Financial assets ch02
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Transcript of Financial assets ch02
Financial Assets (Instruments)
Chapter 2Requests for permission to make
copies of any part of the work should be mailed to:
Thomson/South-Western5191 Natorp Blvd.Mason, OH 45040
Assets
Real asset a physically observable, or touchable, item
Assets
Financial asset an asset that represents a promise to
distribute cash flows some time in the future
Promissory Note
Major Financial Instruments
Treasury bills Repurchase agreements Federal funds Bankers’ acceptances Commercial paper Negotiable CDs Eurodollars Money market funds
Treasury notes/bonds Municipal bonds Term loans Mortgages Corporate bonds Preferred stock Common stock
Financial Instruments and the Firm’s Balance Sheet
Firm issues financial instruments so it can purchase the tangible assets necessary to produce income
Balance Sheet - Equity
Common equity stockholder’s total investment in the firm
Par value nominal or face value of a stock or bond
Retained earnings earnings the firm has not paid out as dividends
throughout its history Additional paid-in capital
difference between the value of newly issued stock and its par value
Debt - A loan to an individual, company, or government
Debt featuresPriority to assets and earningsPrincipal value, Face value, Maturity
value, and Par value Interest payments or discounted
securitiesMaturity dateControl of the firm (voting rights)
Short-Term Debt
Treasury Bill (T-bill) Repurchase Agreement (Repo) Federal Funds Banker’s Acceptance Commercial Paper Certificate of Deposit Eurodollar Deposit Money Market Mutual Fund
Long-Term Debt
Term LoansBonds
Government Bonds
Treasury notes or bonds - issued by US government
Municipal bonds - issued by state or local governmentsRevenue bondsGeneral obligation bonds
Corporate Bonds
Mortgage bonds Debenture Subordinated debenture Income bond Putable bond Indexed (purchasing power) bond Floating rate bond Zero coupon bond Junk bond
Bond Contract Features
Bond Indenture Trustee Restrictive covenant
Call provision Sinking fund
call for redemption by annual lottery buy bonds on the open market
Convertible
Bond Ratings
Moody’s Investors Service (Moody’s) Standard & Poor’s Corporation (S&P) Investment grade bonds
triple B or better
Criteria for rating bonds Importance of bond ratings Changes in ratings
Yields on Selected Long-Term Bonds, 1965-2005
Stock (Equity)
Preferred stock has preference over common stock in distribution of dividends and assets; dividend payments are fixed
Preferred stock may provide for cumulative dividends, conversion into common stock, voting rights, dividend participation, sinking funds, call provisions, and even maturity
Stock (Equity)
Common stock represents ownership in a corporation common stockholders vote for members of
the board of directors has last claim on distribution of earnings
and assets may have preemptive rights to purchase
any additional shares sold by the firm
Stock (Equity)
Classified stock special purpose stock
Closely held corporationsPublicly owned corporations
Derivatives
Value depends on some underlying asset such as a stock or bond
Option - contract that gives the right to buy or sell an asset at a set price within a specified period of timeCall: holder has the right to buyPut: holder has the right to sellStriking price: exercise price of the option
Derivatives
Convertibles - bonds or preferred stocks that can be exchanged for common stock at the option of the holder Conversion ratio defines the number of shares of
stock the convertible holder receives upon conversion
Futures - arrangement for delivery of an item at a set future date at a set price
Derivatives
Swaps - an agreement to exchange cash flows or assets at a set time in the future
Rationale for Using Different Types of Securities
Differences in trade-off between risk and expected after tax return
Appeal to broad market and different investment needs
Differences in popularity through time
Which Financial Instrument is Best?
Issuer’s or investor’s viewpoint ?Bonds
fixed interest payments does not represent ownership may have restrictions on dividends interest expense is deductible
Preferred stock fixed payment - but not obligated no voting rights higher after-tax cost since dividends are not
deductible expenses
Which Financial Instrument is Best?
Which Financial Instrument is Best?
Common Stock no obligation of dividend payments no maturity date for “repayment” sales increases creditworthiness prospects affect terms gives control to stockholders shares the income of the firm higher costs of distribution than debt dividends are not deductible
Risk & Returns on Different Classes of Financial Instruments
Financial Instruments in International Markets
American Depository Receipts (ADRs) represent ownership in stocks of foreign
countries that are held in trust by a bank located in the country the stock is traded
Foreign debt sold by a foreign borrower but denominated
in the currency of the country in which it is sold
Financial Instruments in International Markets
Eurodebt debt sold in a country other than the one in
whose currency the debt is denominated Eurobonds Eurocredits: usually tied to London
InterBank Offer Rate (LIBOR) Euro-commercial paper (Euro-CP) Euronotes
Financial Instruments in International Markets
Equity instruments Euro stock is traded in countries other than
the “home” country of the company, not including the United States
Yankee stock is stock issued for foreign companies that is traded in the United States
End of Chapter 2
Financial Assets (Instruments)