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Investment Securities
The document outlines the characteristics of various investment securities, including fixed income securities like bonds, which have features such as par value, maturity, and coupon payments. It also discusses equity securities, distinguishing between preferred and common stocks, with details on their rights and characteristics. Additionally, derivative securities, including futures and options, are explained, focusing on their purpose in hedging and speculation.
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Investment Securities
- 1. A. Fixed incomesecurities B. Equity Securities Characteristics of Investment Securities
- 2. Characteristics of bond •Par value or face value of most bonds is $1000 • Typical bonds have a maturity time • Most bonds are coupon bonds, where coupon refers to the periodic interest that the issuer pays to the holder of the bond • Interest on bonds is typically paid semi- annually
- 3. Characteristics of Bonds •Zero coupon bond: • An innovation in traditional format of bonds • These bonds are sold at discount • Issuers of zero bonds include local and federal government • Bond prices are quoted as a percentage of par value
- 4. • The bondprice reflect the par value and any accrued interest, and increase or decrease in the market interest yield • If bond is selling at discount, it means that the interest rate on the bond is below the current interest rate on similar bonds in the market and vice versa
- 5. • Callable bonds •If a bond is callable, the issuer can call it back by paying off the obligations • Exercising the call provision become attractive to the issue when market interest rate fall significantly below the coupon rate on the bond • Cost of calling back include call premium or administrative costs
- 6. • Senior securities: •Corporate bonds are senior securities, which mans they are senior to any prefferred stock and to the common stock in terms of priority of payment • Within bonds categories, there exist differences of priority of claims • Debentures: unsecured bond that is not backed by a specific asset
- 7. • Convertible Bonds: •Bonds that are convertible at the holder’s option into common stocks • Junk bonds: High risk, high yield bonds carrying low rating
- 8. Equity securities • Equitysecurities represent ownership in a corporation • These securities represent residual claim • There are two types of equities: – Preferred stock – Common stock
- 9. Preferred stock • Dividendis fixed in amount and known in advance on preferred stocks (like debt) • The stream of dividends continues forever(like on shares) unless it is called • Preferred shareholders cannot force the firm into liquidation if their dividend is not paid (like in case of common stock) • Preferred stock is also know is hybrid security because it resembles both equity and fixed income securities
- 10. • Preferred stockshave the feature of cumulative dividends • Preferred stock may carry variable rate of dividend that is tied to current market interest rate • Preferred stock may also have feature of convertibility into common stock (may be mandatory or optional)
- 11. Common stock • Commonstock represents the ownerships interest of the company. • Ownership is concentrated or closely held when the firm’s shares are held by few individuals • Ownership is scattered when shares are held by lots of people
- 12. Characteristic of commonstock • Common shares give the right to shareholders to vote • It gives the right to receive dividends, however, dividend rate is not fixed • Common shares also give the right to right issues • Common shares are riskier than preferred stock and bonds
- 13. Derivative Securities • Securitiesthat derive their values from an asset or security • There are two types of derivative securities – Future contracts – Options
- 14. Future contract • Afuture contract obliges traders to purchase or sell an asset at an agreed-upn price at a specified future date • The contract can be used for commodities or securities • Cash is not required to be paid until delivery, only a margin is required to reduce the chances of default of the other party
- 15. • The marginis small compared to the value of the purchase or sell • Many investors in future markets are hedgers or speculator • Hedgers seek to reduce risk of price uncertainty over some future period of time • Speculators seek to profit from future uncertainty in prices
- 16. Types of futurecontracts • There are two types of future contracts – Long position – Short-position • Long-position: • The long position is held by a trader who commits to purchasing the asset on the maturity date • Short position (short-selling) The short position is held by a trader who commits to deliver the asset on the maturity date
- 17. Advantages of futurecontract • A. Helps in hedging • B. investors can benefit from price fluctuations. • Helps producers to get orders at current prices and continue production without worry • Buyers do not have to pay the full price, still they can obtain the commodities in future at current price • Buyers don’t have to worry about storage problems
- 18. Option Contracts • Optionis a right to buy or sell a stated number of shares of stock within a specified period at a specified price • There are two types of option contracts: – Put option – Call option • Put option • An option to sell a stated number of shares at a stated period at a specified price
- 19. • Call option •A right to buy a stated number of shares at a stated period at a specified price • Parties in option contract: • Option writer: who gives the right to the buyer of the option in exchange for a price • Option holder: who obtains the right to buy or sell shares