TI Flashcards
money market instruments
Treasury Bills Federal Funds Repurchase agreements (Repos or RPs) Certificate of Deposits Commercial Paper Eurodollar LIBOR (London Interbank Offer Rate)
capital market instruments
Treasury Bonds Corporate Bonds Municipal Bonds Common Stocks Preferred Stocks Depository receipts
money market characteristics
maturity less 1 year liquidity high risk low return low trading no formal place transaction size large role liquidity adjustments, government needs
capital market characteristics
maturity more than 1 year liguidity low risk high return high trading formal place transaction size small amount role capital requirements of companies
treasury bills
issuer federal government
riskless investment
interest income exempt from state and local taxes but subject to federal taxes
sold at face value
federal funds
reserves banks have to keep at FED
banks with surplus lend to other banks
Repurchase agreements
Short-term collateralized loan
Borrower, usually a government securities dealer, sells securities (e.g., fixed income securities) to a lender with an agreement to buy back securities at a future date at a specific (higher) price
Securities serve as collateral
LIBOR
Premier short–term interest rate at which large banks in London (and elsewhere) lend to each other
treasury Eurodollar TED spread
Indicator of perceived credit risk in the economy
An increase in the TED spread Lenders believe the risk of default on interbank loan (i.e., counterparty risk is increasing)
A decrease in the TED spread The risk of bank defaults decreases
Certificate of Deposits
Time deposit with a depository institution
Fixed term and usually pays a fixed interest rate greater than saving accounts.
Commercial Paper
Unsecured short-term debt note issued by large creditworthy corporations
Sold at discount and the interest rate depends on the creditworthiness of the corporation
Eurodollar
Dollar-denominated (time) deposits held at foreign banks or foreign branches of American banks
Bond Instruments
Longer term borrowing
Include fixed income securities with maturities greater than one year
Fixed cash flows: coupons/interest payment
But bonds are NOT risk-free
Issued by
Federal Government (Treasury notes/bonds)
State and local governments (Municipal bonds)
Firms (Corporate Bonds)
Treasury Bonds
Issued by the federal government over a broad range of maturities
1 to 10 years -> Treasury Notes, 10 to 30 years -> Treasury Bonds
Semiannual coupon + repay principal (face value) on the maturity date
Municipal Bonds
Issued by states, counties, cities, and so forth other than the federal government or its agencies
Default (in rare cases) and interest is exempt from federal and state tax
Because of the tax-exempt feature of municipal bonds, they sell at a lower promised yield than non-municipal bonds of the same risk
Corporate Bonds
Similar to government bonds in payment pattern: coupon + principal (face value) at maturity
Have the risk of default. Rated as to quality by agencies (S&P, Moody’s).
Common stocks(equity instruments)
Represent ownership claim on the earnings and assets of a corporation The holder of common stocks has: Voting rights Limited liability Residual claim
Preferred stocks
At first blush resembles an infinite life bond
Periodic payments like coupons, but called dividends rather than interest
No principal like in a bond or no bankruptcy if dividends are not paid
Priority over common stocks
Can be callable, convertible, or adjustable-rate
Depository receipts
Certificates traded in the U.S. representing ownership in foreign security
market indexes
Provide a broad representative portfolio of investment holdings
Used as benchmarks to gauge the movement and the performance of the overall stock market or market segments
Used as a basis for passive investing
Used as benchmarks to assess the performance of active investors
Price-weighted index
Each company makes up a fraction of the index proportional to its price.
In its simplest form, adding the prices of each stock and dividing by the total # of companies determine the index’s value
Market-value-weighted index
Each company makes up a fraction of the index proportional to its market value (price * shares outstanding)
Index value is derived by sum of market value divided by a divisor
Value Line Index
Simple average of returns
Placing equal weights on each return is a strategy that places equal dollar values in each stock
derivative market instruments
Options
Future contracts
Forward contracts
Swaps
Options
gives the holder the right to either buy (a call option) or sell (a put option) an asset at a specific price (strike price) on or before a specified expiration date
The buyer (option holder) pays a price for the option (option premium) but is free not to exercise it.
European options can be exercised only at expiry
call option (buyer, seller )
Buyer :Has the right to buy the stock Want the stock to appreciate in value Pays the premium seller : Has the obligation to sell the stock Want the stock to depreciate in value Collects the premium
put option
buyer : Has the right to sell the stock Want the stock to depreciate in value Pays the premium seller : Has the obligation to buy the stock Want the stock to appreciate in value Collects the premium
Futures
The buyer (long position) is obliged to buy a particular asset at a particular time (maturity date) for an agreed-upon price, and the seller (short position) commits to delivering the asset at contract maturity. Speculators such as portfolio managers or some retail investors can trade futures purely for profit as long as the trade is closed before expiration.
