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Financial Instruments and Markets

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Title: Financial Instruments and Markets


1
Topic?
Financial Instruments and Markets
2
Financial Instruments
3
Global Investment Choices
  • Fixed-Income Investments
  • Equities
  • Derivatives
  • Indirect, Managed Investments

4
Fixed Income Investments
  • Most fixed income instruments specify a number of
    features including the following
  • The maturity date
  • The coupon
  • The par value

5
Money Market Instruments
  • Treasury Bills
  • Certificate of Deposits(CD)
  • Commercial Paper(CP)
  • Bankers Acceptances(BA)
  • Eurodollars
  • Repos and Reverses Repos
  • Brokers Calls
  • Federal Funds
  • the LIBOR Market

6
Fixed Income Securities-Capital Market
(I)
  • Government Bonds
  • Treasury notes
  • Treasury bonds
  • Government agency bonds
  • Municipal Bonds
  • General obligation bonds (GOs)
  • Revenue bonds

7
Fixed Income Securities-Capital Market
(II)
  • Corporate Bonds
  • Debentures
  • Senior secured bonds
  • Subordinated debentures
  • Income bonds
  • Convertible bonds
  • Callable bonds
  • Bonds with Warrants

8
Fixed Income Securities-Capital Market
(?)
  • International Bond Investment
  • Eurobond market
  • Yankee bonds, Bulldog market, Samurai Market
  • International domestic bonds
  • Other Fixed Income Instruments
  • Asset backed securities

CMOs
CARs
  • Zero coupon bonds
  • Preferred Stocks

9
Equity Securities
  • Common Stock
  • Foreign Equities
  • American Depository Receipts(ADRs)
  • American Shares
  • Direct purchase
  • International or global mutual funds

10
American Depository Receipts
  • Easiest way to acquire foreign shares
  • Certificates issued by a U.S. bank
  • Buy and sell in U.S. dollars
  • Dividends in U.S. dollars
  • May represent multiple shares
  • Very popular, over 1500 ADR programs available
    in 2002

11
Derivative Securities
There are many types of derivative investments,
including financial derivative securities whose
payoffs are tied to various financial assets.
  • Options
  • Warrants
  • Puts and calls
  • Futures contracts

12
Derivatives Options
  • Warrants
  • Puts and calls

13
Derivatives Futures
  • Standardized contracts to make or take delivery
    of some financial (or other) asset in exchange a
    specified payment at a future date.

14
Managed Investments
  • Closed-end investment companies
  • Open-end investment companies (Mutual funds)
  • Hedge Funds
  • Venture capital pools
  • Real Estate Investment Trusts (REITs)

15
Historic Return and Risk
16
Exhibit 3.1
Exhibit 3.2
17
Return/Risk Characteristics
  • Major classes of assets
  • large company common stocks
  • small capitalization common stocks
  • long-term U.S. government bonds
  • long-term corporate bonds
  • Intermediate-term U.S. T-bonds
  • U.S. T-bills
  • consumer goods (measure inflation)

18
Return/Risk focuses
  • Consider

Exhibit 3.15
19
Summarizing the Historic Data
  • Average premiums earned
  • Equity risk premium
  • Small-stock premium
  • Horizon premium
  • Default premium

20
Exhibit3.10
21
World Portfolio Performance
Exhibit3.16
Exhibit3.17
Exhibit3.18
Exhibit3.11
Exhibit3.12
22
Financial Markets and Market Structures
23
Types of markets
  • Direct Search Markets
  • Brokered Markets
  • Dealer Markets
  • Auction Markets

24
Characteristics of A Good Market
  • Availability of info (timely accurate)
  • Liquidity
  • Low TCs (Internal efficiency)
  • External efficiency

25
Primary Capital Markets
  • Underwriting Functions
  • Relationships with Investment Bankers
  • Negotiated
  • Competitive bids
  • Best-efforts

Exhibit6.1
26
Primary MarketsCommon Stock
  • Types of new issues
  • Forms of Underwriting
  • Negotiated
  • Competitive bids
  • Best efforts
  • Introduction of Rule 415 (Shelf Registration)
  • Private Placement and Rule 144A

27
Rule 415 Shelf Regis tration
Allows firms to register securities and sell them
piecemeal over the next two years
  • Pros
  • Cons
  • Used for straight debentures rather than CS or CB

28
Private Placements and Rule 144A
  • Firms sells to a small group of

institutional investors, with some assistance of
an investment banker
29
Primary MarketsGovernment Bond
  • Federal Reserve System Auction
  • Competitive bids vs. non-competitive bids
  • ????????
  • ?????????????
  • ????
  • 1.????(??)?
  • 2.????(??)?,????

30
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31
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32
Primary Markets Corporate Bond
  • Negotiated arrangement
  • ?????????

33
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34
Secondary Markets
  • Provide liquidity to investors who acquire
  • securities in the primary market
  • An active secondary market

35
Secondary Bond Markets
  • Stock Exchanges (First Market)
  • Over-the-counter market (Second Market)
  • Third Market
  • Fourth Market

36
Secondary Market Trading Systems
  • Pure auction market
  • Dealer market

p.190??Dealer Bid Ask
37
Call Versus Continuous Markets
  • Call markets(????)
  • Continuous markets(???? )

38
Exchange Membership
  • Four categories of membership
  • Specialists
  • Commission brokers
  • Floor brokers
  • Registered traders

39
Major Types of Orders
  • Market orders
  • Limit orders
  • Special Orders
  • Stop loss
  • MIT (Market-if-touched)

40
Margin Trading Example (I)
P050,200 shares, IM50 ?I05000
? leverage factor1/0.52
P1 R R(100commission,6 on loan)
60 (?20)
40 (?20)
41
Margin Trading Example (II)
  • If MM25
  • If P 30
  • Investors Margin

Margin call for
42
Short Sales Example (I)
Suppose bearish on Xerox when P 100 Short
1,000 shares IM 50, MM 30
Assets Assets Liabilities and Owners Equity Liabilities and Owners Equity
Cash 100,000 Short position in Xerox stock(1,000 shared owed) 100,000
T-bills 50,000 Equity 50,000
43
Short Sales Example II
Purchase of Stock Purchase of Stock Purchase of Stock
Time Action Cash flow
0 Buy share -Initial price
1 receive dividend, sell share Ending price dividend
Short Sale of Stock Short Sale of Stock Short Sale of Stock
Time Action Cash flow
0 Borrow share sell it Initial price
1 Repay dividend and buy share to replace the share originally borrowed -(Ending price Dividend)
44
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45
Changes in the Securities Markets
  • In recent years, major changes in securities
    markets have largely been driven by the influence
    of large financial (institutional) investors.
  • Among the impacts
  • Negotiated (competitive) commission rates
  • Influence of block trades
  • Impact on stock price volatility
  • Development of National Market System (NMS)

46
New Trading Systems
  • Super DOT
  • Display Book
  • Opening Automated Report Service (OARS)
  • Market Order Processing
  • Limit Order Processing

47
Global Market Changes (I)
  • NYSE Off-hours trading
  • Listing foreign stocks on the NYSE

48
Global Market Changes (II)
  • London Stock Exchange Big Bang
  • Tokyo Stock Exchange Big Bang

49
Future Developments
  • Creation and consolidation of stock exchanges
  • More specialized investment companies
  • Changes in the financial services industry
  • Trading in Cybermarkets

50
SECURITY MARKET INDICATOR SERIES
51
What is an indicator series?
It is an index that answers the question What
happened in the market today?
52
Uses of Security Market Index
  • Performance benchmark
  • Develop an index portfolio
  • Measure(or examine factors of) market movements
  • Technical Analysis,to predict future price move
  • Proxy for mkt portfolio to compute

53
Factors in Constructing Market Indicator Series
  • Sample
  • Weighting
  • price weighted
  • value-weighted
  • unweighted
  • Computational procedure

54
Stock-Market Indicator Series
  • Price-Weighted Series
  • Value-Weighted Series
  • Equal-Weighted Series

55
DIJA Computation
????/????
Exhibit b7.2
Exhibit 7.1
56
Value Weighted Series
???????
????

??????
(????)
Exhibit 7.3
Exhibit7.4
57
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? ??55????100 ? ?????????,???????????,???
???,?????????????? ?
?????????????????????????? ???????(??????????)
,??????? ??????? ??????
??????
????
?????
58
Taiwan TAIEX Example
A A B B C C D D
?? ?? ?? ?? ?? ?? ?? ??
20 5 30 2 40 6 50 2
40 5 50 2 50 6 100 2
59
Unweighted Price Indicator Series
  • Arithmetic and Geometric Means

GM Index
AM Index
60
Exhibit7.8
61
Unweighed IndexExample
ex A B C ??
t0 80 40 16 100
t1 100 50 20 150
t2 104 57 21 161.5
62
Value Line Index
63

A 10 250 2500 2500 2500 (50)
B 50 30 1500 1500 1500 (30)
C 100 10 1000 1000 1000 (20)
160 5000 5000 5000
64
Stock Split
Prices Prices Prices
Stocks 4/1 4/2
A 20
B 35 37
C 50 51
If Stock A splits 21 on 4/1
65
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66
Price
A
40
20
B
35
37
C
50
51
67
Style Indexes
  • Measure the performance of various investment
    styles or sectors
  • Size indexes
  • type indexes
  • Small-cap

growth
midcap
growth
Large-cap
growth
68
Global Equity Indexes
  • FT/SP Actuaries World Indexes
  • Morgan Stanley Capital International (MSCI) World
    Indexes
  • Dow Jones World Stock Index

69
Exhibit7.9
Exhibit7.10
Exhibit7.12
70
Comparison of World Stock Indexes
Exhibit7.13
71
Bond-Market Indicator Series
  • Relatively new and not widely published
  • Growth in fixed-income mutual funds increase
    need for reliable benchmarks for evaluating
    performance
  • Increasing interest in bond index funds, which
    requires an index to emulate

72
Difficulties in Creating a Bond-Market Index
  • bond quality
  • Bond market changes
  • Bond prices are affected differently
  • without current and continuous transaction
  • prices

73
Bond Market Index Series
  • Investment-Grade Bond Indexes
  • High-Yield Bond Indexes
  • Global Government Bond Market Indexes
  • Composite Stock-Bond Indexes
  • Merrill Lynch-Wilshire U.S. Capital Markets
    Index
  • (ML-WCMI)
  • Brinson Partners Global Security Market Index
    (GSMI)

74
Comparison of Indexes Over Time
Exhibit7.15
Exhibit7.16
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