Investment Alternatives by pptfiles


									Vicentiu Covrig                 FIN352

  Investment Alternatives
                  (chapter 2)

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

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

Vicentiu Covrig                             FIN352
                  Money Market Securities

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

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

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

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

Vicentiu Covrig                                     FIN352
         Innovation in Bond Features
  nZero-coupon bond
      - Sold at a discount and redeemed for face value at
      - 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

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

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.

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

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
  nEmphasis on the issuer’s relative probability of

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

Vicentiu Covrig                                     FIN352
  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

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

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

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

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

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

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

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

Vicentiu Covrig                                  FIN352
  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

Vicentiu Covrig                                      FIN352
  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

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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