financial assets (instruments) chapter 2. assets utangible asset f a physically observable, or...
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Financial Assets Financial Assets (Instruments)(Instruments)
Chapter 2
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AssetsAssets
Tangible asset a physically observable, or touchable, item
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AssetsAssets
Financial asset an asset that represents a promise to
distribute cash flows some time in the future
Promissory Note
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Major Financial InstrumentsMajor Financial Instruments
Treasury bills Repurchase agreements Federal funds Bankers’ acceptances Commercial paper Negotiable CDs Eurodollars Money market funds
Treasury notes/bonds Municipal bonds Term loans Mortgages Corporate bonds Preferred stock Common stock
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Financial Instruments and Financial Instruments and the Firm’s Balance Sheetthe Firm’s Balance Sheet
Firm issues financial instruments so it can purchase the tangible assets necessary to produce income
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Balance Sheet - EquityBalance Sheet - Equity Common equity
stockholder’s total investment in the firm Par value
nominal or face value of a stock or bond Retained earnings
earnings the firm has not paid out as dividends throughout its history
Additional paid-in capital difference between the value of newly issued stock
and its par value
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DebtDebt
A loan to an individual, company, or government
Debt features Principal value Face value Maturity value Par value
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More Debt FeaturesMore Debt Features
Interest payments or discounted securities
Maturity date Priority to assets and earnings Control of the firm (voting rights)
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Short-Term DebtShort-Term Debt
Treasury Bills (T-bills) Repurchase Agreement (Repo) Federal Funds Banker’s Acceptance Commercial Paper Certificate of Deposit Eurodollar Deposit Money Market Mutual Funds
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Long-Term DebtLong-Term Debt
Term Loans Bonds
Government bonds Treasury bonds Municipal bonds
– Revenue bonds
– General obligation bonds
Corporate bonds Mortgage bonds
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BondsBonds
Debenture Subordinated debenture Income bond Putable bond Indexed (purchasing power) bond Floating rate bond Zero coupon bond Junk bond
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Bond Contract FeaturesBond Contract Features
Bond Indenture Trustee Restrictive covenant Call provision Sinking fund
call for redemption by annual lottery buy bonds on the open market
Convertible
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Bond RatingsBond Ratings
Moody’s Investors Service (Moody’s) Standard & Poor’s Corporation (S&P) Investment grade bonds
triple B or better
Criteria for rating bonds Importance of bond ratings Changes in ratings
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Stock (Equity)Stock (Equity)
Preferred stock has preference over common stock in distribution of dividends and assets; dividend payments are fixed
Preferred stock may provide for cumulative dividends, conversion into common stock, voting rights, dividend participation, sinking funds, call provisions, and even maturity
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Stock (Equity)Stock (Equity)
Common stock represents ownership in a corporation common stockholders vote for members of
the board of directors has last claim on distribution of earnings
and assets may have preemptive rights to purchase
any additional shares sold by the firm
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Stock (Equity)Stock (Equity)
Classified stock special purpose stock
Closely held corporations Publicly owned corporations
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DerivativesDerivatives
Value depends on some underlying asset such as a stock or bond
Option - contract that gives the right to buy or sell an asset at a set price within a specified period of time Call: holder has the right to buy Put: holder has the right to sell Striking price: exercise price of the option
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DerivativesDerivatives
Covertibles - bonds or preferred stocks that can be exchanged for common stock at the option of the holder Conversion ratio defines the number of
shares of stock the convertible holder receives upon conversion
Futures - arrangement for delivery of an item at a set future date at a set price
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DerivativesDerivatives
Swaps - an agreement to exchange cash flows or assets at a set time in the future
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Rationale for Using Different Rationale for Using Different Types of SecuritiesTypes of Securities
Differences in trade-off between risk and expected after tax return
Appeal to broad market and different investment needs
Differences in popularity through time
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Which Financial Instrument Which Financial Instrument is Best?is Best?
Issuer’s or investor’s viewpoint ? Bonds
fixed interest payments does not represent ownership may have restrictions on dividends interest expense is deductible
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Preferred stock fixed payment - but not obligated no voting rights higher after-tax cost since dividends are
not deductible expenses
Which Financial Instrument Which Financial Instrument is Best?is Best?
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Which Financial Instrument Which Financial Instrument is Best?is Best?
Common Stock no obligation of dividend payments no maturity date for “repayment” sales increases creditworthiness prospects affect terms gives control to stockholders shares the income of the firm higher costs of distribution than debt dividends are not deductible
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Financial Instruments in Financial Instruments in International MarketsInternational Markets
American Depository Receipts (ADRs) represent ownership in stocks of foreign
countries that are held in trust by a bank located in the country the stock is traded
Foreign debt sold by a foreign borrower but
denominated in the currency of the country in which it is sold
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Financial Instruments in Financial Instruments in International MarketsInternational Markets
Eurodebt debt sold in a country other than the one in
whose currency the debt is denominated Eurobonds Eurocredits: usually tied to London
InterBank Offer Rate (LIBOR) Euro-commercial paper (Euro-CP) Euronotes
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Financial Instruments in Financial Instruments in International MarketsInternational Markets
Equity instruments Euro stock is traded in countries other than
the “home” country of the company, not including the United States
Yankee stock is stock issued for foreign companies that is traded in the United States
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End of Chapter 2End of Chapter 2
Financial Assets(Instruments)