Chapter 2 Investment Analysis

Money Market

• short term, highly marketable securities

• trade in large denominations and are out of the reach of individual investors

T-bills

• most marketable of all money market instruments

• simplest form of borrowing, highly liquid

• issued with initial maturities of 4, 13, 26, or 52 weeks

• sell in minimum denominations of only $100

Ask price

price you would have to pay to buy a T-bill from a securities dealer

Bid price

slightly lower price you would receive if you wanted to sell a bill to a dealer

Bid-ask spread

difference between bid price and ask price

Certificates of deposit

• time deposit with a bank

• bank pays interest and principal to the depositor only at maturity

• issued in denominations greater than $100,000

• insured by FDIC

Commercial paper

• large companies that issue their own short-term unsecured debt notes rather

  than borrow directly from banks

• backed by a bank line of credit

• range up to 270 days

• denominations in multiples of $100,000

Banker’s acceptances

• starts as an order to a bank by a bank’s customer to pay a sum of money at a future date

• When the bank endorses the order for payment as “accepted,” it assumes responsibility for ultimate payment to the holder of the acceptance

Eurodollars

dollar-denominated deposits at foreign banks or foreign branches of American banks

Repos

Dealer sells government securities to an investor on an overnight basis, with an agreement to buy back those securities the next day at a slightly higher price (the increase in the price is the overnight interest)

Reverse Repo

the dealer finds an investor holding government securities and buys them, agreeing to sell them back at a specified higher price on a future date

Federals funds

each member bank of the the Fed is required to maintain a minimum balance in a reserve account depending on the total deposits of the bank’s customers

Federal funds rate

rate of interest banks charge each other for borrowing money overnight

Brokers' Calls

interest rate banks charge brokerage firms for short-term loans used to finance client margin accounts

LIBOR Market

premier short-term interest rate quoted in the European money market and serves as a reference rate for a wide range of transactions

Bond market

composed of longer term borrowing or debt instruments than those that trade in the money market. This market includes Treasury notes and bonds, corporate bonds, municipal bonds, mortgage securities, and federal agency debt

T-notes

• maturities ranging up to 10 years

• may be issued in increments of $100 but far more commonly trade in denominations of $1,000

• make semiannual interest payments called coupon payments

T-bonds

• maturities ranging up to 10 to 30 years

• may be issued in increments of $100 but far more commonly trade in denominations of $1,000

• make semiannual interest payments called coupon payments

TIPS

• principal amount on these bonds is adjusted in proportion to increases in the Consumer Price Index

• provide a constant stream of income in real (inflation-adjusted) dollars

Federal Agency debt

• some government agencies issue their own securities to finance their activities

• formed to channel credit to a particular sector of the economy that Congress believes might not receive adequate credit through normal private sources.

Eurobond/International Bonds

bond denominated in a currency other than that of the country in which it is issued

Municipal Bonds

• issued by state and local governments

• interest income is exempt from federal income taxation, sometimes from local too

• Capital gains taxes must be paid on “munis” when the bonds mature or if they are sold for more than the investor’s purchase price

General obligation bonds

backed by the “full faith and credit” of the issuer

Revenue bonds

issued to finance particular projects and are backed either by the revenues from that project or by the particular municipal agency operating the project → more risky

Industrial development bond

• revenue bond that is issued to finance commercial enterprises

• private-purpose bonds give the firm access to the municipality’s ability to

  borrow at tax-exempt rates

Corporate Bonds

• private firms borrow money directly from the public

• typically pay semi-annual coupons over their lives and return the face value to the bondholder at maturity

Secured Bonds

specific collateral backing them in the event of firm bankruptcy

Debentures

no collateral backing them in the event of firm bankruptcy

Subordinated debentures

lower priority claim to the firm’s assets in the event of bankruptcy

Callable bonds

give the firm the option to repurchase the bond from the holder at a stipulated call price

Convertible bonds

give the bondholder the option to convert each bond into a stipulated number of

shares of stock

Mortgage Backed Securities

either an ownership claim in a pool of mortgages or an obligation that is secured by such a pool

Common Stock

• equities that represent ownership shares in a corporation

• each share entitles its owner to one vote on any matters of corporate governance

• can be bought or sold freely on one or more stock markets.

• residual claim and limited liability

Residual Claim

stockholders are the last in line of all those who have a claim on the assets and income of the corporation

Limited Liability

the most shareholders can lose in the event of failure of the corporation is their original investment

Preferred stock

• it promises to pay a fixed amount of income each year

• no voting power

• discretion to make the dividend payments

• the firm does have a contractual obligation to make the interest payments on the debt

American Depository receipts

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

DJIA

measures the return (excluding dividends) on a portfolio that invests one share in each of the 30 large, blue chip stocks in the index

S&P 500 Index

• market-value-weighted index

• more broadly based index of about 500 firms

NYSE index

publishes a market-value-weighted composite index of all NYSE-listed stocks, in addition to subindexes for industrial, utility, transportation, and financial stocks

Wilshire 5000 index

market

value of essentially all actively traded stocks in the U.S

Bond market indexes

• measure the performance of various categories of bonds

• Merrill Lynch, Barclays, and the Citi Broad Investment Grade

Call option

gives its holder the right to purchase an asset for a specified price, called the exercise or strike price, on or before a specified expiration date

Put option

gives its holder the right to sell an asset for a specified exercise price on or before a specified expiration date

Futures contracts

calls for delivery of an asset (or, in some cases, its cash value) at a specified delivery or maturity date for an agreed-upon price, called the futures price, to be paid at contract maturity

Long position

held by the trader who commits to purchasing the asset on the delivery date

Short position

commits to delivering the asset at contract maturity