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    Financial Markets & Instruments: Investments Term 3 (2013-15)

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    Vivek Kumar
    The document provides an overview of financial markets and instruments. It defines investments as the deployment of money or resources with the expectation of future benefits. It distinguishes between real assets, such as factories and land, and financial assets, which are claims on real assets like stocks and bonds. The document outlines the key types of financial assets including money market securities, fixed income securities, equities, and derivatives. It discusses how financial markets function, from primary issuance to secondary trading.

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    Financial Markets & Instruments: Investments Term 3 (2013-15)

    Uploaded by

    Vivek Kumar
    23 views31 pages
    The document provides an overview of financial markets and instruments. It defines investments as the deployment of money or resources with the expectation of future benefits. It distinguishes between real assets, such as factories and land, and financial assets, which are claims on real assets like stocks and bonds. The document outlines the key types of financial assets including money market securities, fixed income securities, equities, and derivatives. It discusses how financial markets function, from primary issuance to secondary trading.

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    Session 2 (1)

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    The document provides an overview of financial markets and instruments. It defines investments as the deployment of money or resources with the expectation of future benefits. It distinguishes between real assets, such as factories and land, and financial assets, which are claims on real assets like stocks and bonds. The document outlines the key types of financial assets including money market securities, fixed income securities, equities, and derivatives. It discusses how financial markets function, from primary issuance to secondary trading.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    23 views31 pages

    Financial Markets & Instruments: Investments Term 3 (2013-15)

    Uploaded by

    Vivek Kumar
    The document provides an overview of financial markets and instruments. It defines investments as the deployment of money or resources with the expectation of future benefits. It distinguishes between real assets, such as factories and land, and financial assets, which are claims on real assets like stocks and bonds. The document outlines the key types of financial assets including money market securities, fixed income securities, equities, and derivatives. It discusses how financial markets function, from primary issuance to secondary trading.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    of 31

    Financial Markets & Instruments

    Investments Term 3 (2013-15)

    Outline
    What is investment? Real and financial assets Financial markets Axioms of finance What determines price?

    What is Investment?
    Deployment of money or resources in expectation of future benefits
    Real or financial assets Benefits commensurate with risk Ability to convert back to money or resources

    Real vs. Financial Assets


    Real assets
    Assets used to produce goods and services Examples: factories, land, human capital

    Financial assets
    Claims on real assets such as
    Stocks Bonds

    Derivatives (contingent claims)

    Savings of US Households

    Source: Fed Reserve

    Savings of Indian Households

    Benefits of Financial Assets


    Allocation of capital
    Financing of projects

    Allocation of risk
    Diversification (risk-sharing) Hedging

    Consumption smoothing
    Moving consumption over time through saving and borrowing

    Separation of ownership and control


    Investors and managers can be different

    Important Financial Assets


    1. Money market securities 2. Fixed Income securities 3. Equities 4. Derivatives

    I. Money Market Securities


    Very short-term borrowing instrument (up to 1 year)
    Working capital Cash flow smoothing Government is a major issuer

    Usually issued by reputable issuers No coupons (adjustment in price) Highly liquid (high volume/low cost of trading)

    10

    Money Market Securities


    Treasury bills Federal Funds
    Certificates of Deposit (CDs) Repurchase Agreements (Repos) Bankers Acceptance

    Commercial Paper (CPs) Eurodollars LIBOR Market

    11

    Crisis in the CP Market

    12

    II. Fixed Income Securities

    Borrowing instruments for longer maturities (greater than 1 year)


    Funding longer duration projects Financing deficit

    Issued by governments, municipalities, corporates Pre-specified cash-flows (coupons and principal)


    Valuation through time value of money (TVM) Example: a 10-year, 8%, semi-annual coupon bond with $1000 face value

    Risk of default varies


    Credit rating of issuances

    Liquidity varies

    13

    Treasury Bonds
    Two types
    Treasury notes (1-10 years maturity) Treasury bonds (10-30 years maturity)

    Semi-annual coupon payments Regular issues (often preannounced schedule) Proceeds used to fund government expenditure/deficit Attractive for investors with longer durations
    Pensions/insurance companies

    14

    A Concept Question
    Which bond would pay a higher interest rate?
    A 10-year T-bond or a 1-year T-note? A US government 1o-year T-bond or Zimbabwean government 10-year T-bond?

    15

    Muni Bonds
    Issued by state and local governments
    Exempt from federal income tax Exempt from (issuing) state and local tax General obligation bonds (for no specific purpose and backed by full faith of credit of the issuer, i.e., taxes)

    Two types

    Revenue bonds (for a specific purpose like building a bridge and backed by revenue generated by the project)

    16

    A Concept Question
    A muni bond pays 4% interest. A Treasury bond of similar maturity pays 5% interest.
    If your marginal tax rate is 20%, which bond would you prefer?

    What if the tax rate is 30%?

    17

    Corporate Bonds
    Issued by companies for longer term maturities Significant default risk
    Investment grade Non-investment grade (junk)

    Seniority Embedded features


    Callable/puttable Convertible

    Less liquid

    18

    19

    III. Equity Securities



    Ownership in a firm Future cash-flows (dividends) are uncertain Involves risk and variable liquidity Maturity is indefinite Two types
    Preferred equity or stock (fixed dividend, non-voting, senior) Common equity or stock (residual dividend, voting rights, junior)

    Common stock
    Valuation: TVM + risk adjustment

    20

    Googles Stock Price Over Last 5 Years

    http://finance.yahoo.com

    21

    Equity Market Performance


    Dow Jones Industrial Average (DJIA)
    Price-weighted index Includes 30 blue-chip companies

    Standard & Poors Composite 500 Index (S&P 500)


    Value-weighted index Includes 500 firms across varied sectors

    S&P BSE Sensex


    Value-weighted index 30 stocks

    CNX NSE Nifty Index


    Value-weighted index 50 stocks

    22

    Google vs. S&P500

    http://finance.yahoo.com

    23

    Long-term Performance of Stocks, Bonds and Treasury Bills

    Source: Ibbotson and Associates

    24

    IV. Derivative Securities


    Securities whose cash flows depend on values of other assets
    Examples: options, futures, swaps, bonds with option features (convertible or callable bonds)

    Options are rights to buy (sell) the underlying asset Futures are obligations to buy (sell) the underlying asset Swaps are exchanges of one type of cash flow for another

    Valuation: TVM + risk + option adjustment

    25

    Axioms Governing Investment Theory


    1. Investors prefer more to less 2. Investors are risk averse in general 3. Money paid in the future is worth less than the same amount today 4. Financial markets are mostly competitiveno arbitrage

    26

    Equilibrium Prices
    What determines the price?
    In economic theory? In reality?

    What is the equilibrium price? What is the mechanism that drives prices towards equilibrium?
    Price Supply

    P*=40

    Demand
    Q*=20,000 40,000 Quantity

    27

    Financial Market Setup


    RETURN

    Search Issuers
    (Needers of Capital/ Risk Originators)

    Transact
    Enforce

    Investors
    (Providers of Capital/ Risk Takers)

    RISK

    28

    Financial Market Setup


    RETURN

    Search Issuers
    (Needers of Capital/ Risk Originators)

    Transact
    Enforce

    Investors
    (Providers of Capital/ Risk Takers)

    REGULATORS
    RISK

    29

    Asset Markets
    Primary market
    Issuance of new securities

    Secondary market
    Exchange of existing securities between investors

    30

    Primary Markets
    Raises capital Price-setting mechanism differs
    Government securities: typically auctioned Corporate securities, federal agency debt, municipal bonds, mortgage-backed securities: typically underwritten by investment banks

    31

    Secondary Markets
    Investors can:
    Trade with each other directly or Trade with each other with the help of brokers or Trade with dealers

    Brokers dont commit any capital while dealers commit their own capital to the transaction Exchanges facilitate meeting of buyers and sellers

    Clearing and settlement firms ensure agreement to terms and exchange of funds between the buyer and seller
    Can guarantee the performance of the trade

    Depositories maintain records and custody of securities

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