bkm 1-3 - nyu sternacebenoy/bkm1-3.ppt · ppt file · web view · 2002-07-09chapter 1 investments...

Essentials of Investments

© 2001 The McGraw-Hill Companies, Inc. All rights reserved.

Fourth Edition

Irwin / McGraw-Hill

Bodie • Kane • Marcus1

Chapter 1

Investments - Background and Issues



Fourth Edition

Irwin / McGraw-Hill


Investments & Financial Assets

• Essential nature of investment– Reduced current consumption– Planned later consumption

• Real Assets– Assets used to produce goods and

services• Financial Assets

– Claims on real assets



Fourth Edition

Irwin / McGraw-Hill


The Investment Process

• Asset allocation• Security selection• Risk-return trade-off• Market efficiency• Active vs. passive management



Fourth Edition

Irwin / McGraw-Hill


Active vs. Passive Management

Active Management• Finding undervalued securities• Timing the marketPassive Management• No attempt to find undervalued

securities• No attempt to time• Holding an efficient portfolio



Fourth Edition

Irwin / McGraw-Hill


Major Classes of Financial Assets or Securities

• Debt– Money market instruments– Bonds

• Common stock• Preferred stock• Derivative securities



Fourth Edition

Irwin / McGraw-Hill


Investments and Innovation

Technology and Delivery of Service• Computer advancements• More complete and timely informationGlobalization• Domestic firms compete in global

markets• Performance in regions depends on

other regions• Causes additional elements of risk



Fourth Edition

Irwin / McGraw-Hill


Key Trends - Globalization

International and Global Markets Continue Developing• Managing foreign exchange• Diversification to improve

performance• Instruments and vehicles continue

to develop• Information and analysis improves



Fourth Edition

Irwin / McGraw-Hill


Key Trends - Securitization

Securitization & Credit Enhancement• Offers opportunities for investors and

originators• Changes in financial institutions and

regulation• Improvement in information

capabilities• Credit enhancement and its role



Fourth Edition

Irwin / McGraw-Hill


Key Trends - Financial Engineering

Repackaging Services of Financial Intermediaries

• Bundling and unbundling of cash flows• Slicing and dicing of cash flows• Examples: strips, CMOs, dual

purpose funds, principal/interest splits



Fourth Edition

Irwin / McGraw-Hill


The Future

• Globalization continues and offers more opportunities

• Securitization continues to develop • Continued development of derivatives and

exotics• Strong fundamental foundation is critical• Integration of investments & corporate

finance



Fourth Edition

Irwin / McGraw-Hill


Chapter 2

Financial Markets and Instruments



Fourth Edition

Irwin / McGraw-Hill


Major Classes of Financial Assets or Securities

• Debt– Money market instruments– Bonds

• Common stock• Preferred stock• Derivative securities



Fourth Edition

Irwin / McGraw-Hill


Markets and Instruments

• Money Market– Debt Instruments– Derivatives

• Capital Market– Bonds– Equity– Derivatives



Fourth Edition

Irwin / McGraw-Hill


Money Market Instruments

• Treasury bills• Certificates of deposit• Commercial Paper• Bankers Acceptances• Eurodollars• Repurchase Agreements (RPs) and

Reverse RPs• Federal Funds



Fourth Edition

Irwin / McGraw-Hill


Money Market Instrument Yields

• Yields on Money Market Instruments are not always directly comparable

Factors influencing yields • Par value vs. investment value• 360 vs. 365 days assumed in a year

(366 leap year)• Bond equivalent yield



Fourth Edition

Irwin / McGraw-Hill


Interest rates that arise in connection with money market securities.Bank discount rate (rBD ).This is a rate that is used solely for determining theprice of a MM security for trading purposes..Bond equivalent yield (rBEY ).In general, a yield is an interest rate that (under veryspecific, sometimes unrealistic, assumptions) representsa rate of return..rBEY is such a rate of return. It is an annual percentagerate (APR).For comparing different MM instruments, we often use theeffective annual rate (EAR) of the rBEY .



Fourth Edition

Irwin / McGraw-Hill


Bank Discount Rate (T-Bills)

rrBDBD = bank discount rate= bank discount rate

PP = market price of the T-bill= market price of the T-billnn = number of days to maturity= number of days to maturity

rrBDBD == 10,00010,000 -- PP10,00010,000 xx 360360

nn

90-day T-bill, P = $9,87590-day T-bill, P = $9,875

rrBDBD == 10,00010,000 -- 9,8759,87510,00010,000

x x 3603609090

== 5%5%

ExampleExample



Fourth Edition

Irwin / McGraw-Hill


Bond Equivalent Yield

• Can’t compare T-bill directly to bond– 360 vs 365 days – Return is figured on par vs. price paid

• Adjust the bank discounted rate to make it comparable



Fourth Edition

Irwin / McGraw-Hill


Bond Equivalent Yield

P = price of the T-billP = price of the T-billn = number of days to maturityn = number of days to maturity

rr BEYBEY == 10,00010,000 -- PPPP xx 365365

nn

rrBEYBEY == 10,00010,000 -- 9,8759,8759,8759,875 x x 365365

9090rrBEYBEY = .0127 x 4.0556 = .0513 = 5.13% = .0127 x 4.0556 = .0513 = 5.13%

Example Using Sample T-BillExample Using Sample T-Bill



Fourth Edition

Irwin / McGraw-Hill


Capital Market - Fixed Income Instruments

Publicly Issued Instruments• US Treasury Bonds and Notes• Agency Issues (Fed Gov)• Municipal BondsPrivately Issued Instruments• Corporate Bonds• Mortgage-Backed Securities



Fourth Edition

Irwin / McGraw-Hill


Capital Market - Equity

• Common stock– Residual claim– Limited liability

• Preferred stock– Fixed dividends - limited– Priority over common– Tax treatment



Fourth Edition

Irwin / McGraw-Hill


Uses• Track average returns• Comparing performance of managers• Base of derivativesFactors in constructing or using an Index• Representative?• Broad or narrow?• How is it constructed?

Stock Indexes



Fourth Edition

Irwin / McGraw-Hill


Examples of Indexes - Domestic

• Dow Jones Industrial Average (30 Stocks)

• Standard & Poor’s 500 Composite• NASDAQ Composite• NYSE Composite• Wilshire 5000



Fourth Edition

Irwin / McGraw-Hill


Examples of Indexes - Int’l

• Nikkei 225 & Nikkei 300• FTSE (Financial Times of London)• Dax• Region and Country Indexes

– EAFE– Far East– United Kingdom



Fourth Edition

Irwin / McGraw-Hill


Construction of Indexes

• How are stocks weighted?– Price weighted (DJIA)– Market-value weighted (S&P500,

NASDAQ)– Equally weighted (Value Line Index)



Fourth Edition

Irwin / McGraw-Hill


Example.Suppose we have two stocks

#SharesStock Pr 9/19/01 Pr 9/20/01 Return OutstandA 100 120 20% 10MB 10 9 –10% 500M.Computation of a price-weighted index (like the Dow).Index on 9/19/01 (100+10)/2 = 55Index on 9/20/01 (120+9)/2 = 64.5Return on index 17.27%.This is called a price-weighted index because the indexreturn is the price-weighted average of the component(100/110) x 20% + (10/110) x –10% = 17.27%.Portfolio: one share in each stock.



Fourth Edition

Irwin / McGraw-Hill


Market-value weighted index.A market-value weighted average (like the S&P)..Index on 9/19/01 = “100” (an arbitary base level).Market value of A = $100 x 10M = $1,000MMarket value of B = $10 x 500M = $5,000M.Return on index is(1,000/6,000) x 20% + (5,000/6000) x –10% = –5%.Index on 9/20/01 = 100 x (1–5%) = 95.Portfolio: 1/6 in A; 5/6 in B

.An equally-weighted index (like the Wilshire 5000)

.Index on 9/19/01 = “100” (an arbitary base level)

.Return on index is(20% + –10%)/2 = +5%.Index on 9/20/01 = 100 x (1+5%) = 105.Portfolio: equal amounts in A and B



Fourth Edition

Irwin / McGraw-Hill


Chapter 3

How Securities are Traded



Fourth Edition

Irwin / McGraw-Hill


Primary vs. Secondary Security Sales

• Primary– New issue– Key factor: issuer receives the proceeds

from the sale• Secondary

– Existing owner sells to another party– Issuing firm doesn’t receive proceeds

and is not directly involved



Fourth Edition

Irwin / McGraw-Hill


Investment Banking Arrangements

• Underwritten vs. “Best Efforts”– Underwritten: firm commitment on

proceeds to the issuing firm– Best Efforts: no firm commitment

• Negotiated vs. Competitive Bid– Negotiated: issuing firm negotiates terms

with investment banker– Competitive bid: issuer structures the

offering and secures bids



Fourth Edition

Irwin / McGraw-Hill


• Public offerings: registered with the SEC and sale is made to the investing public– Shelf registration (Rule 415, since 1982)

• Initial Public Offerings (IPOs)– Evidence of underpricing– Performance

Public Offerings



Fourth Edition

Irwin / McGraw-Hill


Private placement: sale to a limitednumber of sophisticated investors notrequiring the protection of registration• Dominated by institutions• Very active market for debt securities• Not active for stock offerings

Private Placements



Fourth Edition

Irwin / McGraw-Hill


Organization of Secondary Markets

• Organized exchanges• OTC market• Third market• Fourth market



Fourth Edition

Irwin / McGraw-Hill


Organized Exchanges

• Auction markets with centralized order flow

• Dealership function: can be competitive or assigned by the exchange (Specialists)

• Securities: stock, futures contracts, options, and to a lesser extent, bonds

• Examples: NYSE, AMEX, Regionals, CBOE



Fourth Edition

Irwin / McGraw-Hill


Types of Orders

Instructions to the brokers on how tocomplete the order• Market• Limit• Stop loss



Fourth Edition

Irwin / McGraw-Hill


Margin Trading

• Using only a portion of the proceeds for an investment

• Borrow remaining component• Margin arrangements differ for stocks

and futures



Fourth Edition

Irwin / McGraw-Hill


Stock Margin Trading

• Maximum margin is currently 50%; you can borrow up to 50% of the stock value

• Set by the Fed• Maintenance margin: minimum amount

equity in trading can be before additional funds must be put into the account

• Margin call: notification from broker you must put up additional funds



Fourth Edition

Irwin / McGraw-Hill


Margin Trading - Initial Conditions

X Corp $7050% Initial Margin40% Maintenance Margin1000 Shares PurchasedInitial PositionStock $70,000 Borrowed $35,000 Equity 35,000



Fourth Edition

Irwin / McGraw-Hill


Margin Trading - Maintenance Margin

Stock price falls to $60 per shareNew PositionStock $60,000 Borrowed $35,000 Equity 25,000Margin% = $25,000/$60,000 = 41.67%



Fourth Edition

Irwin / McGraw-Hill


Margin Trading - Margin Call

How far can the stock price fall before amargin call?

(1000P - $35,000)* / 1000P = 40%

P = $58.33* 1000P - Amt Borrowed = Equity



Fourth Edition

Irwin / McGraw-Hill


Short SalesPurpose: to profit from a decline in the price

of a stock or securityMechanics• Borrow stock through a dealer• Sell it and deposit proceeds and margin in

an account• Closing out the position: buy the stock

and return to the party from which is was borrowed



Fourth Edition

Irwin / McGraw-Hill


Short Sale - Initial Conditions

Z Corp 100 Shares50% Initial Margin30% Maintenance Margin$100 Initial Price

Sale Proceeds $10,000Margin & Equity 5,000Stock Owed 10,000



Fourth Edition

Irwin / McGraw-Hill


Short Sale - Maintenance Margin

Stock Price Rises to $110

Sale Proceeds $10,000Initial Margin 5,000Stock Owed 11,000Net Equity 4,000Margin % (4000/11000) 36%



Fourth Edition

Irwin / McGraw-Hill


Short Sale - Margin Call

How much can the stock price rise before a margin call?

($15,000* - 100P) / (100P) = 30%P = $115.38

* Initial margin plus sale proceeds

bkm 1-3 - nyu sternacebenoy/bkm1-3.ppt · ppt file · web view · 2002-07-09chapter 1 investments...

Documents