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Unformatted text preview: markets. Money market instruments include short-term, marketable, liquid, low-risk debt securities. Money market instruments some- times are called cash equivalents, or just cash for short. Capital markets, in contrast, include longer-term and riskier securities. Securities in the capital market are much more diverse than those found within the money market. For this reason, we will subdivide the capital market into four segments: longer-term bond markets, equity markets, and the derivative markets for options and futures. We first describe money market instru- ments. We then move on to debt and equity securities. We explain the structure of vari- ous stock market indexes in this chapter because market benchmark portfolios play an important role in portfolio construction and evaluation. Finally, we survey the deriva- tive security markets for options and futures contracts. ASSET CLASSES AND FINANCIAL INSTRUMENTS P R T I C H A P T E R T WO YOU LEARNED IN Chapter 1 that the process of building an investment portfolio usually begins by deciding how much money to allo- cate to broad classes of assets, such as safe money market securities or bank accounts, longer-term bonds, stocks, or even asset classes like real estate or precious metals. This process is called asset allocation. Within each class the investor then selects specific assets from a more detailed menu. This is called security selection. Each broad asset class contains many specific security types, and the many varia- tions on a theme can be overwhelming. Our goal in this chapter is to introduce you to the important features of broad classes of secu- rities. Toward this end, we organize our tour of financial instruments according to asset class. Financial markets are traditionally seg- mented into money markets and capital 2 24 PART I Introduction The money market is a subsector of the fixed-income market. It consists of very short-term debt securities that usually are highly marketable. Many of these securities trade in large denominations, and so are out of the reach of individual investors. Money market funds, however, are easily accessible to small investors. These mutual funds pool the resources of many investors and purchase a wide variety of money market securities on their behalf. Figure 2.1 is a reprint of a money rates listing from The Wall Street Journal. It includes the various instruments of the money market that we will describe in detail. Table 2.1 pro- vides the outstanding volume of the major instruments of the money market. Treasury Bills U.S. Treasury bills (T-bills, or just bills, for short) are the most mar- ketable of all money market instru- ments. T-bills represent the simplest form of borrowing: The govern- ment raises money by selling bills to the public. Investors buy the bills at a discount from the stated matu- rity value. At the bills maturity, the holder receives from the government a payment equal to the face value of the bill. The difference between the the bill....
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This note was uploaded on 10/06/2010 for the course FINANCE 08FB40447 taught by Professor Raymond during the Spring '10 term at University of Manchester.
- Spring '10