Lecture3 - Lecture 3 ● Money Market...

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Unformatted text preview: Lecture 3 ● Money Market Instruments(continued) Review of Previous Lecture Financial markets Broadly speaking we can divide financial markets into: ● Money Markets-Short-term,highly liquid, low-risk securities-Often referred to as cash or cash equivalent ● Capital Markets-Longer-term and riskier securities-Mainly stocks and bonds Bonds ● Treasury Notes and Bonds ● Federal Agency Debt ● Municipal Bonds ● Corporate Bonds ● International Bonds ● Mortgages and Mortgage-Backed Securities Bonds: Pricing Treasury Debt – Present Value ● T-Notes and Bonds: Usually pay a coupon (C ) – Suppose 4-year security, Face = $100, r = 4%, annual 5% coupon: – What is the price of the bond? ( 29 ( 29 ( 29 ( 29 ( 29 4 4 3 2 1 1 1 1 1 r Face r C r C r C r C P + + + + + + + + + = Bonds: Pricing Treasury Debt – Present Value ● T-Notes and Bonds: Usually pay a coupon (C ) – Suppose 4-year security, Face = $100, r = 4%, annual 5% coupon: – Current price ($103.63) > face value ($100)?!!? ● That's OK: Coupon payment exceeds required return (4%) ● Extra income from coupons offset by capital losses (bond's price declines) – Bond price falls about 1 % per year – On net, actual return will equal required return of 4% ( 29 ( 29 ( 29 ( 29 ( 29 4 4 3 2 1 1 1 1 1 r Face r C r C r C r C P + + + + + + + + + = ( 29 ( 29 ( 29 ( 29 ( 29 63 . 103 $ 04 . 1 100 $ 04 . 1 5 $ 04 . 1 5 $ 04 . 1 5 $ 04 . 1 5 $ 4 4 3 2 = + + + + + + + + + = P Equity Market ● Owning shares of a company represents ownership of part of that company ● Separation between ownership and management that cause agency problems (Worldcom example 2000) ● Characteristics:-normally traded on the exchange-pays dividend-different types: common, preferred-voting rights Equities ● Common Stock – Share of ownership in a firm ● Get share of profits after taxes and debt service ● Returns vary with market conditions – no promises ● If firm can't pay its debts, shareholders give company to creditors ● Preferred Stock – Cross between common stock and bonds: promises to pay fixed amount of income each year, however these dividends can be withheld at firm's preference – Preferred stock generally has a dividend that must be paid out before dividends to common stockholders and the shares usually do not have voting rights. – Pros: priority over common stockholders on earnings and assets in the event of liquidation and they have a fixed dividend – Cons: giving up voting rights and less potential for appreciation. Stock Market Indices ● Dow Jones Industrial average : 30 of the largest publicly held companies (GE, Disney, MSFT) ● S&P 500- more broad-based index. Leading indicator of US equities ● Wilshire5000 - all NYSE and American Stock Exchange stocks, and actively traded NASDAQ stocks ● International indexes:-Nikkei(Japan)-FTSE(“footsie” U.K) Derivatives ● A derivative (contingent claim) is a security that provides a payoff which depends on the price of another security...
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This note was uploaded on 04/17/2008 for the course ECON 171A taught by Professor Yusim during the Spring '08 term at Brandeis.

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Lecture3 - Lecture 3 ● Money Market...

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