Ch3

• Interest bearing money market instruments are short-term debt obligations of largecorporations and governments.–These securities promise to make one futurepayment.–When they are issued, their lives are less than one year.
• -very liquid
• -treasury bill
• •Potential gains/losses: A known future
• payment, except when the borrower defaults (i.e., does not pay).
• •Price quotations: Usually, the
• instruments are sold on a discount basis, and only the interest rates are quoted.
• •Therefore, investors
• must be able to calculate prices from the quoted rates.

• Fixed-income securities are longer-term debt
• obligations of corporations and governments.
• These securities promise to make fixed payments according to a pre-set schedule.
• When they are issued, their lives exceed one year.
• •Examples: U.S. Treasury notes,corporate bonds, car loans, student loans.
• •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.
• Current yield =annual coupon/price and changes with price of bond
• while coupon rate=semiannual rate usually. always stays the same.

• Represents ownership in a corporation. A
• part owner receives a pro rated share of whatever is left over after all obligations have been met in the event of a liquidation.
• –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.

• • The dividend is usually fixed and must be paid before any dividends for the common shareholders. In the event of a liquidation, preferred shares have a particular face value.
• -harder to find
• –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.

Security sold by a business or government to raise money

•Derivativeasset: A financial asset that is derived from an existing traded asset, rather than issued by a business or government to raise capital. More generally, any financial asset that is not a primary asset.

• •Futures contract: An agreement made today regarding the
• terms of a trade that will take place later.
• •Examples: financial futures
• (i.e., S&P 500, T-bonds, foreign currencies, and others), commodity futures
• (i.e., wheat, crude oil, cattle, and others).

• •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.

• •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 “something” can be an asset, a commodity, or an index.
• •The price you pay today to buy an option is called the option premium.
• The specified price at which the underlying asset can be bought or sold is called the strike price, or exercise price
• •An American option can be exercised anytime up to and including the expiration date, while a European option can be exercised only on the expiration date.

• •Options differ from futures in two main ways:
• –Holders of call options have no obligation to buy the underlying asset.
• –Holders of put options have no obligation to sell the underlying asset.
• –To avoid this obligation, buyers of calls and puts must pay a price today. Holders of futures contracts do not pay for
• the contract today.
• •Potential gains and losses
• from call options:

• –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.

price specified in an option contract at which the underlying asset can be bought(call) or sold (put).