ch2outline - Chapter 2 outline: Asset classes and financial...

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Chapter 2 outline: Asset classes and financial instruments I. The Money Market A. The money ,market is a subsector of the debt market 1. It consists of very short term debt securities that are highly marketable 2. Many of these securities trade in large denominations and so are out of the reach of individual investors 3. Money market mutual funds , however, are easily accessible to small investors. a. These mutual funds pool the resources of many investors and purchase a wide variety of money market securities on their behalf B. Treasury Bills 1. U.S. Treasury bills are the most marketable of all money market instruments 2. T-bills represent the simplest form of borrowing 3. The government raises money by selling bills to the public 4. Investors buy the bills at a discount from the stated maturity value 5. T-bills with initial maturities of 28, 91, and 182 days are issued weekly 6. T-bills are highly liquid 7. Sold at low transaction cost and with little price risk 8. Unlike most other money market instruments, which sell in minimum denominations of $100,000. 9. T-bills sell in minimum denominations of only $1,000 10. While the income earned on T-bills is taxable at the federal level, it is exempt from all state and local taxes 11. Rather than providing prices of each bill, the financial press reports yields based on those prices 12. The asked price is the price you would have to pay a T-bill from a securities dealer 13. The bid price is the slightly lower price you would receive if you wanted to sell a bill to a dealer 14. The bid-asked spread is the difference in these prices, which is the dealer’s source of profit 15. The bank-discount method : a. A method that can be used to report yields(bid and ask prices) b. The bill’s discount from par value is “annualized” based on a 360-day year, and then reported as a percentage of par value 16. Prices and yields are inversely related, so the higher bid yield reported implies a lower bid price 17. Bank discount method is flawed for at least two reasons a. First, is assumes that the year hasonly360 days
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b. Second, it computes the yield as a fraction of par value rather than of the price the investor paid to acquire the bill 18. Annualizing the return using a 365-day year results in an “asked yield” a. This last value is called the Treasury bill’s bond equivalent yield C. Certificates of Deposit 1. A certificate of deposit(CD) is a time deposit with a bank 2. Time deposits may not be withdrawn on demand 3. The bank pays interest and principal to the depositor only at the end of the fixed term of the CD 4. CDs issued in denominations larger than $100,000 are usually negotiable, that is, they can be sold to another investor if the owner needs to cash in the certificate before its maturity date 5. Short-term CDs are highly marketable, although the market significantly thins out for maturities of three months or more 6. CDs are treated as bank deposits by the Federal Deposit Insurance Corporation, so they are insured for up
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This note was uploaded on 09/10/2010 for the course FIN 367 taught by Professor Han during the Fall '08 term at University of Texas at Austin.

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ch2outline - Chapter 2 outline: Asset classes and financial...

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