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FIN 355 Week 2 Notes

by: Gabby Greenberg

FIN 355 Week 2 Notes FIN 355

Marketplace > Colorado State University > Finance > FIN 355 > FIN 355 Week 2 Notes
Gabby Greenberg
GPA 3.5

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Equity, Securities, Debt
Principles of Investments
Tianyang Wang
Class Notes
25 ?




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This 7 page Class Notes was uploaded by Gabby Greenberg on Monday September 5, 2016. The Class Notes belongs to FIN 355 at Colorado State University taught by Tianyang Wang in Fall 2016. Since its upload, it has received 6 views. For similar materials see Principles of Investments in Finance at Colorado State University.


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Date Created: 09/05/16
DEBT INSTRUMENTS  Money market securities, fixed income securities  Treasury Bills (T-Bills) o Government debt with maturity less than or equal to one year o At issue maturities of: 4 week bills (1 month) Auctioned Weekly 13 week bills (3 months) Auctioned Weekly 26 week bills Auctioned Weekly 52 week bills Auctioned Monthly o Minimum denomination of $100 o Income is tax exempt for state or local taxes, but not federal taxes o Treasury bill is also called a zero coupon bond and does not pay interest - issued at discount to par and interest earned by receiving yield o T-bill yields (and thus prices) are often quoted in the financial press using the bank discount method (unfortunately) o Bid/Ask  Bid price is the price dealer will pay  Ask price is the price dealer will charge  Treasury Notes and Bonds o Treasury Notes: Maturity 1-10 years o Treasury Bills: Maturity > 10 years o Notes and Bonds make semiannual coupon payments o Coupon income: % of par.  Example: 4% coupon, two $20 semiannual coupon payments. o Price quotes are % of par (par = $1000)  The numbers to the right of the colon in the bid and ask prices represent units of 1/32 of a point. (1/32 = 0.0313 .03125)  Ask price 102:23 = 102(23/32) = 102.719% * $1,000 = $1,027.19 $1,027.19 PLUS accrued interest o TIPS (inflation-protected treasury bonds)  Hedge inflation risk  Municipal Bonds (Muni's) o Bonds issued by local governments  General Obligation (GO) - backed by the taxing power of the issuing entity  Revenue Bonds - payments on bonds tied to specific projects  Toll roads, bridges, airports, power plant, prisons, etc. o Key features of munis is that interest is tax-free at federal and state level  Equivalent taxable yield on a muni calculated as o You buy a muni if o Break-even tax rate given by t = 1 - (muni rate/taxable rate) o Clientele is usually high tax bracket o Taxable Rate = Muni Rate / (1-tax rate)  Commercial Paper (CP) o Short-term unsecured debt issued by private companies o Maturity is less than or equal 270 days  Maturity greater than 27 days would be required registration with SEC (Security Exchange Commission)  Denominations of multiples of $100,000 o CP is rated for credit quality by the rating agencies o CP can and occasionally does default  Enron o Asset-backed commercial paper  The markets can also seize up and stop working, as it did shortly after the Lehman Brothers fall  Corporate Bonds o Pay semiannual interest  Every six months, in maturity month and 6 months from maturity month o Pricing  Price quotes are percentage of par ($1,000), but quoted in decimals instead of the 32nds of the Treasury Market o Corporate Default Risk o Embedded Option  Callable (by corporation)  Convertible (by bondholder)  Foreign Bond o Foreign Bond - bonds issued in a domestic market by foreign entity, in the domestic market's currency.  Yankee Bond - a dollar denominated bond issued by a non-US issuer in the US.  Samurai Bond - a yen-denominated bond issued by non-Japanese issuer in Japan  Bulldog Bond - a pound-denominated bond issued by a non-British issuer in British Pounds. Eurobonds  o Eurobonds - bond denominated in a currency other than that of the country in which it is issued.  Ex: dollar denominated bond sold in Britain called a Eurodollar bond or a yen- denominated bond sold outside of Japan called a Euroyen bond.  Certificates of Deposit (CDs) o Time deposits  Penalty for early liquidation or withdrawal  Like a zero coupon rate bond in that they pay no intermediate interest - interest and principal paid to depositor at maturity of the .  Treated as bank deposits by the government so they enjoy FDIC insurance  Insures up to $250k  Eurodollars o Eurodollars  Time-deposits denominated in US dollars at foreign banks or foreign branches of US banks  Need to be in European banks o More generally, the euro- prefix can be used to indicate any currency held in a country where it is not the official currency:  Examples: Euroyen or Euroeuro  LIBOR Market o LIBOR stands for London InterBank Offer Rate  Lending rate analogous to the fed fund rate for London banks, although the LIBOR rate is widely quoted and used both in Europe and the US o Widely used index for floating rate instruments and interest rate swaps  EX: LIBOR + 200 bps (2%)  So 50 Bps = .5%; 175bps = 1.75% o Other benchmark Rate  Repos  Fed Funds  Government Agency Debt o Government agencies issue bonds and funnel the money into specific markets  At soe point in time, government believed they needed to help the flow of capital into these segments of the economy o Mortgage Agencies  Fannie Mae, Freddie Mac, Ginnie Mae o Others  Federal Farm Credit  Student Loan Marketing (SLMA, Sallie Mae)  Mortgage Backed Securities (MBS) o Payment on MBS can be simple pass-though of mortgage payments or tranched PnL flows  Principal, interest, and principal prepayment o MBS market bigger than Treasury market and corporate market o Most MBS outstanding are agency issued and thur have no real default risk EQUITY Equity Instruments  Risky financial assets o Residual claim on the firm's cash flows  Cash flows distributed in three events o Dividend payment o Stock repurchase o Liquidation  There is really no promise to pay out cash o Shareholder rights and protection become crucial Equity Markets  Common stock o Residual claim o Limited liability  Preferred Stock o Fixed dividends - limited o Priority over common on dividends o Preferred dividends are tax exempt to firms o No voting power  American Depository Receipts (ADR) o Certificates trading in US that represent ownership in foreign firms. Indices  Capital Market: Equity Indexes o Dow Jones Industrial Average (1896)  About 1/5 of the total market cap o S&P 500 500 "larger" capitalization firms   S&P 100 (large), S&P 400 (mid), S&P 500 (small), S&P 1500 o NASDAQ Composite  Tracks al 4000 stocks trading on NASDAQ.  Heavy in software/hardware technology. o International - Nikkei 225; DAX (Ger), FTSE (Fin Times)  Stock Indices o Usually value-weighted  S&P 500, NASDAQ, etc  Interpretation: portfolio with market weights  Market Value = # shares outstanding * share price o Can be price-weighted  Dow Jones and Nikkei 225  Interpretation: portfolio with equal shares o Equal-weighted indices are not common  Value Line Composite Average 1799  Equal dollar values in each stock ISSUING AND TRADING SECURITIES  How Firms Issue Securities  Private Placements/Offerings o Sold to a limited number of sophisticated investors o Less regulation and active for debt issues o Not tradable in the secondary market, illiquid  IPOS - Initial Public Offering o Primary Market, First offer  Steps in IPOS  Choose an underwriter o Lead underwriter assembles an underwriting syndicate o Two common types of deal:  Best effort: underwriter tries to sell as many shares as possible  Firm commitment: underwriter buy all shares from the firm and resells them to the public o File a registration with the SEC  Red Herring - informal document  Prospectus - formal documents  Finalize the prospectus and decide upon the filing range  Book-building: conducting road shows to institutional investors. Have a sense on non-binding indications of interest.  Set an offer price based on the book-building process.  Publish advertisement to attract subscription  Green shoes - option contract (right but not obligation for investment banker)  Trading Securities  Exchanges (Secondary Markets) o Also called the aftermarket o Physical locations where trading occurs o Members trade on the floor at posts  Must own a seat to be a commission or floor  Trading Hours o Since 1985, the regular trading hours for major exchanges in the US, such as NYSW and the NASDAQ stock market, have been from 9:30 am to 4:00 pm EST. o Pre-market trading occurs from 4:00 am to 9:30 pm EST o After-hours trading on a day with a normal session occurs from 4:00 pm to 8:00 pm EST. o Limited to high-net-worth investors and institutional investors like mutual funds.  Floor trading o Floor trading is where traders or stockbrokers meet a specific venue referred to as a trading floor or pit to buy and sell financial instruments using open outcry method to communicate with each other o During the 1980s and 1990s phone and electronic trading replaced physical floor trading in more exchanges around the world. o Even though over 82% of the trades take place electronically, the action on the floor of the stock exchange still has its place. o As of 2007, few exchanges still have floor trading. One example is the NYSE which still executes a small percentage of its trades on the floor.  OTC Markets (Third Markets) o Over the Counter - directly between two parties. Via phone, internet, etc. o No unique physical place o Less-standard products. EX: majority of bond trading o Instruments such as bonds do not trade on a formal exchange and are, therefore, considered OTC securities. o Most debt instruments are traded by investment banks making markets for specific issues. If an investor wants to buy or sell a bond, he or she must call the bank that makes the market in that bond and asks for quotes. o OTC stocks are generally unlisted stocks which trade on Over the Counter Bulletin Board (OTCBB) or on the pink sheets (stocks that are so small they cannot be listed on the exchange, therefore list themselves on OTC market)  Pink sheet (no reporting required, easier listing)  Dark/Black Pool (allow institutional investors to trade blocks of securities directly, rather than through an exchange)  ECNs (Fourth market) o Electronic Communication Networks - private computer networks that directly link buyers with sellers.  No unique physical place  Investors (and dealers) interact directly  No Bid-Ask spread  Anonymity in trades  Currency trading  After-hours trading  3 Main Trading Mechanisms  Methods to buy and sell securities in the US o Dealer Markets o Specialists o ECN  1st Trading Mechanism: Dealers Dealer based system  o NASDAQ - National Association of Securities Dealers Automated Quotations o OTC: Over the Counter o Consists a network of dealers  Each dealer posts a bid price, ask price, and the depth (Number of shares the dealer is willing to buy or sell at the quoted prices) o Best quotes are displayed o When an order is placed, it automatically gets routed to the dealer with the highest bid or lowest ask o Block trades  2nd Trading Mechanism: Specialists  Act as Broker. o Execute the order of other brokers.  Act as Dealer. o Make the market: Market Maker o Set the buy or sell prices (i.e. bid and ask price) based on the observed order flow (sell and buy orders).  Why would they provide these bid/ask services? o Provide liquidity o Provide price continuity  3rd Trading Mechanism: ECNs  ENCs = Electronic Communication Networks  Rely on computer networks without brokers o Direct crossing of trades without using a broker-dealer system. o No need for market makers o Eliminate the bid-ask spread o Better price for buyers and sellers o Considerable anonymity for investors  Market Order Vs. Price Contingent Order  Market Order: an order to buy or sell at a current market price.  Limit Order: an order to buy or sell a pre-specified price.  Stop Order: Trade is not to be executed unless stock hits a price limit. (when the market is moving against you)  Buying on Margin  Some traders may want to "buy on margin" o Using only a portion of the proceeds for an investment o Borrow remaining component from brokers  Fed requires 50% as initial margin  Broker sets maintenance margin  Margin Call: Notification from broker that you must put up additional funds.  Short Sales  Purpose: to profit from a decline in the price of stock or security  Mechanics o Borrow stock from a broker, very risky o Sell it and deposit proceeds and margin in an account o Closing out the positions: buy the stock and return to the party from which was borrowed o Unlimited risk as price goes up, used with "stop-buy" o Uptick rule repealed (2007); back under review (2009), a modified form was adopted in 2010-02-24.


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