Investments Chapter 2 condensed

Money Market

A subsector of the fixed-income market that is short-term, highly liquid, low risk, and often has large denominations.

Treasury Bills (T-Bills)

Short-term securities issued by the federal government; highly liquid, no default risk, sold at a discount, and exempt from state/local taxes.

T-Bill Maturities

4, 13, 26, or 52 weeks.

Bank Discount Rate

A T-bill's discount from face value annualized using a 360-day year and reported as a percentage of face value.

Bank Discount Rate Formula

rBD = [(Face Value − Price) / Face Value] × (360 / Days to Maturity).

Certificates of Deposit (CDs)

Money market securities issued by depository institutions; marketable CDs are generally $100,000 or more, use add-on interest, and the first $250,000 is FDIC insured.

Commercial Paper

Short-term unsecured debt issued by large creditworthy corporations and financial institutions; maximum maturity is 270 days and it is sold at a discount.

Bankers' Acceptance

A time draft in which a purchaser authorizes a bank to pay a seller later; once accepted by the bank, it becomes a contingent liability of the bank and is marketable.

Eurodollars

Dollar-denominated time deposits held outside the United States that pay higher interest rates than U.S. deposits.

Repurchase Agreement (Repo)

A short-term sale of securities with a promise to repurchase them at a higher price; economically, it is a collateralized loan.

Reverse Repo

The lending side of a repo transaction; the lender provides money and receives security title as collateral.

Brokers' Calls

Loans used by investors buying stock on margin that may be called in by the broker.

Federal Funds

Trading in reserves held at the Federal Reserve; the federal funds rate is a key interest rate for the economy.

LIBOR

The former rate at which large banks lent to each other; it was a base rate for many loans and derivatives.

SOFR

Secured Overnight Financing Rate; replaced LIBOR and is based on overnight repos collateralized by Treasury securities.

Why aren't money-market yields always directly comparable?

They may use par vs. investment value, 360 vs. 365 days, and simple vs. compound interest.

Bond Equivalent Yield (BEY)

Adjusts a T-bill's bank discount rate to make its yield more comparable to bond yields.

Money Market Mutual Fund Crisis of 2008

After Lehman Brothers failed, the Reserve Primary Fund "broke the buck," causing a run on money market funds.

TIPS

Treasury Inflation-Protected Securities; principal is adjusted for changes in the Consumer Price Index.

Agency Issues

Federal government-related securities, many tied to mortgages, including FNMA, FHLMC, GNMA, and Federal Home Loan Banks.

Municipal Bonds (Munis)

Bonds issued by state and local government entities that can provide tax advantages.

General Obligation vs. Revenue Bonds

GO bonds rely on the government's general resources; revenue bonds are associated with revenue from a particular project or source.

Equivalent Taxable Yield

The taxable yield required to equal the return on a tax-exempt municipal bond.

Equivalent Taxable Yield Formula

Equivalent Taxable Yield = Tax-Exempt Yield / (1 − Marginal Tax Rate).

Equivalent Taxable Yield Example

A 4% tax-exempt yield with a 40% tax rate = 4% ÷ (1 − .40) = 6.67%.

Corporate Bonds

Corporate debt securities classified broadly as investment grade or speculative grade.

Mortgage-Backed Securities (MBS)

Securities backed by pools of mortgages with monthly mortgage payments passed through to investors.

Common Stock

Equity with a residual claim and limited liability.

Preferred Stock

Has priority over common stock, usually fixed dividends, limited gains, and generally no voting rights.

Cumulative Preferred Stock

If dividends are skipped, they accumulate and are paid later.

ADR (American Depositary Receipt)

A U.S.-traded certificate representing ownership in a foreign security.

Dividend Yield

Dividend income as a percentage of the beginning stock price.

Dividend Yield Formula

Dividend Yield = Dividend / Beginning Stock Price.

Capital Gain Yield

The percentage return caused by a change in the stock's price.

Capital Gain Yield Formula

Capital Gain Yield = (Ending Price − Beginning Price) / Beginning Price.

Total Stock Return

Dividend yield + capital gain yield.

Stock Return Example

Buy for $50, receive $1 dividend, sell for $54 → dividend yield = 2%, capital gain yield = 8%, total return = 10%.

Price-Weighted Index

Assumes one share of each stock; stock prices are added and divided by a divisor. Example: DJIA.

Market Value-Weighted Index

Weights companies according to total market value. Examples: S&P 500 and NASDAQ.

Equally Weighted Index

Invests the same amount in each security and uses the simple average of returns. Example: Value Line Index.

Three Index Weighting Methods

Price weighted = DJIA; market value weighted = S&P 500/NASDAQ; equally weighted = Value Line.

Derivative / Contingent Claim

A security whose payoff depends on the price of another security.

Call Option

The right to BUY an asset at a specified strike price on or before expiration.

Put Option

The right to SELL an asset at a specified strike price on or before expiration.

Strike Price

The specified price at which the option holder can buy or sell the underlying asset.

Option Contract Cost

Quoted option price × 100 shares for a standard 100-share stock option contract.

Call In the Money

The stock price is ABOVE the call's strike price.

Put In the Money

The stock price is BELOW the put's strike price.

Futures Contract

The long agrees to buy and the short agrees to deliver a specified quantity at expiration for an agreed-upon price.

Long vs. Short Futures

Long = purchaser/buyer; Short = seller/deliverer.

Forward Contract

Similar to a futures contract but traded over-the-counter (OTC) and commonly used for specialized needs.

Futures vs. Forwards

Both establish future transactions at agreed prices, but forwards trade OTC and are more customizable.