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Markets and Instruments Chapter 2

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									Markets and Instruments
Chapter 2




    Finance 650
    Spring 1999

                            Lecture notes prepared by:
                            Dr. Susan D. Jordan
          Chapter 2 (BKM)                        1
The Money Market



Treasury Bills
  auction or primary market
  secondary market
  Treasury Auction Process
    competitive versus noncompetitive




                    Chapter 2 (BKM)      2
Auction results

                                          13-Week
            Applications                  $26.11 Billion
            Accepted bids                 $7.52 Billion
            Accepted noncompetitively     $1.43 billion
            Auction Price (Rate)          98.890 (4.390%)
            Coupon Equivalent             4.502%
            Bids at market yield          26%
            Cusip number                  912795BH3



Results in WSJ and http://www.publicdebt.treas.gov/of/ofbills.htm


                             Chapter 2 (BKM)                   3
TBill Formulas


P = Face [ 1 - rBD * (n/360)]
rBD = (F-P)/F * 360/n (bank discount yield)
rBEY = (F-P)/P * 365/n = (365* rBD )/(360 - t* rBD )
rBEY = bond (coupon) equivalent yield or APR
 effective annual yield = [1 + (F-P)/P ] 365/n - 1
   = (F/P) 365/n - 1



                        Chapter 2 (BKM)                 4
Secondary market
transactions

From WSJ on Tuesday, August 25, 1998
Dealer’s selling price (your purchase
 price)
Dealer’s purchase price (your selling
 price)
     Mat.
            Days to
            Mat.    Bid Asked Chg.
                                   Ask
                                   Yld
    Oct 29 ‘98   65   4.94   4.92       + 0.10   5.03




                      Chapter 2 (BKM)                   5
Money market instruments

Commercial Paper
Eurodollar
Certificate of Deposit
   Domestic
   Eurodollar
   Yankee
   Bear Market CD
   Bull Market CD
                  Chapter 2 (BKM)   6
Money market instruments
(cont.)

Banker's Acceptance
Repurchase Agreement Repo RP Reverse Repo
Federal Funds
Broker's call
LIBOR rate -- London Interbank Offered
 Rate


                 Chapter 2 (BKM)        7
The Fixed-Income Capital Market



Includes Treasury notes and bonds, corporate
 bonds, municipal bonds, mortgage securities,
 and federal agency securities.
Overview of Bond Features
  indenture
  term to maturity
  principal value
  coupon rate

                   Chapter 2 (BKM)              8
Bond features (cont.)
  sinking fund
  debenture
  mortgage or secured bond
  income bond
Embedded Options
  convertible bond
  callable bond
  put bond
  exchangeable bond
                Chapter 2 (BKM)   9
Treasury Notes and Bonds


Notes: original maturity of 2 to 10 years
Bonds: original maturity > than 10 years
  Denominations of $1,000 or more
  Both make semiannual coupon payments
  Some T-Bonds may be called (last 5 years).
  T-bonds issued since Feb. 1985 not callable.
  Inflation-indexed Treasury securities


                   Chapter 2 (BKM)                10
Treasury quotes
From WSJ Wednesday, August 28, 1997

                Maturity                                Ask
         Rate   Mo/Yr      Bid          Asked    Chg.   Yld
         7      Jul 06n    103:16       103:18   -6     6.47

 If date is followed by p or n it is a note
 Numbers to the right of the colon = 1/32 of a
  point
 If you purchase, you pay 103.5625% of par
 If you sell $1000 face, you receive $1035.00
 Coupon rate of 7 = 7% of par ($70/year or
  $35 semi)
                      Chapter 2 (BKM)                          11
Treasury quotes
From WSJ Wednesday, August 28, 1997

                Maturity                               Ask
        Rate    Mo/Yr      Bid      Asked       Chg.   Yld
        7       Jul 06n    103:16   103.18      -6     6.47

 Yld = semiannual yield * 2 = Simple Interest =
  APR (Annual Percentage Rate ) = bond
  equivalent yield
 Other Treasury bonds
   Flower bond
   Callable bonds (Maturity YR is a range)
      yield on callables
         • discount bond = yield to maturity
         • premium bond = yield to first call
                        Chapter 2 (BKM)                       12
Municipal Bonds

general obligation bond
revenue bond
  industrial development bond or private purpose
   bond
tax anticipation bond                     Taxable bond yield = 7.20
Equivalent taxable yield                  and tax-exempt yield = 5.31
   r(1-t) vs. rm        or    r vs. rm/(1-t)
     7.20*(1-.20)= 5.76
      7.20*(1-.30)= 5.04 Chapter 2 (BKM)                           13
Corporate bonds


issued by private firms to borrow money from
 the public
 Corp Bond Quotes from WSJ on Wed, Sept. 3, 1997

                   Cur                     Net
       Bonds       Yld   Vol   Close       Chg.
       ATT 63/ 404 6.7   10    1005/ 8     …


       Current yield = 67.50/1006.25


                         Chapter 2 (BKM)            14
Equities
Common stock
  Residual claim and limited liability
  Two Basic Rights
     Preemptive right
     Right to control
        • Proxy

Preferred stock
  fixed dividends
  priority over common
  tax treatment

                         Chapter 2 (BKM)   15
Stock market quotes
52 Weeks                               Yld           Vol                                 Net
Lo      Hi   Stock     Sym   Div       %     PE      100s    Hi      Lo        Close     Chng
  1
39 /8   22   WalMart   WMT   .27       .7    27      19206   391/2   3715/16   385/16    1
                                                                                           /2




Dividends: annual disbursements based
 on last quarterly declaration
Yield: div/close
PE: close/(last four EPS)
       So what was EPS for last four quarters?
             27 = 38.3125/E or $1.42
                                   Chapter 2 (BKM)                                      16
Derivative Assets or Contingent
Claims

Option Contract
  purchaser of an option contract has the right to buy
   or sell the underlying at a stated price (the strike or
   exercise price) on or before a specified date
   (expiration).
  Put: right to sell
  Call: right to buy
  Option Premium
  Writer/Seller Naked versus covered


                        Chapter 2 (BKM)                      17
Option contract quotes


                                       Call             Put
Option/   Strike   Exp.     Vol.           Last   Vol      Last
BestBuy   35       Sep      10            8 7/8   312      5
                                                             /8
43 1/16   40       Sep      154           5 3/4   390      1 11/16
43 1/16   45       Sep      368           2 3/8   630      3 7/8




                          Chapter 2 (BKM)                            18
Derivative Assets or Contingent
Claims

Futures Contract
  calls for delivery of an asset (or its cash value) on a
   specified date for an agreed upon price to be paid at
   the maturity date.
  Long: commitment to purchase the underlying
  Short: commitment to deliver the underlying
  cash settlement for index options
  How is a long futures contract different from long
   call?


                        Chapter 2 (BKM)                  19
Futures quotes



                     S&P 500 Index (CME) - $250 times index
                                                                          Open
       Open     High     Low      Settle      Chg       High     Low      Interest
Sept   103700   105600   101960   103100      -5.00     119940   879.20   365,506
Dec    105900   106750   103200   104180      -5.00     121210   890.85    34,323
Mr99   106950   107710   104300   105210      -5.00     122500   902.85     5,343
June   107000   108730   105430   106220      -5.10     123810   914.85     1,883




                                  Chapter 2 (BKM)                                    20
Stock Market Indicators

Provide an overall indication of aggregate
 market movements
Uses:
  track average returns
  base of derivatives
  measure systematic risk
  compare performance of managers


                  Chapter 2 (BKM)         21
Stock Market Indicators

Sample
Computation
  Average
    Arithmetic
    Geometric
Indexes
  Value-weighted or capitalization-weighted
  Equal-weighted
                   Chapter 2 (BKM)             22
Dow Jones Average &
Indices
30-Stock Industrial Average (DJIA or DOW)
20-Stock Transportation Average
15-Stock Utilities Average
65-Stock Composite Average
The Dow Jones Equity Index




                   Chapter 2 (BKM)           23
DJIA

Price-weighted
Large, well-known cos (Blue chips)
1884 with 11 stocks
1928 => 30 stocks
Divisor is not equal to # companies
Divisor adjusted:
  Companies added/deleted
  Stock splits or stock dividends > 10%
                  Chapter 2 (BKM)          24
Consider a 2-stock sample

Price-weighted average
Equal-weighted index
Value-weighted index
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                Chapter 2 (BKM)   25
DOW or price-weighted average
  Day 0 = ($110+$30)/2 = 70
  Day 1 = ($154+$33)/2 = 93.5
  Change in DOW = 93.5/70 - 1 = 33.57%
Value-weighted Index (base = 100)
  Day 0 = (MV1 + MV2)/Base * 100 =100
  Day 1 = (1540+33000)/31100 *100 =111.06
  Change in Value = 111.06/100 -1 = 11.06%
Equal-weighted Index
  Change of (40% + 10%)/2 = 25%
                    Chapter 2 (BKM)           26
Consider 3 stocks


    tP t
    o S
    c
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    k h
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     i a
     c M
     e k
       r
       sa
        l
        u
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    B5
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           Chapter 2 (BKM)   27
Examples of domestic indices

Dow Jones Industrial Average
Standard & Poor’s 500 Composite
Nasdaq Composite
NYSE Composite
Wilshire 5000
Value Line Composite


                Chapter 2 (BKM)    28
Examples of international
indices

Nikkei 225 & Nikkei 300
FTSE (Financial Times of London)
Dax
Region and Country Indexes
  EAFE
  Far East
  United Kingdom

                    Chapter 2 (BKM)   29
Example of bond indices

Lehman Brothers
Merrill Lynch
Salomon Brothers
Specialized Indexes
  Merrill Lynch Mortgage




                  Chapter 2 (BKM)   30

								
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