Chapter 2

Monday, February 5, 2024 5:39 PM

ASSET CLASSES

FIXED INCOME (MONEY MARKET AND CAPITAL INVESTMENTS)

Money Market
Include short-term, highly liquid, and relatively low-risk debt instruments.
These securities trade in large denominations and are out of reach of individual investors, but
hedge funds are more accessible
Treasury Bills
Gov borrowing money by selling bills to the public
- Bought at discount of face value and repaid at maturity
- Can tailor what you are willing to invest
- Not risky
- The difference from the maturity value is the interest paid on the bills
- Highly liquid/marketable and can be bought at a minimum of $100
- Taxed at federal level, but exempt of state and local tax

The listing of T-bills

ASK: the price you would have to pay to buy a T-bill from a dealer
BID: the slightly lower price that ask, to sell the bill to the dealer
The bid-ask spread is the dealer's source of profit

Bank-discount method has 360 days

ASK: 1.868% -> annualized based on a 360 day year
!"" $%&'
Actual Discount: 1.868%× ()" $%&' = .519%
Price of ask for a $10,000 bill: 10,000 × (1 − .519%) = $9948.11

!""""
Yield by buying and holding to maturity = = 0.5216%
**+,.!!
Capital Market (Money Market ) Equity Securities
Longer-term borrowing or debt instruments
Common Stock
Government Issued - Residual Claim (claim
1. T-Notes: issued with maturities of less than 10 - Limited liability (lose
years - Entitled to a vote reg
2. T-bonds: 10-30 years maturity 𝑫𝑰𝑽𝟏 + 𝑷𝟏 − 𝑷𝑽
=
𝑷𝑽
- Denominations: $100 to $1000 Preferred Stock
Inflation-Protected Treasury Bonds - Fixed Dividends: infin
Principal adjusted for changes in the Consumer Price ○ Not obligated b
Index, to hedge inflation risk dividend are pa
Federal Agency issues - No voting power
- Government agencies issue their own securities
(freddie or fannie mae), and have an assumed Tax Treatment (dividends
idea that the gov will be there to help against - DIVIDEND EXCLUSIO
default - Not generally attract
advantage of the divi
- Why they exist? Encourage affordability of home
ownership American Depositary Rece
Municipal Bonds - Certificates traded in
Issued by the state and local government - U.S investors trading
- Low interest rate, but the interest income is Stock Market Index
exempt of the state and local taxation, so that A way to tracks returns.
makes it even a higher gain for those with high Dow Jones Industria
income - 30 large blue-chip co
- Vary in maturity - Return is calculated b
- Key feature is their tax-exempt status one share of these 30
1. General Obligation Bonds - backed by the faith of - % change in average
the issuer - Price Weighted Aver
2. Revenue Bonds - to finance a project and backed - Higher priced s
by revenue - When a spilt oc
3. Industrial Development bonds - a revenue bond - Requires equal
m par of operating income less of interest and income taxes)
e only original investment, worthless stock)
garding corporate governance
𝑫𝑰𝑽𝟏 𝑷𝟏 − 𝑷𝑽
+
𝑷𝑽 𝑷𝑽

nite maturity bond, i.e. perpetuity

but they are cumulative, so unpaid dividends must be paid before any
aid to the holders of common stock

are not tax-deductible)

ON: First 50% of income (dividend) is tax-free, the rest is taxed at 21%
tive due to the low yield and riskiness as some investors cannot take
idend exclusion
eipts (ADRs)
n the U.S market representing ownership in the shares of a foreign company
g the shares of foreign firm within the US

al Average (DIJA)
ompanies
based on the average of the 30 prices, and it measures the return of holding
0 stocks holding
is = the % change in sum
rage: an average of adding the prices of the stock and dividing by a divisor
shares have more weight
ccurs or a more than 10% stock is paid the "divisor" is adjusted
l number of shares of each stock
 ASK: 1.868% -> annualized based on a 360 day year
!"" $%&'
Actual Discount: 1.868%× ()" $%&' = .519%
Price of ask for a $10,000 bill: 10,000 × (1 − .519%) = $9948.11

!""""
Yield by buying and holding to maturity = = 0.5216%
**+,.!!
Annualizd: 0.5216%×(365 days)/(100 days)=1.904%

Bank Discount Rate (T-bill quotes)

𝟏𝟎, 𝟎𝟎𝟎 − 𝑷 𝟑𝟔𝟎
𝒓𝑩𝑫 = ×
𝟏𝟎, 𝟎𝟎𝟎 𝒏
FV = 10,000 P = market Price n= days to maturity

Bond-equivalent yield
𝟏𝟎, 𝟎𝟎𝟎 − 𝑷 𝟑𝟔𝟓
𝒚𝒊𝒆𝒍𝒅𝒃𝒐𝒏𝒅 = ×
𝑷 𝒏

Certificate of Deposit
A time deposit with the bank; can't withdraw
- Interest and principal paid to maturity
- Liquidity: up to you short (3 months) or long-term (more than 1 yr)
- Non-negotiable to be with-drawn, unless above $100,000
- Treated as bank deposits and insured by FDIC, low risk for the first $250,000
- Taxed at all levels

Commercial Paper
Short-term unsecured debt (for NWC) notes issued by large corporations to the public
- Sometimes backed by a bank line of credit for access to cash to pay off the paper at
maturity
- Denominations start at $100,000, most likely purchased by money market managers
- Liquid at three months, matures in 1-2 months
- Very liquid and safe, bc issued from high quality and low risk corporations and its short
term
- Discount interest
- ASSET-BACKED COMMERCIAL PAPER: assets used as collateral

Banker's Acceptance
An order to a bank by a customer to pay a sum of money at a future date.
- Like a postdated check (within 6 months)
- The acceptance of the draft by the bank becomes a liability for them
- Safe and traded at discount in the secondary market
- Foreign trade

Eurodollar
Dollar-denominated deposits at foreign banks or foreign branches of American banks.
 - Key feature is their tax-exempt status one share of these 30
1. General Obligation Bonds - backed by the faith of - % change in average
the issuer - Price Weighted Aver
2. Revenue Bonds - to finance a project and backed - Higher priced s
by revenue - When a spilt oc
3. Industrial Development bonds - a revenue bond - Requires equal
issued to commercial enterprises to finance the
construction of a factory Standard & Poor's Co
Tax exempt or taxable yield (Equivalence between - Index of 500 stocks
taxable yields for bonds vs tax-exempt municipal - Market Value-Weigh
bonds) component security,
- The rate of return rep
𝒓𝒎𝒖𝒏𝒊 = 𝒓𝒕𝒂𝒙𝒂𝒃𝒍𝒆 ×(𝟏 − 𝒕)
r_taxable = before-tax rate of return on taxable bonds - Investments in propo
t = combined federal and local marginal tax - No affected by stock
(1-t) = the portion of taxable yield/return that is retained
r_muni = after-tax rate on the securities
- Tax-exempt mutual bonds are attractive to high- Equally Weighted Ind
tax bracket investors due to the high , - Equal weight placed o
- However, over time,
International Bonds rates, leading to chan
- Eurobonds, different currencies dominated bonds increases significantly
outside that country or inside that country but not reflecting the initial e
issued by that country - The purpose of reba
Corporate Bonds the portfolio
- Large corporation issuing bonds to the public

Secured bonds - have collateral backing them

Derivative Market
Debentures - non-secured bonds
A security which payoff dep
Corporate bonds have options attached: Call Option
Callable bonds - option to repurchase the bon at a Right to buy asset at a spec
stipulated call price - Can be bought with l
Convertible bonds - the option to convert the bond into - Will exercise if the m
a number of shares - Greatest Benefit: wh
Mortgage-Backed Securities - Must pay a premium
- pools of mortgages secured by the collateral Put Option
- Pass-through monthly payment satisfies The right to sell an asset at
underwriting guidelines, specifically - Profits increase when
creditworthiness of the borrower - Will exercise if the m
- Subprime mortgages, risker loans made to weaker - Only realized if the h
borrowers, and gov agencies were encouraged to
buy them to make houses more affordable Options
- Put options increase
- Price increases with
 0 stocks holding
is = the % change in sum
rage: an average of adding the prices of the stock and dividing by a divisor
shares have more weight
ccurs or a more than 10% stock is paid the "divisor" is adjusted
l number of shares of each stock

omposite 500 (S&P500)

hted Stock: Index return equals the weighted average of the returns of each
with weights proportional to outstanding market value.
presented on the increase of day-to-day market value
ortion to outstanding value
k splits

dexes
on each return
the prices of individual stocks within the index may change at different
nges in their relative weights in the index. For instance, if one stock's price
y while another decreases, the index may become skewed, no longer
equal weighting.
alancing is to maintain the desired asset allocation and risk exposure within

pends on the prices of other securities

cified price before a specified expiration date (Strike price)

leverage
market value of the asset is greater than the exercise price
hen stock price increase, bullish investment vehicle
m to be exercised

t a specified exercise price on or before a specified expiration date

n the asset falls in value
market value of the asset is lower than the exercise price
holder delivers the asset that is worth less than the exercise price

e as call option price decrease

time to expiration: longer durations are more expensive
 - The acceptance of the draft by the bank becomes a liability for them
- Safe and traded at discount in the secondary market
- Foreign trade

Eurodollar
Dollar-denominated deposits at foreign banks or foreign branches of American banks.
- Escape the regulation of Federal reserve board bc located outside US, higher interest
rate
- Began in europe but does not mean that it occurs only there
- Large sums at six months maturity

Repurchase Agreements or Repos

Short-term sales of securities with an agreement to repurchase the securities at a higher price
- Short-term overnight borrowing, buying at a higher price (overnight interest)
- The sale of securities serves as collateral
- Can also be reverse, where selling the securities at a higher price

Broker's Call
- Buying on margin, as to borrowing what you need in excess to purchased shares
- Broker lends money to the investor, who in turn buys stock in excess to their funds by
borrowing
- The broker will call in the loan to protect his interest

Federal Funds
Funds in the accounts of commercial banks at the Federal Reserve Bank.
- A minimum deposit to ensure liquidity for the customer needs
- Fed set the rate at which these funds can earn interest (i.e when a central bank in one
state borrows from one other banks who have funds in excess)
- Now it has simply become the rate of interest on very-short term loans among financial
institutions
- Key barometer for monetary policy

The LIBOR Market (London Interbank Offer Rate)

Lending rate among banks in the London market. (similar to federal funds rate but more
eurocentric)

Money Market Funds

- Mutual funds that invest in money market instruments
- Prime funds: commercial paper or CDs
- Government funds: short-term U.S. Treasuries or agency securities
 creditworthiness of the borrower - Will exercise if the m
- Subprime mortgages, risker loans made to weaker - Only realized if the h
borrowers, and gov agencies were encouraged to
buy them to make houses more affordable Options
- Put options increase
- Price increases with
Future Contract
Obliges traders to purchase
maturity)
Long Position: trader
- Profits from the
Short Position: trader
e. - The loss equals
- No purchase price to

l
market value of the asset is lower than the exercise price
holder delivers the asset that is worth less than the exercise price

e as call option price decrease

time to expiration: longer durations are more expensive

e or sell an asset at an agreed-upon price at a specified future date (contract

r who agrees to purchase

e price increase
r who commits to deliver the commodity
s the long position profit
o be entered but has obligation