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Chap 003
Chap 003
Chap 003
3 Overview of
Security Types
McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning Objectives
Price quotes for all types of investments are easy to find,
but what do they mean? Learn the answers for:
2. Equity securities.
3. Futures contracts.
4. Option contracts.
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Security Types
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Classifying Securities
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Interest-Bearing Assets
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Money Market Instruments
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Fixed-Income Securities
• Potential gains/losses:
– Fixed coupon payments and final payment at maturity, except when the
borrower defaults.
– Possibility of gain (loss) from fall (rise) in interest rates
– Depending on the debt issue, illiquidity can be a problem. (Illiquidity
means it is possible that you cannot sell these securities quickly.)
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Quote Example: Fixed-Income Securities
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Equities
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Common Stock
• Potential gains/losses:
– Many companies pay cash dividends to their shareholders.
However, neither the timing nor the amount of any dividend
is guaranteed.
– The stock value may rise or fall depending on the prospects
for the company and market-wide circumstances.
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Common Stock Price Quotes
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Common Stock Price Quotes Online
at http://finance.yahoo.com
Resulting
Screen
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Preferred Stock
• Potential gains/losses:
– Dividends are “promised.” However, there is no legal requirement
that the dividends be paid, as long as no common dividends are
distributed.
– The stock value may rise or fall depending on the prospects for the
company and market-wide circumstances.
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Derivatives, I.
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Derivatives, II.
• Option contract: An agreement that gives the owner the right, but
not the obligation, to buy or sell a specific asset at a specified price
for a set period of time.
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Futures Contracts
• Potential gains/losses:
– At maturity, you gain if your contracted price is better than
the market price of the underlying asset, and vice versa.
– If you sell your contract before its maturity, you may gain or
lose depending on the market price for the contract.
– Note that enormous gains and losses are possible.
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Futures Contracts: Online Price Quotes
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Futures Price Quotes Online
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Option Contracts, I.
• A call option gives the owner the right, but not the obligation, to buy
something, while a put option gives the owner the right, but not the
obligation, to sell something.
• The price you pay today to buy an option is called the option
premium.
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Option Contracts, II.
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Option Contracts, III.
– Buyers:
• Profit when the market price minus the strike price is greater than
the option premium.
• Best case, theoretically unlimited profits.
• Worst case, the call buyer loses the entire premium.
– Sellers:
• Profit when the market price minus the strike price is less than the
option premium.
• Best case, the call seller collects the entire premium.
• Worst case, theoretically unlimited losses.
– Note that, for buyers, losses are limited, but gains are not.
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Option Contracts, IV.
– Buyers:
• Profit when the strike price minus the market price is greater than
the option premium.
• Best case, market price (for the underlying) is zero.
• Worst case, the put buyer loses the entire premium.
– Sellers:
• Profit when the strike price minus the market price is less than the
option premium.
• Best case, the put seller collects the entire premium.
• Worst case, market price (for the underlying) is zero.
– Note that, for buyers and sellers, gains and losses are limited.
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Option Contracts: Online Price Quotes
for Hewlett-Packard (HPQ) options
Source: www.finance.yahoo.com
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Investing in Stocks versus Options, I.
Stocks:
• If Macron is selling for $55 per share 3 months later, gain = ($55
200) - $10,000 = $1,000
• If Macron is selling for $45 per share 3 months later, gain = ($45
200) - $10,000 = -$1,000
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Investing in Stocks versus Options, II.
Options:
• If Macron is selling for $45 per share 3 months later, gain = ($0
2500) – $10,000 = -$10,000
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Useful Internet Sites
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Chapter Review, I.
• Classifying Securities
• Interest-Bearing Assets
– Money Market Instruments
– Fixed-Income Securities
• Equities
– Common Stock
– Preferred Stock
– Common and Preferred Stock Price Quotes
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Chapter Review, II.
• Derivatives
– Futures Contracts
– Futures Price Quotes
– Gains and Losses on Futures Contracts
• Option Contracts
– Option Terminology
– Options versus Futures
– Option Price Quotes
– Gains and Losses on Option Contracts
– Investing in Stocks versus Options
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