Investment Alternatives by pptfiles

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									Vicentiu Covrig                 FIN352



  Investment Alternatives
                  (chapter 2)




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Vicentiu Covrig                               FIN352
              The Role of Financial Markets

  nHelp firms and governments raise cash by
   selling claims against themselves
  nProvide a place where investors can buy and
   sell securities ( investments)
  nHelp the private companies to become public
   and original investors to cash out




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Vicentiu Covrig                                    FIN352
             Nonmarketable Financial Assets

  n Commonly owned by individuals
  n Represent direct exchange of claims between issuer
    and investor
  n Usually very liquid or easy to convert to cash without
    loss of value
  n Examples: Savings accounts and bonds, certificates
    of deposit, money market deposit accounts




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Vicentiu Covrig                             FIN352
                  Money Market Securities

  nMarketable: claims are negotiable or salable in
   the marketplace
  nShort-term, liquid, relatively low risk debt
   instruments
  nIssued by governments and private firms
  nExamples: Money market mutual funds,
   T-Bills, Commercial paper


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Vicentiu Covrig                                      FIN352
                  Capital Market Securities

  nMarketable debt with maturity greater than one
   year and ownership shares
  nMore risky than money market securities
  nFixed-income securities have a specified
   payment schedule
      - Dates and amount of interest and principal
        payments known in advance




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Vicentiu Covrig                                 FIN352
                  Bond Characteristics

  nBuyer of a newly issued coupon bond is
   lending money to the issuer who agrees to
   repay principal and interest
  nBonds are fixed-income securities
      - Buyer knows future cash flows
      - Known interest and principal payments
  nIf sold before maturity price will depend on
   interest rates at that time


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Vicentiu Covrig                                  FIN352
                  Bond Characteristics
  nPrices quoted as a % of par value
  nBond buyer must pay the price of the bond
   plus accrued interest since last semiannual
   interest payment
      - Prices quoted without accrued interest
  nPremium: amount above par value
  nDiscount: amount below par value



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Vicentiu Covrig                                     FIN352
         Innovation in Bond Features
  nZero-coupon bond
      - Sold at a discount and redeemed for face value at
        maturity
      - Locks in a fixed rate of return, eliminating
        reinvestment rate risk
      - Responds sharply to interest rate changes
      - Not popular with taxable investors
      - May have call feature



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Vicentiu Covrig                            FIN352
                  Major Bond Types
  nFederal government securities (eg., T-bonds)
  nFederal agency securities (eg., GNMAs)
  nFederally sponsored credit agency securities
   (eg., FNMAs, SLMAs)
  nMunicipal securities: General obligation bonds,
   Revenue bonds
      - Tax implications for investors



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Vicentiu Covrig                                                        FIN352
                     Equivalent taxable yield
  n Interest income received from muni bonds is free from
    federal income tax and state income tax in the same state as
    the bonds were issued.
  n To appreciate the tax exempt advantages of muni bonds,
    compare with similar bond producing taxable income

  n Equivalent taxable yield =

      - Example : For an investor in a 30 % tax bracket, which is more
         attractive, a corporate bond with a 7.5 % coupon or a muni bond
         with a 5.5% coupon?
        Solution: Equivalent taxable yield for the muni = 5.5% / (1-0.3) =
         7.86%, which is greater than 7.5% taxable bonds. Muni is more
         attractive for this investor.



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Vicentiu Covrig                                     FIN352
                  Corporate Bonds
  nUsually unsecured debt maturing in 20-40
   years, paying semi-annual interest, callable,
   with par value of $1,000
      - Callable bonds gives the issuer the right to repay
        the debt prior to maturity
      - Convertible bonds may be exchanged for another
        asset at the owner’s discretion
      - Risk that issuer may default on payments



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Vicentiu Covrig                                FIN352
                   Bond Ratings
  nRate relative probability of default
  nRating organizations
      - Standard and Poors Corporation (S&P)
      - Moody’s Investors Service Inc
  nRating firms perform the credit analysis for the
   investor
  nEmphasis on the issuer’s relative probability of
   default

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Vicentiu Covrig                                       FIN352
                    Bond Ratings
  nInvestment grade securities
      - Rated AAA, AA, A, BBB
      - Typically, institutional investors are confined to
        bonds in these four categories
  nSpeculative securities
      - Rated BB, B, CCC, C
      - Significant uncertainties
      - C rated bonds are not paying interest


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Vicentiu Covrig                                     FIN352
                    Securitization
  nTransformation of illiquid, risky individual
   loans into asset-backed securities
      - GNMAs
      - Marketable securities backed by auto loans, credit-
        card receivables, small-business loans, leases
  nHigh yields, short maturities, investment-grade
   ratings



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Vicentiu Covrig                                    FIN352
                  Equity Securities
  nDenote an ownership interest in a corporation
  nDenote control over management, at least in
   principle
      - Voting rights important
  nDenote limited liability
      - Investor cannot lose more than their investment
        should the corporation fail



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Vicentiu Covrig                                 FIN352

                  Preferred Stocks
  nHybrid security because features of both debt
   and equity
  nPreferred stockholders paid after debt but
   before common stockholders
      - Dividend known, fixed in advance
      - May be cumulative if dividend omitted
  nOften convertible into common stock
  nMay carry variable dividend rate

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Vicentiu Covrig                              FIN352
                  Common Stocks
  nCommon stockholders are residual claimants
   on income and assets
  nPar value is face value of a share
      - Usually economically insignificant
  nBook value is accounting value of a share
  nMarket value is current market price of a share




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Vicentiu Covrig                                     FIN352
                  Common Stocks
  nDividends are cash payments to shareholders
      - Dividend yield is income component of return
        =D/P
      - Payout Ratio is ratio of dividends to earnings




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Vicentiu Covrig                               FIN352
                  Common Stocks
  nStock dividend is payment to owners in stock
  nStock split is the issuance of additional shares
   in proportion to the shares outstanding
      - The book and par values are changed
  nP/E ratio is the ratio of current market price of
   equity to the firm’s earnings




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Vicentiu Covrig                                          FIN352
            Investing Internationally
  nDirect investing
      - US stockbrokers can buy and sell securities on
        foreign stock exchanges
      - Foreign firms may list their securities on a US
        exchange or on Nasdaq
      - Purchase ADR’s
         uIssued by depositories having physical possession of
          foreign securities
         uInvestors isolated from currency fluctuations



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Vicentiu Covrig                            FIN352
                  Derivative Securities
  nSecurities whose value is derived from another
   security
  nFutures and options contracts are standardized
   and performance is guaranteed by a third party
      - Risk management tools
  nWarrants are options issued by firms




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Vicentiu Covrig                                  FIN352
                         Options
  nExchange-traded options are created by
   investors, not corporations
  nCall (Put): Buyer has the right but not the
   obligation to purchase (sell) a fixed quantity
   from (to) the seller at a fixed price before a
   certain date
      - Right is sold in the market at a price
  nIncreases return possibilities


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Vicentiu Covrig                                      FIN352
                         Futures
  nFutures contract: A standardized agreement
   between a buyer and seller to make future
   delivery of a fixed asset at a fixed price
      - A “good faith deposit,” called margin, is required
        of both the buyer and seller to reduce default risk
      - Used to hedge the risk of price changes




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Vicentiu Covrig                               FIN352

                  Learning Objectives
  nAll the concept issues from the chapter
  nCalculation using taxable equivalent yield
  nP/E, Div yield calculations, stock splits (see
   text page 41)
  nAll end of chapter questions
  nProblems 2-1, 2-2



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