market– Debt Instruments– Derivatives
• Capital Market– Bonds– Equity– Derivatives
Essentials of Investments
© 2001 The McGraw-Hill Companies, Inc. All rights reserved.
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Money Market Instruments
• Treasury bills
• Certificates of deposit
• Commercial Paper
• Bankers Acceptances
• Eurodollars
• Repurchase Agreements (RPs) and Reverse RPs
• Federal Funds
• Brokers’ calls
Essentials of Investments
© 2001 The McGraw-Hill Companies, Inc. All rights reserved.
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Components of the money market
Essentials of Investments
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Figure 2.1 Money Rates
Essentials of Investments
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Figure 2.2 Treasury Bills
Essentials of Investments
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Indexes•Dow Jones averages
•Standard & Poor’s indexes and forwards
•Bond market indicators
•International indexes
Essentials of Investments
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• Treasury bonds and notes
• Certificates of deposit Federal agency debt
• Municipal bonds
• Corporate bonds
• Mortgage-backed securities
BOND MARKET
Essentials of Investments
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Figure 2.4 Treasury Notes, Bonds and Bills
Essentials of Investments
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Figure 2.8 Corporate Bond Prices
Essentials of Investments
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EQUITY MARKETS
• Common stocks
• Preferred stocks
Essentials of Investments
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DERIVATIVE MARKETS
• Options
• Futures and forwards
Essentials of Investments
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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
Essentials of Investments
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Essentials of Investments
© 2001 The McGraw-Hill Companies, Inc. All rights reserved.
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Bank Discount Rate (T-Bills)
rrBDBD = bank discount rate= bank discount rate
PP = market price of the T-bill= market price of the T-bill
nn = number of days to maturity= number of days to maturity
rrBDBD == 10,00010,000 -- PP
10,00010,000 xx 360360
nn
90-day T-bill, P = $9,87590-day T-bill, P = $9,875
rrBDBD == 10,00010,000 -- 9,8759,875
10,00010,000 x x
360360
9090== 5%5%
Example:Example:
Essentials of Investments
© 2001 The McGraw-Hill Companies, Inc. All rights reserved.
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Essentials of Investments
© 2001 The McGraw-Hill Companies, Inc. All rights reserved.
Fourth Edition
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Bodie • Kane • Marcus18
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
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Global Financial Instruments
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Bond Equivalent Yield
P = price of the T-billP = price of the T-bill
n = number of days to maturityn = number of days to maturity
rr BEYBEY == 10,00010,000 -- PP
PP xx 365365
nn
rrBEYBEY == 10,00010,000 -- 9,8759,875
9,8759,875 x x 365365
9090
rrBEYBEY = .0127 x 4.0556 = .0513 = 5.13% = .0127 x 4.0556 = .0513 = 5.13%
Example Using Sample T-BillExample Using Sample T-Bill
Essentials of Investments
© 2001 The McGraw-Hill Companies, Inc. All rights reserved.
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Essentials of Investments
© 2001 The McGraw-Hill Companies, Inc. All rights reserved.
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Essentials of Investments
© 2001 The McGraw-Hill Companies, Inc. All rights reserved.
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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
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Capital Market - Equity
• Common stock– Residual claim– Limited liability
• Preferred stock– Fixed dividends - limited– Priority over common– Tax treatment
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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?
Stock Indexes
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Examples of Indexes - Domestic
• Dow Jones Industrial Average (30 Stocks)
• Standard & Poor’s 500 Composite
• NASDAQ Composite
• NYSE Composite
• Wilshire 5000
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Examples of Indexes - Int’l
• Nikkei 225 & Nikkei 300
• FTSE (Financial Times of London)
• Dax
• Region and Country Indexes– EAFE– Far East– United Kingdom
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Construction of Indexes
• How are stocks weighted?– Price weighted (DJIA)
– Market-value weighted (S&P500, NASDAQ)
– Equally weighted (Value Line Index)
Essentials of Investments
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Derivatives Securities
Options• Basic Positions
– Call (Buy)– Put (Sell)
• Terms– Exercise Price– Expiration Date– Assets
Futures • Basic Positions
– Long (Buy)– Short (Sell)
• Terms– Delivery Date– Assets
Essentials of Investments
© 2001 The McGraw-Hill Companies, Inc. All rights reserved.
Fourth Edition
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Bodie • Kane • Marcus30
Essentials of Investments
© 2001 The McGraw-Hill Companies, Inc. All rights reserved.
Fourth Edition
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Bodie • Kane • Marcus31
Essentials of Investments
© 2001 The McGraw-Hill Companies, Inc. All rights reserved.
Fourth Edition
Irwin / McGraw-Hill
Bodie • Kane • Marcus32
