Investments Kapitel 2

Chapter
Asset Classes and

2 Financial Instruments
Bodie, Kane, and Marcus

Essentials of Investments
12th Edition
Asset classes
Common Stock
Asset
Classes
Fixed Income
Securities
Derivative Securities • Money Market
• Bond Market
• Preferred Stock
Copyright © 2022 McGraw Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill. 2
2.1 The Money Market
Money Market Instruments
• Treasury Bills
• Repos and
• Certificates of
Reverses
Deposit
• Federal Funds
• Commercial Paper
• LIBOR (London
• Bankers’
Interbank Offer
Acceptances
Rate)
• Eurodollars
Copyright © 2018 McGraw Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill Education. 3 3
2.1 The Money Market
• Money markets
• Subsector of the fixed-income market
• Short-term
• Highly liquid
• Low risk
• Often have large denominations
2.1 The Money Market: Treasury Bills
Treasury Bills
Issuer: Federal Government
Denomination: Commonly $10,000; $1,000
Maturity: 4, 13, 26 or 52 Weeks
Liquidity: High
Default Risk: None
Interest Type: Discount
Taxation: Owed: Federal;
Exempt: State, Local
2.1 The Money Market: Certificates of Deposit (CDs)
Certificates of Deposit
Issuer: Depository Institutions
Denomination: Any, $100,000 or more marketable
Maturity: Varies, Typically 14-day Minimum
Liquidity: High for CDs <3 months, if marketable
Default Risk: First $250,000 FDIC insured
Interest Type: Add on
Taxation: Owed: Federal, State, Local
2.1 The Money Market: Commercial Paper
Commercial Paper
Issuer: Large creditworthy corps.; financial institutions
Denomination: Minimum $100,000
Maturity: Maximum 270 days, usually 1-2 months
Liquidity: CP < 3 months liquid if marketable
Default Risk: Unsecured, rated, mostly high quality
Interest Type: Discount
Taxation: Owed: Federal, State, Local
• New Innovation: Asset-backed commercial paper
2.1 The Money Market: Instruments
• Bankers’ Acceptances
• Purchaser authorizes a bank to pay a seller for
goods at later date (time draft)
• When purchaser’s bank “accepts” draft, it becomes
contingent liability of the bank (and marketable)
• Eurodollars
• Dollar-denominated time deposits held outside U.S.
• Pay higher interest rate than U.S. deposits
2.1 The Money Market: Repurchase Agreements
• Repurchase Agreements (RPs)
• Short-term sale of securities + promise to
repurchase at higher price
• RP is a collateralized loan
• Many RPs are overnight
• “Term” RPs may have a 1-month maturity
• Reverse RPs
• Lending money; obtaining security title as collateral
• “Haircuts” may be required
2.1 The Money Market: Brokers’ Calls
• Brokers’ Calls
• Call money rate applies for investors buying
stock on margin
• Loan may be “called in” by broker
2.1 The Money Market: Instruments
• Federal Funds
• Trading in reserves held at the Federal Reserve *
• Key interest rate for economy
• LIBOR (London Interbank Offer Rate)

• Rate at which large banks in London (and
elsewhere) lend to each other
• Base rate for many loans and derivatives
* Depository institutions must maintain deposits with

Federal Reserve Bank
Figure 2.2 Funds rate and T-bill rate
2.1 The Money Market: Credit Crisis
• MMMF and the Credit Crisis of 2008
• 2005-2008: Money market mutual funds
(MMMFs) grew 88%
• MMMFs had their own crisis in 2008: Lehman
Brothers
• Reserve Primary Fund “broke the buck”
• Run on money market funds ensued
• U.S. Treasury temporarily offered to insure all
money funds
2.1 The Money Market: Instrument Yield
Money Market Instrument Instrument Yield

Treasury Bills Discount
Certificates of Deposit Bond Equivalent Yield
Commercial Paper Discount
Bankers’ Acceptances Discount
Eurodollars Bond Equivalent Yield
Federal Funds Bond Equivalent Yield
Repurchase Agreements Discount
Reverse RPs Discount
2.2 The Bond Market
• Capital Market—Fixed-Income Instruments
• Government Issues—U.S. Treasury Bonds and
Notes
• Bonds vs. notes
• Denomination
• Interest type
• Treasury Inflation Protected Securities (TIPS)
• Principal adjusted for changes in the Consumer
Price Index
• Marked with a trailing “i” in quote sheets
2.2 The Bond Market: Agency Issues
• Agency issues (federal government)
• Most are home-mortgage-related: FNMA,
FHLMC, GNMA, Federal Home Loan Banks
• Risks of these securities?
• Implied backing by the government
• In September 2008, federal government took over
FNMA and FHLMC
2.2 The Bond Market: Municipal Bonds
• Municipal bonds
• Issuer?
• Differ from treasuries and agencies?
• Risk?
•G.O. vs. revenue
•Industrial development
• Taxation?
2.2 The Bond Market: Private Issue
• Corporate Bonds
• Investment grade vs. speculative grade
• Mortgage-Backed Securities
• Backed by pool of mortgages with “pass-through”
of monthly payments; covers defaults
• Collateral
• Traditionally all mortgages conform, since 2006 Alt-A
and subprime mortgages are included in pools
• Private banks purchased and sold pools of subprime
mortgages
• Issuers assumed housing prices would continue to rise
Moody’s Investment grade
Moody's credit ratings

Investment grade
Rating Long-term ratings Short-term ratings
Aaa Rated as the highest quality and lowest credit risk.
Aa1 Prime-1
Aa2 Rated as high quality and very low credit risk. Best ability to repay short-
Aa3 term debt
A1
A2 Prime-1/Prime-2
Rated as upper-medium grade and low credit risk.
Best ability or high ability to
A3
repay short term debt
Prime-2
Baa1 High ability to repay short
term debt
Prime-2/Prime-3
Rated as medium grade, with some speculative High ability or acceptable
Baa2
elements and moderate credit risk. ability to repay short term
debt
Prime-3
Baa3 Acceptable ability to repay 19
short term debt
Moody’s speculative grade
Speculative grade
Rating Long-term ratings Short-term ratings
Ba1
Judged to have speculative elements and a significant credit
Ba2
risk.
Ba3
B1
B2 Judged as being speculative and a high credit risk.
B3
Not Prime
Caa1
Do not fall within any of the prime
Caa2 Rated as poor quality and very high credit risk. categories
Caa3
Judged to be highly speculative and with likelihood of being

Ca near or in default, but some possibility of recovering principal
and interest.
Rated as the lowest quality, usually in default and low

20
C
likelihood of recovering principal or interest.
Figure 2.6 Mortgage-Backed Securities Outstanding
Figure 2.7 Asset-Backed Securities Outstanding
Figure 2.9 The U.S. Fixed-Income Market
2.3 Equity Securities: Instruments
• Equity Securities
• Common stock
• Residual claim
• Limited liability
• Preferred stock
• Priority over common
• Fixed dividends: Limited gains
• Nonvoting
• Tax treatment: Corporate tax exclusions on 70% of
dividends earned
2.3 Equity Securities: Instruments
• Depository receipts
• American Depositary Receipts (ADRs), also
called American Depositary Shares (ADSs)
• Certificates traded in the U.S. markets
representing ownership in shares of a foreign
company.
• They were created to make it easier for
foreign firms to satisfy US security
registration requirements,
2.3 Equity Securities: Returns
• Capital gains and dividend yields
• Buy a share of stock for $50, hold for 1 year,
collect $1 dividend, and sell stock for $54 What
were dividend yield, capital gain yield, and total
return?
PSell - PBuy + Div $54 - 50 + 1
Total Return = = = 10%
PBuy $50
Div $1
Dividend Yield = = = 2%
PBuy $50
PSell - PBuy $54 - 50
Capital Gains Yield = = = 8%
PBuy $50
2.4 Stock and Bond Market Indexes
• Uses
• Track average returns
• Compare performance of managers
• Base of derivatives
• Factors in constructing/using index

• Representative?
• Broad/narrow?
• How is it constructed?
• Constructing Market Indexes
• Weighting schemes:
• Price-weighted average:
• Add prices and divide by “divisor”
• Market value-weighted index:

• Return = weighted average of returns of each security
proportional to market value
• Equally weighted index:

• Computed from simple average of returns
• Construction of Indexes
• How are stocks weighted?
• Price weighted (DJIA)
• Market value weighted (S&P 500, NASDAQ)
• Equally weighted (Value Line Index)
• How much money do you put in each stock in

the index?
Stock and Bond Market Indexes
• Price-weighted average index: computed by adding
prices of stocks and dividing by «divisor»
• Market value weighted index: return equals weighted

average of returns of each component security, with
weights proportional to outstanding market value
• Equally weighted index: computed from simple

averages of return. If an investor invests equal dollar
amounts into various stocks, then this is probably the
better benchmark.
An example
Standard & Poor’s 500 Composite index
It represents an improvement over the DJIA in two
ways:
1. It is a more broadly based index of 500 firms;
2. It is a market-value index. It is computed by
calculating the total market value of 500 firms
and the total market value of those firms on the
previous day of trading. The percentage
increase in the total market value from one day
to another represents the increase in the index.
Stock PriceB QuantityB P1 Q1
Price-Weighted A $10 40 $15 40
Series B 50 80 25 160
C 140 50 150 50
• Time 0 index value: (10 + 50 + 140)/3 = 200/3 = 66.7

• Time 1 index value: (10 + 25 + 140)/Denom = 66.67
• Denominator = 2.624869
• Time 1 index value: (15 + 25 + 150)/2.624869 = 72.38
• Other problems:
• Similar % change movements in higher-price stocks cause
proportionally larger changes in the index
• Splits arbitrarily reduce weights of stocks that split in index
Stock PriceB QuantityB P1 Q1
A $10 40 $15 40
B 50 80 25 160
C 140 50 150 50
• Value-Weighted Series
(15 ´ 40) + (25 ´160) + (150 ´ 50)
IndexV = ´100 = 106.14
(10 ´ 40) + (50 ´ 80) + (140 ´ 50)
• Equal-Weighted Series
• wlog invest $300 in each
(15 ´ 30) + (25 ´12) + (150 ´ 2.143)
IndexE = ´100 = 119.05
(10 ´ 30) + (50 ´ 6) + (140 ´ 2.143)
Case 1 Case 2
Stock PB QB P1 Q1 P1 Q1
A $10 40 $12 40 $10 40
B 100 80 100 80 100 80
C 50 200 50 200 60 200
• Why do the two differ?

• Case 1: 20% change in price of small-cap firm
(12 ´ 40) + (100 ´ 80) + (50 ´ 200)
IndexV = ´100 = 100.43
(10 ´ 40) + (100 ´ 80) + (50 ´ 200)
• wlog invest $100 in each stock
(12 ´10) + (100 ´1) + (50 ´ 2)
IndexE = ´100 = 106.67
(10 ´10) + (100 ´1) + (50 ´ 2)
Case 1 Case 2
Stock PB QB P1 Q1 P1 Q1 Case 1 VW = 100.43
A $10 40 $12 40 $10 40 Case 1 EW = 106.67
B 100 80 100 80 100 80
C 50 200 50 200 60 200
• Why do the two differ?

• Case 2: 20% change in price of large-cap firm
(10 ´ 40) + (100 ´ 80) + (60 ´ 200)
IndexV = (10 ´ 40) + (100 ´ 80) + (50 ´ 200) ´100 = 110.86
• Assume $100 investment in each stock
(10 ´10) + (100 ´1) + (60 ´ 2)
IndexE = ´100 = 106.67
(10 ´10) + (100 ´1) + (50 ´ 2)
• Examples of Indexes—Domestic
• Dow Jones Industrial Average (30 stocks)
• Standard & Poor’s 500 Composite
• NASDAQ Composite (>3,000 firms)
• Wilshire 5000 (>6,000 stocks)
DJIA component companies
Company Exchange Industry Date added Index weighting
(September 1, 2020)
3M NYSE Conglomerate 09/08/1976 3.80%
American Express NYSE Financial services 30/08/1982 2.35%
Amgen NASDAQ Pharmaceutical industry 31/08/2020 5.81%
Apple Inc. NASDAQ Information technology 19/03/2015 2.87%
Boeing NYSE Aerospace and defense 12/03/1987 4.04%
Caterpillar Inc. NYSE Construction and Mining 06/05/1991 3.30%
Chevron Corporation NYSE Petroleum industry 19/02/2008 1.97%
Cisco Systems NASDAQ Information technology 08/06/2009 0.97%
The Coca-Cola Company NYSE Food industry 12/03/1987 1.14%
Dow Inc. NYSE Chemical industry 02/04/2019 1.06%
Goldman Sachs NYSE Financial services 20/09/2013 4.77%
The Home Depot NYSE Retailing 01/11/1999 6.57%
Honeywell NYSE Conglomerate 31/08/2020 3.87%
IBM NYSE Information technology 29/06/1979 2.87%
Intel NASDAQ Information technology 01/11/1999 1.16%
Johnson & Johnson NYSE Pharmaceutical industry 17/03/1997 3.53%
JPMorgan Chase NYSE Financial services 06/05/1991 2.36%
McDonald's NYSE Food industry 30/10/1985 4.93%
Merck & Co. NYSE Pharmaceutical industry 29/06/1979 1.97%
Microsoft NASDAQ Information technology 01/11/1999 5.26%
Nike NYSE Apparel 20/09/2013 2.58%
Procter & Gamble NYSE Fast-moving consumer goods 26/05/1932 3.19%

Salesforce NYSE Information technology 31/08/2020 6.23%
The Travelers Companies NYSE Financial services 08/06/2009 2.66%
UnitedHealth Group NYSE Managed health care 24/09/2012 7.22%
Verizon NYSE Telecommunication 08/04/2004 1.36%
Visa Inc. NYSE Financial services 20/09/2013 4.95%
Walgreens Boots Alliance NASDAQ Retailing 26/06/2018 0.89%
Walmart NYSE Retailing 17/03/1997 3.22%
The Walt Disney Company NYSE Broadcasting and entertainment 06/05/1991 3.11%
2.5 Derivative Markets
• Derivative Asset/Contingent Claim
• Security with payoff that depends on the price
of other securities
• Call Option
• Right to buy an asset at a specified price on or
before a specified expiration date
• Put Option
• Right to sell an asset at a specified exercise
price on or before a specified expiration date
Figure 2.10 Stock Options on Microsoft
Now: September 4, 2019
Today: Microsoft stock price is $ 137.49

Each option contract comprehend 100 shares
2.5 Derivative Markets: Call Option
• Call Options on Microsoft
• The right to buy 100 shares at a strike price of
$140 using the September contract costs:
Cost call = 100 ´ $1.99 = $199

• Is this contract “in the money”? (out of money: 140>137.49)
• When should you buy this contract?

• When should you write it?
2.5 Derivative Markets: Put Option
• Put Options on Microsoft
• The right to buy 100 shares at a strike price of
$140 using the September contract costs:
Cost put = 100 ´ $4.35 = $435

• Is this contract “in the money?”
• Why do the two option prices (Call and Put)
differ?
• Futures Contracts
• Purchaser (long) buys specified quantity at
contract expiration for set price
• Contract seller (short) delivers underlying
commodity at contract expiration for agreed-
upon price
Figure 2.11 Futures Contracts
• Corn futures prices in the Chicago Board of
Trade, September 4, 2019
• Contract size: 5,000 bushels of corn
• Price quote for Sept-19 contract: 3.45 per bushel, or $
(5000 * 3.45$)
• If you bought the Sept-19 contract, what are you
agreeing to do?
• Purchase 5,000 bushels of corn in Sept-19 for 5,000
× $3.45 = $17,250
• What is your obligation if you sell the Sept-19 contract?
• How does this contract differ from an option?
Derivatives Securities
• Options • Futures
• Basic Positions • Basic Positions
• Call (Buy/Sell?) • Long (Buy/Sell?)
• Put (Buy/Sell?) • Short (Buy/Sell?)
• Terms • Terms
• Exercise price • Delivery date
• Expiration date • Deliverable item
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Chapter

Asset Classes and

Bodie, Kane, and Marcus

• New Innovation: Asset-backed commercial paper

• LIBOR (London Interbank Offer Rate)

* Depository institutions must maintain deposits with

Money Market Instrument Instrument Yield

Moody's credit ratings

Rating Long-term ratings Short-term ratings

B2 Judged as being speculative and a high credit risk.

Judged to be highly speculative and with likelihood of being

Rated as the lowest quality, usually in default and low

• Factors in constructing/using index

• Market value-weighted index:

• Equally weighted index:

• How much money do you put in each stock in

• Market value weighted index: return equals weighted

• Equally weighted index: computed from simple

• Time 0 index value: (10 + 50 + 140)/3 = 200/3 = 66.7

• Why do the two differ?

• Why do the two differ?

Procter & Gamble NYSE Fast-moving consumer goods 26/05/1932 3.19%

Today: Microsoft stock price is $ 137.49

Cost call = 100 ´ $1.99 = $199

• When should you buy this contract?

Cost put = 100 ´ $4.35 = $435

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