FINANCE 511 LECTURE ONE ± Investment Asset Classes Financial markets ± Play a central role in the allocation of capital

resources. Investors who purchase shares of stocks and/or bonds from companies in the primary market are providing funds for investments. The value of a firm reflects the investors¶ beliefs regarding future cash flows. Over time, information is revealed that alters perceptions and values should change. The secondary market that trades existing securities is the mechanism that permits information to flow to and from the financial markets. I. Debt Markets: 1. Money Markets ± short term, highly liquid, fixed income securities. a. Treasury Bills (U.S. Gov) b. CDs (Banks) c. Commercial paper (large U.S. corporations) d. Bankers acceptances (like a post-dated check that is then traded by banks) e. Eurodollars ± dollar deposits in non-U.S. banks (not just European banks) f. Repos and reverses (dealer sells with agreement to buy back next day) g. Fed funds ± Banks are required to meet Fed¶s reserve requirements. Excess reserves may be loaned overnight. h. Brokers¶ calls ± short sellers borrow money to buy shares. Brokers then may borrow from banks with agreement to repay on call from bank. i. LIBOR ± London Interbank Offered Rate ± rate quoted on dollar denominated loans. RISK ± low but only t-bill considered risk-free. 2. Bond Market ± Longer term borrowing a. Treasury Notes/Bonds - Maturity date - Par value - Coupon rate - Call features - YTM b. TIPS ± non constant coupon payment. c. Federal Agency Debt - Federal Home Loan Bank - Federal National Mortgage Association (Fannie May) - Government National Mortgage Association (Ginnie May) - Federal Home Loan Mortgage Corp (Freddie Mac) FHLB issues securities and loans funds to banks.

Dealer markets ± OTC 4. More recently. Common Stocks ± residual claim. Futures 3. limited liability 2. Market Structure A. Mortgages and sells securities based on portfolio. Shelf registration 2. International Bonds e. . Initially. Swaps RISK ± More risk than Equities III. puts 2. Auction markets ± central location. Types of Markets 1. Primmary Market ± IPOs ± Investment Bankers 1. Municipal bonds r(1 ± t) = rM Or r= f. large block trades 3. primary market. Private Placements B. d. Secondary Markets ± market for exiting shares IV. Equity 1. Corporate Bonds g. etc. CBOE. BOT. Depository receipts RISK . RISK ± risk-free to extreme!! II. NYSE. Direct Search ± newspaper ads 2.YES III Derivatives 1.Fannie and Freddie buy bank ind. Options ± calls. Mortgages and Mortgage-Backed Securities ± discussed above with Freddie and Fannie. mortgage-backed securities were conforming mortgages which meant they met Freddie and Ginnie standards for purchase. we have seen sub-prime mortgage-backed securities that do not meet these underwriting guidelines. Brokered markets ± real estate. Preferred Stocks 3.

b. ³Mothers = emerging and high growth. Trading Mechanisms 1. We have stop buy. Full Service ± research and trades 2. and stop loss (sell) Stop becomes a market order when price hit. Stop loss (sell) ± market order to sell if price falls below stop price. VIII. Stop buy ± market order to buy if price rises above stop price. 3. Euronext ± formed by merger of Paris. Narrow spreads mean more trades and more profits.short sales 3. Tokyo ± three sections: Large companies. Types of Orders 1. Dealer Markets (OTC trades 35. each providing different quotes. broker issues a margin call. sells at ask. midsize companies. Will buy and sell from own inventory to make market liquid. Limit orders ± execution dependent on price a. Broker for buyer or seller identifies best price. Stop orders ± similar to limit orders in that trade won¶t be executed unless limit price is hit. Electronic Communications Networks (ECNs) ± Archipelago ± orders are ³crossed´ and matched without bid/ask spreads at a cost of less than 1 cent per share traded. Maintenance Margin ± if percentage margin falls below maintenance level. VI.we can pay half and borrow half paying broker call rate. hold securities. London ± Electronic system (like NASDAQ) called SETS (stock exchange electronic trading system) 2. margin loans. VII.V. Limit buy ± willing to purchase at limit price or LOWER b. Considerable anonymity for trader. Specialist markets ± NYSE ± specialist responsible for making the market in a security. Trading Costs 1. Limit sell ± willing to sell at limit price or HIGHER 3. Market Structures Around the World 1. Bid-ask spread Buying on Margin Initial Margin ± currently 50% . .000 securities using 1000s of dealers. a. Discount ± no frills ± buy and sell. Amsterdam and Brussels exchanges ± electronic system called NSC (Nouveau Systeme de Cotation) 3. Market order ± bid/ask ± executed at best price 2. Buys at bid.) 2.

$4000)/100P = . Must repay $4.000 Margin = $3000/$7000 = 43% If maintenance margin is 30%.3 Then P = $57.000 Margin $4. The short seller must provide the original owner all dividends that are paid while the security is borrowed.5 = $2857 loan.EXAMPLE: Value of Stock 100 sh x $100/sh Equity $6.14) = $5714. 100($57. if price goes to $57. more leverage means greater expected return but greater risk! Short Sales Normally an investor buys a share of stock anticipating an increase in price. Also. must add money to bring position to new initial margin.14. If investor receives margin call. The short seller must also post a margin to cover possible losses if the price goes up.000/$10.000 = 60% If price falls to $70/sh Value of Stock 100 sh x $70/sh Equity $3.000 Margin $4.000 . that is. how far can stock fall before investor receives a margin call? (100P .$2857 (ignoring interest) = $1. $5714 x .143 Why use margin? It adds the power of leverage and as we shall see later. the security is sold first and then repurchased when price falls! How can we sell a security we don¶t own? The security is borrowed and then sold. But what if the analysis shows that the investor believes the price will fall? The investor reverses the normal process.14. This margin requirement is also currently 50%.000 Margin = Equity/Value of Stock = $6. When a security is sold short. In prior example. if the person from whom the security is borrowed sells their security. all sales proceeds must remain on account. . the short seller will borrow another security to maintain their position.

000 .5 x 10.000 Cash required: $5.EXAMPLE: You short sale 100 sh of $100 stock.000 = $5. PFS: 100 x $100 = $10.000 Margin = .

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