CHAPTER

2
Asset Classes and
Financial Instruments

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

2.1 THE MONEY MARKET

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Major Classes of Financial Assets
or Securities
Money market
Bond market
Equity markets
Indexes
Derivative markets

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 Money Market Instruments

Treasury bills
Certificates of deposits
Commercial Paper
Bankers Acceptances

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 Money Market Instruments

Eurodollars
Repurchase Agreements (RPs) and
Reverse RPs
Brokers’ Calls
Federal Funds
LIBOR Market

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Figure 2.1 Money Rates

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Table 2.2 Components of the
Money Market

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Figure 2.2 Treasury Bills

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Figure 2.3 Spreads on CDs and
Treasury Bills

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2.2 THE BOND MARKET

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 Bond Market

Treasury Notes and Bonds

Federal Agency Debt
International Bonds
Inflation-Protected Bonds
Municipal Bonds
Corporate Bonds
Mortgages and Mortgage-Backed
Securities

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 Treasury Notes and Bonds

Maturities
– Notes – maturities up to 10 years
– Bonds – maturities in excess of 10 years
Par Value - $1,000
Quotes – percentage of par

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Figure 2.4 Treasury Notes
and Bonds

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 Federal Agency Debt

Major issuers
– Federal Home Loan Bank
– Federal National Mortgage Association
– Government National Mortgage Association
– Federal Home Loan Mortgage Corporation

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 Municipal Bonds

Issued by state and local governments

Types
– General obligation bonds
– Revenue bonds
Industrial revenue bonds
Maturities – range up to 30 years

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Figure 2.5 Outstanding
Tax-exempt Debt

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 Municipal Bond Yields

Interest income on municipal bonds is not

subject to federal and sometimes state
and local tax
To compare yields on taxable securities a
Taxable Equivalent Yield is constructed

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Table 2.3 Equivalent Taxable Yields

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 Figure 2.6 Ratio of Yields on
Tax-exempts to Taxables, 1955-2006

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 Corporate Bonds

Issued by private firms

Semi-annual interest payments
Subject to larger default risk than
government securities
Options in corporate bonds
– Callable
– Convertible

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Figure 2.7 Investment Grade Bond
Listings

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 Mortgages and
Mortgage-backed Securities
Developed in the 1970s to help liquidity of
financial institutions
Proportional ownership of a pool or a
specified obligation secured by a pool
Market has experienced very high rates of
growth

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Figure 2.8 Mortgage-Backed
Securities Outstanding

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2.3 EQUITY SECURITIES

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 Equity Markets

Common stock
– Residual claim
– Limited liability
Preferred stock
– Fixed dividends - limited
– Priority over common
– Tax treatment
Depository receipts

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Figure 2.9 Stock Market Listings

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2.4 STOCK AND BOND MARKET
INDEXES

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 Stock Market Indexes

There are several indexes worldwide such

as:
– Dow Jones Industrial Average (DJIA)
– Nikkei Average
Offer ways of comparing performance of
managers
Base of derivatives

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 Factors for Construction of
Stock Indexes
Representative?
Broad or narrow?
How is it weighted?
– Price weighted (DJIA)
– Market weighted (S&P 500, NASDAQ)
– Equal (Value Line Index)

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Table 2.4 Data to Construct Stock
Price Indexes

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 DJIA
Price-Weighted Average

Using data from Table 2.4; example 2.2

Initial value = $25 + $100 = $125
Final value = $30 + $ 90 = $120
Percentage change in portfolio value =
Initial index value = (25 + 100)/2 = 62.5
Final index value = (30 + 90)/2 = 60

Percentage change in index =

-2.5/62.5 = -.04 = -4%

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 S&P’s Composite 500
Market Value-Weighted Index

Using data from Table 2.4:

– ABC would have five times the weight given to
XYZ

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 Value Line
Equally Weighted Index
Places equal weight on each return
Using data from Table 2.4
Start with equal dollars in each investment
ABC increases in value by 20%
XYZ decreases by 10%
Need to rebalance to keep equal weights

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Examples of Other Indexes - Domestic

Dow Jones Industrial Average (30 Stocks)

Standard & Poor’s 500 Composite
NASDAQ Composite
NYSE Composite
Wilshire 5000

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Figure 2-10 Comparative Performance
of Several Stock Market Indexes

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Examples of Indexes - International

Nikkei 225 & Nikkei 300

FTSE (Financial Times of London)
Dax
Region and Country Indexes
– EAFE
– Far East
– United Kingdom

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Table 2.6 Sample of MSCI Stock Indexes

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2.5 DERIVATIVE MARKETS

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 Derivative Securities

Options Futures
Basic Positions Basic Positions
– Call (Buy) – Long (Buy)
– Put (Sell) – Short (Sell)
Terms Terms
– Exercise Price – Delivery Date
– Expiration Date – Assets
– Assets

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