Stocks, Bonds, Options, FX

Treasury stock

Shares that a company repurchases

• Don’t receive dividends

• Don’t have voting rights

What do common stockholders vote on?

Board of directors and corporate events (mergers)

NOT on management or dividend distributions

What do board of directors vote on?

Management and dividend distributions

Proxy statement

where investors can find info about shareholder meeting and vote their shares

Statutory voting

A method of voting where each shareholder has one vote per share owned, allowing them to vote for each director individually

Cumulative voting

A voting system that allows shareholders to pool all potential votes (# shares * filling each board seat) and allocate them in any way

• Enables minority shareholders to have a greater voice in director elections

Income stock

Mature industries, consistent dividends

• Ex: utility

  • Objective: income (dividends)

Growth stock

Reinvest earnings into business, higher volatility

• Ex. Technology, biotech

  • Objetive: capital gain (realized on sale)

Defensive stock

Stable across economic cycle, serve basic needs

• Ex: food, hygiene, medicine

  • Objective: stability

Cyclical stock

Performance mirrors economic cycle, captures discretionary spending

• Ex: retail, auto, restaurants, entertainment

  • Objective: outperform market

Systematic Risk (Market risk)

Risk that individual security is impacted by overall market performance

• best protection: hedging

Non-Systematic Risk (Business Risk)

Risk of a specific business doing poorly

• Best protection: diversification

American Depository Receipts (ADR)

Permit domestic (US) trading of foreign stock and represent shares in foreign companies, allowing investors to buy and sell these stocks on US exchanges

• Risks: currency, political, inflation

• Foreign company sells ADS to US bank —> US bank sells ADRs to US investors who trade on exchanges and OTC

• Foreign company pays dividend to US bank, foreign gov can withhold tax on that dividend that will pay ADR holders —> US bank passes dividends to US investorstax on dividends for U.S. investors. P

Preferred Stock

Equity security providing regular, steady income to shareholders, typically with fixed dividends

• Have priority over common stockholders

• Return set at time it is issued

• % of par value EVERY YEAR (must divide by 4 to get each quarter)

• NO voting rights

  • If board skips quarterly dividend payment, next payment would be the same: unpaid dividends are lost with non-cumulative preferred stock

Penny stocks

Less than $5 per share AND quoted over the counter (not traded on any exchange)

• High-volatility stocks, often of small companies

• Very illiquid and speculative (risky).

• Have voting rights since they are common stock

Pre-emptive rights

Grant common stock shareholders ability to participate in issuer’s future offerings to avoid dilution

• given short-term opportunity to buy additional shares at slight discount to market price

  • Ex: ABC corp plans to raise capital by selling 10M new shares —> client receives pre-emptive rights to purchase 50,000 of new shares —> client exercises rights, buys new shares and avoids dilution OR client sells the rights in the market, generating a capital gain OR clients allows the rights to expire

Warrants

Entitle holder to buy issuer’s stock at specific exercise price

• long term, 5+ years typically

• Often issued in connection with other securities

  • freely tradable in secondary market

Dividend

Distribution of company’s profit to shareholders

• cash dividend are taxable to investors even if reinvested

Declaration date

date the board announces a dividend

Ex-date

First date the security trades without dividend included in contract price

• buyer on or after the ex-date won’t receive the dividend

Record date

Date the shareholder just legally own the stock to receive the dividendpy

Payment date

Date the dividend is paid

Settlement

Date a transaction is completed

• Usually T+1, 1 business day after trade date

• Cash settlement is the same day

• On settlement:

  • Ownership transfers to the buyer

  • Payment delivered to the seller

Stock split

Adjusts a company’s stock price and # of shares

• No change in voting power or economic ownership

• Not taxable

• Ex:

  • 2 for 1 split: 1 stock = 20$ —> 2 stocks each $10

  • 1 for 10 spit: 10 stocks each $3 —> 1 stock now $30

Bond coupons

Annual interest rate paid on the face amount

• quoted as a percentage of par

  • typically paid out semiannually

What are 2 features that make a bond more sensitive to interest rate risk?

Low coupon and long maturity (long duration)

Duration

Measure in years of how much a bond’s price is likely to change when interest rates move

Coupon yield / nominal yield

Annual interest established at issuance

• % of par, doesn’t change

Current yield

Coupon yield divided by market price (annual interest / current market value)

Yield to maturity (YTM)

Overall return if bond is held until maturity

Yield to call (YTC)

Same as YTM but assumes the bond is called

Call protection period

Period in which bonds can’t be called, provides safety for investors

Callable bond

Issuer can call or redeem the bond at a set price (except during call protection period)

• higher coupon for investors

  • benefits issuer

Puttable bond

Investor can demand early repayment of principal

• lower coupon for investor

Convertible bond

Investor can convert the bond into a fixed number of common shares

• lower coupon for investor

Interest rate risk

Risk that price of bond will change due to changes in prevailing interest rate

• Most volatile: low coupon, long maturity

Call Risk

Risk that a bond is redeemed before its maturity, once called the interest payments stop

• Bonds usually called by issuer when interest rates are low

Reinvestment risk

Risk that investor is unable to reinvest capital at a previously earned rate of return

• Investable capital can be interest payments or return of principle from called bond

Inflationary Risk

Risk that investments return provided reduces purchasing power

• returns are fixed by costs are rising

Credit risk

Risk of default that an issuer can’t make interest and/or principal payments

• rating agencies help evaluate credit risk

  • credit rating is a big liquidity factor

Accrued Interest

Interest that a bondholder has earned but not yet received

• bond issuer only pays coupon every 6 months

• taxed as ordinary income, doesn’t impact bond’s cost basis

• buyer of bond fronts the accrued interest to the seller and keeps the whole interest period

How do corporate and municipal bonds accrue interest?

Use 30 day months and 360 day years (T+1)

How do government bonds accrue interest?

Use actual days in each month and year

Trade flat

When a bond trades with no accrued interest

• Ex. Zero coupon bonds

Secured bonds

Bonds that are backed by collateral

• mortgage bond

• collateral trust bond

• equipment trust obligations

Unsecured bonds (debenture)

Backed by the good faith and credit of the issuing corporation

Eurodollar bonds

Issued and traded outside the US, but denominated in US dollars

• not registered with the SEC

• used by companies to make their securities more marketable, such as if their home currency is unstable and undesirable

Eurodollar deposits

US dollars held in a bank broad

Convertible bonds

Converts into common stock

• safety of bond but upside of equity

• conversion price & conversion ratio

• yield is lower as the market recognizes the attractiveness

Conversion price

Price paid per share on conversion

• fixed at issuance

Conversion ratio

Number of shares received on conversion

• fixed at issuance, never changes

• CR = Par Value / Conversion Price

Parity price

Point at which the price of a convertible bond = market value of stock received on conversion

US Treasury Securities (T-Bills)

Government bond with a maturity up to 1 year

• no semi-annual interest

T-Notes

Government bond with a maturity of 2-10 years

• pay semiannual coupon

• Quoted percentage of par in 32nds of a point (1/32)

  • Ex: 95:16 = 95 16/32 = 95.5

T-Bonds

Government bond with a maturity of 30 years

• pay semiannual coupon

  • Quoted: percentage of par in 32nds of a point

STRIPS

Us government issued zero coupon bond

• T-note stripped into 21 cash flows and sold individually

Treasury Receipts

Zero coupon securities issued by broker dealers but backed by treasuriesT

Treasury Inflation Protected Security (TIPS)

US government issued coupon bonds that adjust based on the inflation rate (CPI)S

Series I bond

US government savings bond that pay combination of fixed and variable interest that is non-marketable

• can’t be traded on secondary market

Government agencies

Subsidiaries of US government

• explicit guarantee

• Ex: Ginnie Mae

Government Sponsored Enterprises

Created/chartered by US government

• implied guarantee

• ex: Fannie Mae, Freddie Mac

Mortgage Backed Securities (MBS)

Bonds secured by mortgages and other real estate loans

• Each bond represents sliver of all mortgages packed up into instrument

• Pays monthly (how often you pay rent)

• Most mortgages paid off before full term

  • Cash flows vary each month, not consistent income

How do low interest rates affect MBS?

Low interest rates cause mortgage holders to refinance —> more prepayments —> shorter maturity —> reinvestment riskH

How do high interest rates affect MBS?

High interest rates deter people from refinancing —> fewer prepayments —> longer maturity —> extension risk

Municipal securities

Finance projects for the public good

• States, cities, counties, towns, villages, interstate / intrastate authorities, US territories

  • Primary objective: tax-free interest income

Tax criteria of Municipal Bonds

Muni interest is federally tax-free

In-state munis are triple-tax-free (federal, state, local)

US territories munis are always triple tax free regardless of if you live there or not

2 Types of Municipal Bonds

1. General Obligation Bonds

2. Revenue Bonds

General Obligation Bonds

interest and principal are paid from general tax receipts

• process used to build schools, libraries, parks

• backed by the “full faith and credit” of issuer and its taxing power

Revenue Bonds

Interest and principal are paid from revenue produced by project the bond financed

• roads, bridges, tunnels (tolls)

• local hospital (patient fees)

• power or water system (user fees)

  • industrial development bonds (lease payments by corporations)

Money Market

Short-term debt instruments

• max maturity of <1 year

• Objective: safety and liquidity

  • Ex: T-bills, commercial paper, certificates of deposits, banker’s acceptances

Commercial paper

Short-term unsecured promissory note issued by corporation

• max maturity of 20 days

Certificates of deposits (CDs)

Large denomination, negotiable time deposits

Bankers’ acceptances

Finance international transaction of goods and servicesM

Money market mutual fund

Mutual fund holding only market securities

• Because individual investments are constantly maturing

Buying call options

Right to buy shares at strike price

• Pay a premium

  • Hope that option is exercised

Writing call options

Obligation to sell shares at the strike price

• Earn a premium

• Hope that the option expires worthless

Buying put options

Right to sell shares at strike price

• Pay premium

• Hope option is exercised

Writing put options

Obligation to buy shares at strike price

• Earn a premium

• Hope option expires

Protective put

Long shares and a put

Covered call

Long shares and sell a call

Short stock hedge

Short a stock and long a call

Options Expiration

Expire on the 3rd Friday of their expiration month

Standard option contacts expire 9 months after issuance

• American style: exercise at any time

• European style: exercise at expiration only

Index Options

Use value of index as underlying asset

• similar investment objectives as equity options

  • settled for cash

Volatility Market Index (VIX)

Measures volatility of S&P 500 index options

Options Clearing Corporation (OCC)

Issues and guarantees options contracts

• Increased liquidity, reduce credit and counterparts risk

Trading Options

Traded on exchanges

• Take and lose ownership of option contracts T+1

Normal Yield Curve

Longer treasuries have a higher yield than short-term treasuries

• Borrowing for longer is riskier so they charge higher interest rate

• 

Inverted Yield Curve

Short-term treasuries are paying a higher yield than longer-term treauries

• signals a recession

• lots of investors are buying treasuries for safety

Flat Yield curve

Shorter and long term treasury yields are close to each other

• Signals economic transition

Types of Economic Policies

1. Classical Economics

2. Keynesian Theory

3. Monetarist Theory

Classical Economics

Laissez-faire economics, no gouvernement interférence with the market

• Founded by Adam Smith

Keynesian Theory (Fiscal Policy)

Use government tools to affect economy

• Government spending

• Taxation

Monetary policy

Uses the money supply to affect economy through Federal Reserve

1. Discount Rate

2. Open Market Operations

3. Bank Reserve Requirement

How would you ease monetary policy?

Add cash to the economy to spur growth

1. Lower discount rate

2. Buy government bonds/treasuries

3. Lower bank reserve requirements

How would you tighten monetary policy

Remove cash from economy to curb inflation

1. Raise discount rate

2. Sell government bonds/treasuries

3. Raise bank reserve requirement

Federal funds rate

Rate that banks charge each other for overnight loans

Discount rate

Rate that the Fed charges banks for short-term loans

Broker call rate

Rate that broker-dealer pays a bank to borrow money to facilitate margin loans

Prime rate

Rate that banks charge their most creditworthy institutional customers

General, what’s the order from low to high of different interest rates

1. Federal funds rate

2. Discount rate

3. Broker call rate

4. Prime rate