FIN 310: Investments - Ch. 1, 2, 3 (WVU)

FIN 310: Investments (West Virginia University).

Corporate Finance

How firms raise capital, invest capital

and return capital to investors.

Investments

How investors allocate their savings among different investment alternatives.

Markets and Institutions

How financial markets bring

together firms and investors.

Real Assets

Machinery, offices, trademarks, etc.

Financial Assets

Claims on real assets or the income

generated by real assets

Consumption Timing

Use securities to store wealth and transfer consumption to the future

Risk Allocation

The desired risk level investors select

Asset Allocation

The primary determinant of a portfolio's return

Security Selection

Choice of particular securities within asset class

Security Analysis

Analysis of the value of securities.

Risk

The unexpected component of the return (Actual return = Expected return + Unexpected return)

Business Firms

Net demanders of capital

Households

Net suppliers of capital

Governments

Tend to demand funds

Financial Intermediaries

Connect suppliers and

demanders of capital

Investment Banks

Specialize in primary market transactions

Primary market

Newly issued securities offered to public

Secondary market

Preexisting securities traded among investors

Privately held firms

Primary offerings where shares are sold directly to a small group of investors

Publicly Traded Companies

Securities sold to the general public, allows investors to trade shares in established securities markets like the NYSE or Nasdaq

Initial Public Offering (IPO)

First (initial) sale of stock to the public by a formerly privately owned company

Seasoned Equity Offering (SEO)

The sale of additional shares in firms that already are publicly traded

Underwriters

Purchase securities from issuing company and resell the securities (can also be done in other ways)

Prospectus

Description of firm and security being

issued

Bookbuilding

Helps determine demand for the

new issue

Underpricing

Percentage difference between closing market price on first day of trading and the offering price

Non-Traditional IPO Processes

Direct auction, direct listing, issuance without raising money

SEC Rule 415 (Shelf Registration)

Allows already public firms to register securities and gradually sell them to the public within three years of registration

Private Placements

Primary issue of securities to a small group of investors (allowed under SEC Rule 144A)

Direct Search Markets

Buyers and sellers locate one another on their own

Brokered Markets

Third-party assistance in locating buyer or seller

Dealer Markets

Third party acts as intermediate buyer/seller

Auction Markets

Traders converge in one place either physically or electronically to trade

Market Orders

Specifies ticker and quantity with immediate execution at best available price

Market Buy

order will be executed at lowest “ask” price

Market Sell

order will be executed at highest “bid”

price

Limit Orders

You specify ticker, quantity, and price, but the order will be executed only if trade can be made at the limit price or better

Limit Buy

order can only be executed at limit price or lower

Limit Sell

order can only be executed at limit price or higher

Order Matching

A market order will trade at the best price(s) currently available and match immediately

Over-the-counter (OTC) markets

Network of dealers

Electronic Communication Networks (ECNs)

Computer networks that allow direct trading

Specialist Markets

A market in which trading in each security is managed by a specialist

Specialist

makes a market in the shares of one or more firms and maintains “a fair and orderly market”

Latency

The time it takes the exchange’s computer to accept and process an order and send a responding message

Algorithmic Trading

Use of computer programs to make rapid trading decisions

High-Frequency Trading

Computer programs make very rapid trading decisions for relatively small profits per trade

Dark Pools

ECNs where participants can buy/sell large blocks of securities anonymously

Blocks

Transactions of at least 10,000 shares

Commission

Fee paid to intermediary for making a transaction

Spread

Cost of trading with a dealer

Bid

Price at which dealer will buy from you

Ask

Price at which dealer sells to you

Price Impact

Buying securities with money borrowed, in part, from a broker

Account Equity/Margin

Portion of the value of an

investment that is not borrowed

Margin Loan

The portion that is borrowed which incurs an interest charge

Initial Margin Requirement (IMR)

The minimum margin that must be

supplied before a trade can be initiated

Maintenance Margin

the minimum margin amount that must always be present in a margin account

Margin Call

When the margin drops below the maintenance margin the broker can demand more funds

1-IMR

Maximum amount investor can borrow

Short Sale

A sale in which the seller does not

actually own the security that is sold

Covering or closing out position

Buy stock, broker returns title to original party from which it was borrowed

Required Initial Margin

Usually 50%

Securities Act of 1933

Full disclosure of relevant information when issuing new securities

Securities Act of 1934

Establishes periodic reporting for already issued securities and SEC to administer provision of the 1933 Act

Securities Investor Protection Act of 1970

Establishes Securities Investor Protection Corporation (SIPC) to protect investors if broker fails (up to $500,000 per investor)

Financial Industry Regulatory Authority, Inc. (FINRA)

Some rule-making and enforcement is

delegated to the exchanges

Circuit Breakers

Trading Halts

The Sarbanes-Oxley Act (2002)

Rules requiring independent financial experts to serve on audit committees of a firm’s BOD

Inside Information

material nonpublic knowledge about a corporation possessed by officers, major owners, etc., with privileged access to information

Short-term

Generally less than one year

Highly liquid

Easy to buy and sell at fair value

Bank Discount (BD) method

Quoting T-Bill yields uses

T-Bill Bid

The price the dealer is willing to buy the T-Bill from you

The price you receive if you want to sell the T-Bill

T-Bill Asked

The price the dealer is willing to sell the T-Bill to you

The price you pay if you want to buy the T-Bill

T-Bill Asked Yield

Bond equivalent yield (yield-to-maturity if you buy T-Bill)

Annualized return using a simple interest calculation assuming you buy the T-Bill

Repurchase Agreements

Short-term sales of government securities by dealers with an agreement to repurchase the securities (usually the next day) at a higher price (overnight interest)

Reverse Repos

Dealer finds an investor holding government securities and buys them with an agreement to resell securities back at a higher price on a future date

Bankers’ Acceptances/Bank Bills

An order to a bank by its customer to pay a sum of money on a future date to the holder of the bill/note

When accepted, it becomes a contingent liability of the bank (and marketable)

Eurodollars

U.S. dollar-denominated time deposits held outside U.S. (Pay higher interest rate than U.S. deposits)

Federal Funds

Commercial banks’ (i.e., depository institutions) mandatory deposits with the Federal Reserve Bank

Federal Funds Rate (Fed Funds Rate)

Overnight loan rate of federal funds between U.S. banks

Widely watched (barometer of money market) and is the key interest rate for economy

LIBOR (London Interbank Offer Rate)

Rate at which large banks in London (and elsewhere in Europe) used to lend to each other overnight

Inflation-Protected Treasury Bonds (TIPS)

The principal amount is adjusted in proportion to increases in the Consumer Price Index (inflation)

Federal Agency Debt

Primarily arose to provide liquidity and credit to a particular sector of the economy

Municipal bonds

Interest income exempt from federal income tax and from state and local taxes in issuing state

General obligation bonds

backed by the full faith and credit of the issuer

Revenue bonds

Issued to finance particular projects and are backed by the revenues earned on the project (airports, hospitals, etc.)

Mortgage-Backed Securities (MBS)

Backed by pool of mortgages with “pass-through” of monthly payments

American Depository Receipts (ADRs)

Certificates traded in U.S. markets that represent ownership in shares of a foreign company

Indexes

A measure/indicator of performance

Stock Indexes

Dow Jones Industrial Average (Price-Weighted)

Standard & Poor’s 500 (Market Value-Weighted)

Value Line Index (Equally-Weighted)

Bond Indexes

Merrill Lynch

Salomon Smith Barney

(Difficult to obtain up-to-date bond returns because of illiquidity)

Price-Weighted Index

Computed by adding the prices of the stocks in an index and dividing by a “divisor” (Gives greater weight to higher price stocks)

Market Value-Weighted Stock Index

Computed by calculating a weighted average of the returns of each security in the index, with weights proportional to outstanding market value

Equally-Weighted Stock Index

Computed as a simple average of returns and implies equal dollar investment in each stock

Derivative

A security with a payoff dependent (contingent) upon the price of other securities

Options

Grants the holder the right – but not the obligation – to trade an asset at an agreed upon price on or before an agreed upon date

Call Option

The right to buy an asset at a specified price (exercise or strike price) on or before a specified date (expiration date)

Put Option

The right to sell an asset at a specified price (exercise or strike price) on or before a specified date (expiration date)