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

P = price of the T-bill n = number of days to maturity Example: Using Sample T-Bill r BEY =.0204 x =.0828 = 8.28% Bond Equivalent Yield

r BD = bank discount rate P= market price of the T-bill n= number of days to maturity Example 90-day T-bill, P = $980 Bank Discount Rate (T- Bills)

Bond Equivalent Yield  Impossible to compare T-bill directly to bond 360 vs 365 days Return is figured on par vs. price paid  Adjust the bank discount rate to make it comparable

Capital Market - Fixed Income Instruments  Publicly Issued Instruments Canada Bonds Provincial Government Bonds Municipal Bonds  Privately Issued Instruments Corporate Bonds Mortgage-Backed Securities

Canada Bonds  Non marketable (Sold November 1 st ) Canada savings bonds: can be cashed in any time Canada Premium Bonds: Can be cashed in November of succeeding years only

Marketable Canada Bonds Varying maturity, up to 40 years Considered part of the money market when maturity is less than 3 years Interest rate at date of issue is such that the bond can be sold at par value Coupon paid in two semiannual installments

Yield to maturity  Calculated by determining the semi- annual yield and doubling it  Annual Percent Rate (APR), not effective annual rate  Yield for callable bond selling at a premium is up to the first call date  For a discount bound, Yield is to maturity

Provincial and Municipal Bonds  Similar to Canada bonds but generally with a higher YTM  U.S. municipal bonds are exempt of taxes

Corporate Bonds  Riskier than government bonds  Secured bonds have collateral backing  Unsecured bonds, or debentures, have no collateral

Features of bonds  Callable bonds: the firm has the option to repurchase the bond before maturity at a specified price  Retractable: holder has the option to redeem the bond  Extendable: holder has the option to keep the bond after maturity date  Convertible: can be converted to a certain number of shares

Mortgages and MBS  Mortgage-Backed Security (MBS): Ownership claim in a pool of mortgages  The mortgage originator keeps collecting principal and interest for the but borrower but then passes the payments to the MBS holder  Ex: mortgage of $100,000 at 10% over 30 years monthly payment is $ interest, $44.24 principal

MBS  First introduced in Canada by the Canadian Mortgage and Housing Corporation (CMHC) in 1987  MBS are guaranteed by the federal government (no risk)  Yield still higher than T-Bill due to the callable feature, depriving holder from potential capital gains

Equity Securities  Equities: ownership shares in a corporation  Common stock: voting share, allows to participate in directors elections  Some common stocks may have restricted voting rights, usually come with better financial benefits

Equity Securities  Common stocks are residual claims on the liquidation value of the firm  Financial benefits are dividends and/or capital appreciation  Listing

Board Lots and Odd Lots  A board lot is normally 100 shares 1,000 shares if the stock price is below $5 25 shares if the stock price is above $100  Odd lots are not board lots  Stock brokers may charge odd-lot differential

Preferred Stocks  Stocks to which a fixed amount of income is paid each year  Income is dividend, failure to pay it does not mean bankruptcy  Preferred stock holders are paid before common stock holders  No voting power

Preferred Stocks  Advantage for the firm: income need not be paid  Disadvantage: dividends are not tax deductible  Should yield on preferreds be greater or lower than similar bonds? Interest income is taxed more than dividends: yields on preferreds can be lower for that

Stock Indexes  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?

Examples of Indexes – Canadian  TSE 300 Composite Index Introduced in 1977 TSE 300 for 1975 = 1,000  TSE 35 Introduced to stimulate index futures and options trading  TSE 100  S&P/TSE 60 Created to mimic the TSE 300 TSE 60 = 100 in Jan 29, 1982

Examples of Indexes - US  Dow Jones Industrial Average (30 Stocks)  Standard & Poor’s 500 Composite  NASDAQ Composite  NYSE Composite  Wilshire 5000

Construction of Indexes  How are stocks weighted? Price weighted (DJIA) Market-value weighted (S&P500, NASDAQ, TSE 300) Equally weighted (Value Line Index)  How returns are averaged? Arithmetic (DJIA, S&P500, Value Line) Geometric (Value Line Index)

Averaging Methods (Value Line) Component Return r A =10% r B = (-5%) r C = 20% Arithmetic Average: Geometric Average:

Bond Indexes  Lehman Brothers  Merrill Lynch  Salomon Brothers  Scotia Capital (Canada)  Specialized Indexes Merrill Lynch Mortgage

Derivatives Securities Options  Basic Positions Call (Buy) Put (Sell)  Terms Exercise Price Expiration Date Underlying Assets Futures  Basic Positions Long (Buy) Short (Sell)  Terms Delivery Date Underlying Assets

Derivative Securities- Quotes Options  Bid price  Ask price  Last price  Open interest  Underlying asset price Futures  Settlement price  Change  Open interest  Underlying asset price  Physical delivery