ch02 investment alternatives bba salaar

8/2/2019 Ch02 Investment Alternatives BBA Salaar

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Salaar - Finance

INVESTMENTS

BBASPRING Semester 2012Lahore School of Economics

Salaar farooqAssistant Professor


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Investment

Alternatives


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Understanding Investments

Summary of last class

What is Investments?

Why study Investments?

What is the terminology of investments?

What is the investment environment?

What is the Investment decision process?

What are important considerations in Investment

decisions?


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Chapter 2

Investment Alternatives

Learning Objectives

What are major types of Financial Assets?

Direct Investing

Indirect Investing

What are Non-Marketable Financial Assets?

What are Money Market securities?

What are Fixed Income securities?

What are Equity Securities? What are Derivative Securities?


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There are 2 main types:

Direct Investing Assets

Indirect Investing assets


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There are 2 main types:

Direct Investing Assets

Primarily Capital market securities & Derivatives

Investors Buy & Sell securities themselves through brokerages

Investors have direct control over their investment decisions

Indirect Investing assets

Buying & Selling of shares of investment companies (funds), which hold portfolios ofsecurities

Professional managers operate on behalf of investors

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ORGANIZATION

DIRECT INVESTING

Non-Marketable

securities

Money Markets

Capital Markets

Derivatives Markets

INDIRECT INVESTING

Investment Companies

Mutual Funds

Stock, Bond Funds

Unit Investment Trusts

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ORGANIZATION

DIRECT INVESTING

Non-Marketable

securities

Money Markets

Capital Markets

Derivatives Markets

INDIRECT INVESTING


Mutual Funds

Stock, Bond Funds


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Direct Investing

Non-Marketable Securities

Savings Deposits

Certificates of deposits

Money Market deposit accounts

US Savings Bonds

DSCs & SSCs

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Direct Investing

Money Market Securities

Treasury Bills

Negotiable Certificates of Deposit

Eurodollars

Repurchase Agreements

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Direct Investing

Capital Market Securities

Fixed Income (Bonds)

Treasuries Agencies

Municipals

Corporates

Equities

Preferred Stock

Common Stock

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Direct Investing

Derivatives Securities

Options

Futures

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Direct Investing

Non-Marketable Securities Represent personal transactions b/w owner & issuer

Safe investments insured by Govt.

Highly Liquid.

Savings Deposits

Certificates of deposits

Money Market deposit accounts

US Savings Bonds

DSCs & SSCs

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ORGANIZATION

DIRECT INVESTING

Non-Marketable

securities

Money Markets

Capital Markets

Derivatives Markets

INDIRECT INVESTING


Mutual Funds

Stock, Bond Funds


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Direct Investing

Money Market Securities Money Market characteristics:

Tenor/Maturity?

Size?

Liquidity level?

How do you invest into MM?

Treasury Bills


Commercial Paper

Eurodollars


Bankers Acceptances

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Direct Investing

Money Market Securities Money Market: Market for short-term, highly liquid, low risk assets issued

by govts, financial institutions, & corporations.

Size of transactions are usually large (> $100,000)

Owned through MM Mutual funds due to large size

Maturities (Tenor) usually b/w 1 day to 1 year

Treasury Bills


Commercial Paper

Eurodollars


Bankers Acceptances

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Direct Investing

Money MarketsTreasury Bills

Priced at what from face value? (FV = $10,000 min)

Redeemed at ?

Conventional pricing method? Money market basis?

Discount Yield = ?

Investment Yield = ?

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Direct Investing

Money MarketsTreasury Bills

Priced at DISCOUNT from face value (FV = $10,000 min)

Redeemed at Face Value

Discount Yield = conventional pricing method (360d) Money market basis uses 360 days in a year

Discount Yield = ( FV-Pur Px./FV) x (360/maturity in days)Discount Yield understates the actual yield because of the 360 day basis

Investment Yield = ( FV-Pur Px./PV) x (365/maturity in days)

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Direct Investing

M.M Treasury Bills

Yield Calculations Discount Yield

Money market basis uses 360 days in a year

Discount Yield = ( FV-Pur Px./FV) x (360/maturity in days)

FV = 10,000 Pur Px = 9000 Maturity in days = 270 DY=?

Investment Yield (Bond or coupon equivalent yield)

Invst. Yield = ( FV-Pur Px./PV) x (365/maturity in days)FV = 10,000 Pur Px = 9000 Maturity in days = 270 IY=?

NOTE: Pakistan T-Bills use 365 days, all other products use Money Market basis (360)

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Direct Investing

M.M Treasury Bills

Yield Calculations Discount Yield

Money market basis uses 360 days in a year

Discount Yield = ( FV-Pur Px./FV) x (360/maturity in days)

FV = 10,000 Pur Px = 9000 Maturity in days = 270 DY=?

DY =13.33%

Investment Yield (Bond or coupon equivalent yield)

Invst. Yield = ( FV-Pur Px./PV) x (365/maturity in days)FV = 10,000 Pur Px = 9000 Maturity in days = 270 IY=?

IY = 15.02%

NOTE: Pakistan T-Bills use 365 days, all other products use Money Market basis (360)

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Direct Investing

Money Market Securities Treasury Bills (IOU from Treasury, sold in secondary mkts)

Negotiable Certificates of Deposit (against deposits, sold inopen markets, typical range 14-days till 1 year, Min size $100,000)

Commercial Paper (Unsecured promissory note, issued by corp, size$100,000 with maturity


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ORGANIZATION

DIRECT INVESTING

Non-Marketable

securities

Money Markets

Capital Markets

Derivatives Markets

INDIRECT INVESTING


Mutual Funds

Stock, Bond Funds


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Direct Investing



Treasuries Agencies

Municipals

Corporates

Equities

Preferred Stock

Common Stock

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Direct Investing

Fixed-Income Securities

Capital Markets:

Fixed-Income Securities:

Bonds:

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Direct Investing


Capital Markets:Where debt & equity capital is raised. Market for long-termsecurities (stocks & bonds)

Fixed-Income Securities:Securities with specified payment dates andamounts, primarily Bonds

Bonds: Long term debt instrument representing an IOU with a maturity. Calledfixed income because they involve coupon (interest) payments with specifieddates for the life of the Bond. Future stream of cash flows are known at issue.Principal is paid at maturity. IF, bond is sold before maturity, price will reflectcurrent interest rates. Market interest rates affect Bonds price.

Treasuries

Agencies

Municipals

Corporates

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Direct Investing


Bond Characteristics

Par Value:

Term Bond:

Term to Maturity: Coupon:

Coupon Rate:

Zero Coupon:

Bond Prices: add zero Accrued Interest:

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Direct Investing


Bond Characteristics Par Value:Also Face Value of most Bonds is $1000 paid at maturity

Term Bond:Bonds typically mature on a specified date

Term to Maturity:how much longer the bond will exist

Coupon: Periodic interest paid by issuer to the holder. Typically semi-annual. Coupon Rate: Is fixed at issuance & cannot vary

Zero Coupon: Bond with no coupons sold at discount & redeemed at Face Value

Bond Prices: Quoted as a %age of Par Value. Corporations & Treasuries use 100as conventional par rather than 1,000. So, Price 90 = $900 (90% of 1000). Each point,

or a change of 1, represents 1% of 1,000 or $10. Easy conversion: since quoted in%age, just add an extra ZERO to get price.

Accrued Interest: Bonds trade on an accrued interest basis. Buyers pay theprice as well as the interest earned (accrued)

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ORGANIZATION

DIRECT INVESTING

Non-Marketable

securities

Money Markets

Capital Markets Derivatives Markets

INDIRECT INVESTING


Mutual Funds

Stock, Bond Funds


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Direct Investing



Treasuries Agencies

Municipals

Corporates

Equities

Preferred Stock Common Stock

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Direct Investing

Equity Securities

Equity Security:

Preferred Stock:

Common Stock:

Voting Rights:

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Direct Investing

Equity Securities

Equity Security:Represents an ownership interest in a corporation. Afterpayment of all obligations to fixed-income claims, provides residual claim.

Preferred Stock:Hybrid security: Pays dividends known in advance & fallsb/w Bonds & common stocks. However, dividends may be deferred as cumulativeand must be paid before common stock dividends.

Common Stock: Represents ownership interest of corporations or Equity ofstock holders (also called Equity securities)

Example: 100 shares of common stock represents 100/n% ownership interestin the corp (n=outstanding shares). Entitled to income after all other claims aresatisfied

Voting Rights: Gives C.S. Holders legal control of the Corp. Elect the boardof Directors as their reps. To run the corp.

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Direct Investing

Equity Securities

Common Stock Characteristics

Par Value:

Book Value:

Limited Liability:

Market Value (Cap):

Dividends:

Dividend Yield:

Payout Ratio:

Retention Ratio:

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Direct Investing

Equity SecuritiesCommon Stock Characteristics

Par Value:Not a significant economic variable. Any number can be chosen. Newstock usually sells for more than PAR.

Book Value:The accounting value of the equity as shown on the Balance Sheet.Sum of Stock Outstanding, Capital in excess of Par & Retained Earnings.

Limited Liability:Investors cannot lose more than their investment. Creditorshave access only to the assets of the corp.

Market Value: Market Capitalization: Price of Stock x Shares outstanding

Dividends: Cash Payments declared & paid to stockholders

Dividend Yield: 12 mth dividend / current stock price

Payout Ratio: Dividends / Earnings (indicates % of a firms earnings paid out incash to stockholders)

Retention Ratio: 1 Payout Ratio (% of firms earnings retained for re-investment)

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Wh j f Fi i l A ?


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Direct Investing

Equity Securities

Stock Example

Coca-Colas 2002 EPS = $1.23. Paid annual dividend DPS of$0.8. If price of KO is $45, calculate the following.

DY?

Payout ratio?

If the company reported $11.8 Billion in Stockholder Equity &the outstanding shares are 2.478 Billion, whats the BVS?

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Direct Investing

Equity Securities

Stock Example

Coca-Colas 2002 EPS = $1.23. Paid annual dividend DPS of$0.8. If price of KO is $45, calculate the following.

Dividend Yield: 0.8/45 = 1.8%

Payout Ratio: 0.8/1.23 = 65%

If the company reported $11.8 Billion in Stockholder Equity &

the outstanding shares are 2.478 Billion, whats the BVS? BVS = 11.8 / 2.478 = $4.76

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Direct Investing

Equity Securities

More Common Stock Characteristics

Stock Dividend:

Stock Split:

P/E Ratio:

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Direct Investing

Equity Securities


Stock Dividend:Payment of a dividend in the form of stock (instead of cash)

Stock Split:Issuance of stock in proportion to shares outstanding

P/E Ratio: Stock Price/ EPS (what investors are paying per dollar of earnings)

Example: Price of X = $25, EPS = 1.5

P/E = 25/1.5 = ?

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Direct Investing

Equity Securities


Stock Dividend:Payment of a dividend in the form of stock (instead of cash)

Stock Split:Issuance of stock in proportion to shares outstanding

P/E Ratio: Stock Price/ EPS (what investors are paying per dollar of earnings)

Example: Price of X = $25, EPS = 1.5

P/E = 25/1.5 = 16.6

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ORGANIZATION

DIRECT INVESTING

Non-Marketable

securities

Money Markets

Capital Markets

Derivatives Markets

INDIRECT INVESTING


Mutual Funds

Stock, Bond Funds


Salaar - Finance

Wh j f Fi i l A ?


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Direct Investing

Derivative Securities

Derivative:

Options (Rights)

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Wh t j t f Fi i l A t ?


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Direct Investing


Derivative: Securities that derive their value from some underlying asset

Options (Rights) The right (but not the obligation) to buy or sell a stated number of shares

of stock within a specified time at a specified price

CALL: An option to BUY a specified no. of shares at a specified pricewithin a specified period.

PUT: An option to SELL a specified no. of shares at a specified price

within a specified period Trade on organized exchanges & are standardized products

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What are major t pes of Financial Assets?


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Direct Investing


Options Characteristics (Equity)

Size:

Exercise (Strike) Price:

Maturity:

Buyers of Calls bets?

Buyers of Puts bets?

Option Writers:

Leveraged Product: (Buyers):

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Direct Investing


Options Characteristics (Equity)

Size:Typically 100 shares of common stock

Exercise (Strike) Price:The price at which the option is exercised.

Maturity:The date when the option expires.

Buyers of Calls: Are betting the price of the stock will rise.

Buyers of Puts: Are betting the stock price will drop

Option Writers: Receive a premium for betting on a certain view.

Options Value: Based on maturity, interest rates, volatility of stock px, & strikeprice.

Leveraged Product: (Buyers): Loss is limited & gains are magnified.

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Direct Investing


Futures contract (Obligation)?

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Direct Investing


Futures contract (Obligation)

Agreement which provides for the future exchange of an asset at a

specified price on a specified date.

Used for hedging & speculation

Hedger can lock in a future price in advance (reduce uncertainty)

Speculators seek to profit from price uncertainty

Trade on margin

Trade on organized exchanges & are standardized products

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Chapter 2


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Chapter 2

Investment Alternatives

Summary


Direct Investing

Indirect Investing

What are Non-Marketable Financial Assets?

What are Money Market securities?

What are Fixed Income securities?

What are Equity Securities?

What are Derivative Securities?

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ch02 investment alternatives bba salaar

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