Essentials of Investments © 2001 The McGraw-Hill Companies, Inc. All rights reserved. Fourth Edition Irwin / McGraw-Hill Bodie Kane Marcus 1 Chapter 2 Financial Markets and Instruments

Essentials of Investments © 2001 The McGraw-Hill Companies, Inc. All rights reserved. Fourth Edition Irwin / McGraw-Hill Bodie Kane Marcus 2 Major Classes of Financial Assets or Securities Debt – Money market instruments – Bonds Common stock Preferred stock Derivative securities

Essentials of Investments © 2001 The McGraw-Hill Companies, Inc. All rights reserved. Fourth Edition Irwin / McGraw-Hill Bodie Kane Marcus 3 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. Fourth Edition Irwin / McGraw-Hill Bodie Kane Marcus 4 Money Market Instruments Treasury bills Certificates of deposit Commercial Paper Bankers Acceptances Eurodollars Repurchase Agreements (RPs) and Reverse RPs Federal Funds

Essentials of Investments © 2001 The McGraw-Hill Companies, Inc. All rights reserved. Fourth Edition Irwin / McGraw-Hill Bodie Kane Marcus 5 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 © 2001 The McGraw-Hill Companies, Inc. All rights reserved. Fourth Edition Irwin / McGraw-Hill Bodie Kane Marcus 6 Bank Discount Rate (T-Bills) r BD = bank discount rate P= market price of the T-bill n= number of days to maturity r BD = 10,000 - P10,000 x 360 n 90-day T-bill, P = $9,875 r BD = 10, ,875 10,000 x =5% Example

Essentials of Investments © 2001 The McGraw-Hill Companies, Inc. All rights reserved. Fourth Edition Irwin / McGraw-Hill Bodie Kane Marcus 7 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

Essentials of Investments © 2001 The McGraw-Hill Companies, Inc. All rights reserved. Fourth Edition Irwin / McGraw-Hill Bodie Kane Marcus 8 Bond Equivalent Yield P = price of the T-bill n = number of days to maturity r BEY = 10,000 - PP x 365 n r BEY = 10, ,875 9,875 x r BEY =.0127 x =.0513 = 5.13% Example Using Sample T-Bill

Essentials of Investments © 2001 The McGraw-Hill Companies, Inc. All rights reserved. Fourth Edition Irwin / McGraw-Hill Bodie Kane Marcus 9 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

Essentials of Investments © 2001 The McGraw-Hill Companies, Inc. All rights reserved. Fourth Edition Irwin / McGraw-Hill Bodie Kane Marcus 10 Capital Market - Equity Common stock –Residual claim –Limited liability Preferred stock –Fixed dividends - limited –Priority over common –Tax treatment

Essentials of Investments © 2001 The McGraw-Hill Companies, Inc. All rights reserved. Fourth Edition Irwin / McGraw-Hill Bodie Kane Marcus 11 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

Essentials of Investments © 2001 The McGraw-Hill Companies, Inc. All rights reserved. Fourth Edition Irwin / McGraw-Hill Bodie Kane Marcus 12 Examples of Indexes - Domestic Dow Jones Industrial Average (30 Stocks) Standard & Poor’s 500 Composite NASDAQ Composite NYSE Composite Wilshire 5000

Essentials of Investments © 2001 The McGraw-Hill Companies, Inc. All rights reserved. Fourth Edition Irwin / McGraw-Hill Bodie Kane Marcus 13 Examples of Indexes - Int’l Nikkei 225 & Nikkei 300 FTSE (Financial Times of London) Dax Region and Country Indexes –EAFE –Far East –United Kingdom

Essentials of Investments © 2001 The McGraw-Hill Companies, Inc. All rights reserved. Fourth Edition Irwin / McGraw-Hill Bodie Kane Marcus 14 Construction of Indexes How are stocks weighted? –Price weighted (DJIA) –Market-value weighted (S&P500, NASDAQ) –Equally weighted (Value Line Index)

Essentials of Investments © 2001 The McGraw-Hill Companies, Inc. All rights reserved. Fourth Edition Irwin / McGraw-Hill Bodie Kane Marcus 15 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