Overview of Security Types

Chapter 4

Overview of Security Types

Ayşe Yüce – Ryerson University

Copyright © 2012 McGraw-Hill Ryerson

Ayşe Yüce – Ryerson University Copyright © 2012 McGraw-Hill Ryerson

 

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205.pdf

 

VALUATION AND MANAGEMENT

Investments

JORDAN MILLER DOLVIN YÜCE

third canadian edition

fundamentals of

 

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Price quotes for all types of investments are easy to find, but what do they mean? Learn the answers for:

 

1. Various types of interest-bearing assets.

2. Equity securities.

3. Futures contracts.

4. Option contracts.

Ayşe Yüce – Ryerson University

Copyright © 2012 McGraw-Hill Ryerson

Learning Objectives

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Our goal in this chapter is to introduce the different types of securities that investors routinely buy and sell in financial markets around the world.

For each security type, we will examine:

Its distinguishing characteristics

Its potential gains and losses

How its prices are quoted in the financial press.

Security Types

Ayşe Yüce – Ryerson University

Copyright © 2012 McGraw-Hill Ryerson

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Ayşe Yüce – Ryerson University

Copyright © 2012 McGraw-Hill Ryerson

Classifying Securities

Basic Types

Major Subtypes

Interest-bearing

Money market instruments

Fixed-income securities

Equities

Common stock

Preferred stock

Derivatives

Futures

Options

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Money market instruments are short-term debt obligations of large corporations and governments.

  • These securities promise to make one future payment.
  • When they are issued, their lives are less than one year.

 

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.

Ayşe Yüce – Ryerson University

Copyright © 2012 McGraw-Hill Ryerson

Interest Bearing Assets

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Examples: U.S. Treasury bills (T-bills), bank certificates of deposit (CDs), corporate and municipal money market instruments.

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.

Ayşe Yüce – Ryerson University

Copyright © 2012 McGraw-Hill Ryerson

Money Market Instruments

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Examples: 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.

 

Illiquidity means that you might not be able to sell securities quickly for their current market value.

Fixed Income Securities

Ayşe Yüce – Ryerson University

Copyright © 2012 McGraw-Hill Ryerson

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  • Price Quotations from www.wsj.com—the online version of
    The Wall Street Journal (some columns are self-explanatory):

 

 

Ayşe Yüce – Ryerson University

Copyright © 2012 McGraw-Hill Ryerson

Quote Example: Fixed Income Securities

 

 

You will receive 2.20% of the bond’s face

value each year in 2 semi-annual payments.

 

The price (per $100 face) of the bond when it last traded.

 

 

The Yield to Maturity (YTM) of the bond.

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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.

Preferred 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.

 

Ayşe Yüce – Ryerson University

Copyright © 2012 McGraw-Hill Ryerson

Equities

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Examples: RIM shares, Microsoft shares, Tim Horton’s shares, Dell shares, etc.

Potential gains/losses:

  • 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.

Ayşe Yüce – Ryerson University

Copyright © 2012 McGraw-Hill Ryerson

Common Stock

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Ayşe Yüce – Ryerson University

Copyright © 2012 McGraw-Hill Ryerson

Common Stock Price Quotes

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Ayşe Yüce – Ryerson University

Copyright © 2012 McGraw-Hill Ryerson

Common Stock Price Quotes Online at http://finance.yahoo.com

 

First, enter symbol.

Resulting Screen

 

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Information is a bit harder to find for preferred stock versus common stock.

 

Example: Bank of America (BAC) preferred stock

Find all the BAC preferred stock issues via a Google search—one source is: quantumonline.com.

One issue has a ticker of: BAC-J (BAC-PJ is its symbol at Yahoo!)

Potential gains/losses:

  • 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.

Ayşe Yüce – Ryerson University

Copyright © 2012 McGraw-Hill Ryerson

Preferred Stock

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Primary asset: Security originally sold by a business or government to raise money.

 

Derivative asset: 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.

 

 

Ayşe Yüce – Ryerson University

Copyright © 2012 McGraw-Hill Ryerson

Derivatives

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Futures contract: An agreement made today regarding the terms of a trade that will take place later.

 

Option contract: An agreement that gives the owner the right, but not the obligation, to buy or sell a specific asset at a specified price for a set period of time.

 

 

Ayşe Yüce – Ryerson University

Copyright © 2012 McGraw-Hill Ryerson

Derivatives

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Examples: financial futures (i.e., TSX/S&P, 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.

Ayşe Yüce – Ryerson University

Copyright © 2012 McGraw-Hill Ryerson

Futures Contracts

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Source: Markets Data Center at www.wsj.com.

Ayşe Yüce – Ryerson University

Copyright © 2012 McGraw-Hill Ryerson

Futures Contracts:

Online Price Quotes

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Source: www.cmegroup.com

Ayşe Yüce – Ryerson University

Copyright © 2012 McGraw-Hill Ryerson

Futures Price Quotes Online

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    • 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.

Ayşe Yüce – Ryerson University

Copyright © 2012 McGraw-Hill Ryerson

Options Contracts

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  • 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.

Ayşe Yüce – Ryerson University

Copyright © 2012 McGraw-Hill Ryerson

Options Contracts

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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.

Ayşe Yüce – Ryerson University

Copyright © 2012 McGraw-Hill Ryerson

Options Contracts

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Potential gains and losses from put options:

Buyers:

  • Profit when the strike price minus the market price is greater than the option premium.
  • Best case, market price (for the underlying) is zero.
  • Worst case, the put buyer loses the entire premium.

Sellers:

    • Profit when the strike price minus the market price is less than the option premium.
    • Best case, the put seller collects the entire premium.
    • Worst case, market price (for the underlying) is zero.

 

Note that, for buyers and sellers,

gains and losses are limited.

Ayşe Yüce – Ryerson University

Copyright © 2012 McGraw-Hill Ryerson

Options Contracts

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Source: www.finance.yahoo.com

Ayşe Yüce – Ryerson University

Copyright © 2012 McGraw-Hill Ryerson

Options Contracts: Online Price Quotes for Nike (NKE) Options

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Stocks:

  • Suppose you have $10,000 for investments. Macron Technology is selling at $50 per share.
  • Number of shares bought = $10,000 / $50 = 200
  • If Macron is selling for $55 per share 3 months later, gain = ($55  200) – $10,000 = $1,000
  • If Macron is selling for $45 per share 3 months later, gain = ($45  200) – $10,000 = -$1,000

Ayşe Yüce – Ryerson University

Copyright © 2012 McGraw-Hill Ryerson

Investing in Stocks versus Options

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Options:

    • A call option with a $50 strike price and 3 months to maturity is also available at a premium of $4.

 

  • Traded option contracts are on a bundle of 100 shares.
  • One call contract costs $4  100 = $400, so number of contracts bought = $10,000 / $400 = 25 (for 25  100 = 2,500 shares)
  • If Macron is selling for $55 per share 3 months later, gain = {($55 – $50)  2,500} – $10,000 = $2,500
  • If Macron is selling for $45 per share 3 months later, loss = ($0  2,500) – $10,000 = -$10,000

Ayşe Yüce – Ryerson University

Copyright © 2012 McGraw-Hill Ryerson

Investing in Stocks versus Options

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www.m-x.ca (Montreal Exchange)

www.nasdbondinfo.com (current corporate bond prices)

www.investinginbonds.com (bond basics)

www.finra.com (learn more about TRACE)

www.fool.com (Are you a “Foolish investor”?)

www.stocktickercompany.com (reproduction stock tickers)

www.cmegroup.com (CME Group)

www.cboe.com (Chicago Board Options Exchange)

finance.yahoo.com (prices for option chains)

www.wsj.com (online version of The Wall Street Journal)

Ayşe Yüce – Ryerson University

Copyright © 2012 McGraw-Hill Ryerson

Useful Internet Sites

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Classifying Securities

Interest-Bearing Assets

  • Money Market Instruments
  • Fixed-Income Securities

Equities

  • Common Stock
  • Preferred Stock
  • Common and Preferred Stock Price Quotes

Ayşe Yüce – Ryerson University

Copyright © 2012 McGraw-Hill Ryerson

Chapter Review

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34.pdf

 

VALUATION AND MANAGEMENT

Investments

JORDAN MILLER DOLVIN YÜCE

third canadian edition

fundamentals of

 

*

 

Derivatives

  • Futures Contracts
  • Futures Price Quotes
  • Gains and Losses on Futures Contracts

Option Contracts

  • Option Terminology
  • Options versus Futures
  • Option Price Quotes
  • Gains and Losses on Option Contracts
  • Investing in Stocks versus Options

Ayşe Yüce – Ryerson University

Copyright © 2012 McGraw-Hill Ryerson

Chapter Review

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35.pdf

 

VALUATION AND MANAGEMENT

Investments

JORDAN MILLER DOLVIN YÜCE

third canadian edition

fundamentals of

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