8/11/2019 Chapter 3 - FINA

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Chapter 3: Overview of Security Types

Classification of Financial Assets

Basic Types Major Subtypes

Interest-Bearing Money market Instruments

Fixed-Income Securities

Equities Common Stock

Preferred Stock

Derivatives Futures

Options

Interest Bearing Assets: These pay interest. Some pay interest implicitly and some pay explicitly.

o

Money Market Instruments: Debt obligations of large corps & governments w/ an original maturity of 1 or less year. (2 properties)1) They are essentially IOUs sold by large corporations or governments to borrow money.

2) They mature in less than 1 year from the time they are sold, meaning that the loan must be repaid within 1 year.

Most familiar money market instrument is a Treasury Bill or T-Bill. These are sold on a discount basismeaning they

sold at a price that is less than the stated face value. They buy the T-Bill at one price and later, when it matures,

receive the full face value. Difference is the interest earned.

o Fixed Income Securities: Longer-term debt obligations, often of corporations & governments that promise to make fixed payments

according to a preset schedule. These like money market instrument, begins life s a loan of some sort, and are therefore debt obligation

Unlike money market instruments, they have lives that exceed 12 months at a time they are issued.

1) Examples of fixed income securities:

The bonds coupon:When you buy a 2 year note you will receive a check every six months for 2 years for a fixed

amount. This fixed amount is called the Bonds Coupon.

Current Yield:Dont mix this up with the coupon. The Current Yield is an Annual Coupon divided by the current bo

price. For most bonds the coupon rate never changes but the CY fluctuates w/ the price of the bond.

Equities: Equities are probably the most familiar type of security. They come in two forms: Common Stock and Preferred Stock.

o Common Stock: Represents ownership in a corporation. Potential benefit in 2 forms.

1) First: Many companies pay cash dividends to their shareholders. However, neither the timing nor the amount of any dividend

guaranteed. Paid strictly at the discretion of a company BOD which is elected by shareholders.

2) Second: The value of your stock may rise because share values overall increase or because the future prospects for your

particular company improve (or both).

o Preferred Stock: Differs from common stock in a couple ways:

1) First: The dividend on a preferred share is usually fixed at some amount and never changed.

2) Second: in the event of liquidation, preferred shares have a particular face value. The reason its call preferred is that a

company must pay the fixed dividend on its preferred stock before any dividends can be paid to the common shareholders.

3) Third: Dividend can be omitted at the discretion of the BOD, so, unlike debt obligation, there is no legal requirement. Howev

some preferred stock is Cumulativemeaning that any and all skipped dividends must be paid in full before common can receiv

4) Fourth: While not rare, they are less frequently encountered than common stock. Most come from banks and public utilities.

5)

Fifth: Preferred stock is treated as equity.6) Convertible Bond: Ordinary bond in every way except that it can be exchanged for a fixed number of shares of stock at any

time at the bondholders discretion.

Derivatives: There is a clear distinction between real assets, which are essentially tangible items, and financial assets, which are pieces of paper

describing legal claims. Financial assets can be further subdivided into primary and derivatives.

o Primary Asset: Security originally sold by a business or government to raise money. And a primary asset represents a claim on the ass

of the issuer. Thus, stocks and bonds are primary financial assets.

o Derivative Asset: A financial asset that is derived from an existing traded asset rather than issued by a business or gov. to raise capita

More generally, any financial asset that is not a primary asset. Derivative assets usually represent claims either on other financial assets

such as shares of stock or even other derivative assets, or on the future price of a real asset such as gold. 2 types: futures & options.

1) Futures: An agreement made today regarding the terms of a trade that will take place later. No money changes hands today

Futures are standardized: Meaning that one contract calls for the purchase of a specific quantity of the underlyin

asset. Further, the contract specifies in detail what the underlying asset is and where it I to be delivered.

2) Option Contract: An agreement that gives the owners the right, but not the obligation, to buy or sell a specific asset at a

specified price for a set period of time. Call Option: An option that gives the owner the right, but not the obligation, to buy an asset.

Put Option: An option that gives the owner the right, but not the obligation, to sell an asset.

Option Premium: The price you pay to buy an option.

Strike Price: The price specified in an option contract at which the underlying asset can be brought (for a call opti

or sold (for a put option). Also called the striking price or exercise price.