Asset classes and financial
instruments
1
Process of building investment
• Asset allocation: how much money to allocate to each type
of assets of assets (bank accounts, financial markets, real
estate)
• Security selection: within each type of assets the investor
chooses specific assets
2
Financial Markets
• Money Market
• Capital Market
➢ Bond/Sukuk markets
➢ Equity markets
➢ Derivative markets
3
Money Market
• Subsector of the fixed-income market (debt)
• Short-term debts
• Highly liquid
• Low risk
• Often have large denominations
4
Money Market
• Treasury bills
• Certificates of deposit
• Commercial paper
5
Treasury bills
• The government raises money by selling Treasury bills to the
public
• Short-term government securities issued at a discount from face
value and returning the face amount at maturity
• Short maturity up to 52 weeks
• High liquidity
• Low transaction costs
• Low risk
6
Certificates of deposit
• A certificate of deposit (CD) is a time deposit with a bank
• Time deposits may not be withdrawn on demand
• The bank pays the depositor only at the end of the fixed
term
7
Commercial paper
• Large firms often issue their own short-term debt directly to
the public, rather than borrowing from banks
• These notes are called commercial paper
8
Money Market: Interbank Rate
• The Fed funds rate is the rate on very short-term loans among financial
institutions in US
• The London Interbank Offer Rate (LIBOR) is the rate at which banks in
London lend to each other
• The LIBOR is published by the British Bankers’ Association (BBA) between
11:00 a.m and 11:10 a.m (London time)
• LIBOR rates are widely quoted for transactions denominated in several
currencies such as GBP, yen, euros
• EURIBOR, EONIA and ESTER are the main rated at which banks in the
euro zone lend euros among themselves
• Saudi Arabian Interbank Offered Rate (SAIBOR)
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Capital Markets
➢ Bond/Sukuk markets
➢ Equity markets
➢ Derivative markets
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Bond/Sukuk market
• The bond market is composed of longer-term borrowing or
debt instruments than those that trade in the money market
• Issued by firms (corporate bonds) or governments (treasury
bonds)
• Fixed-income
• Cash flows are called coupon payments
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Bond/Sukuk market
• Like bonds, sukuks provide fixed returns
• Like bonds, sukuks have the priority of repayment in case of bankruptcy
• According to the Saudi stock market “Sukuk are Sharia-compliant
financial certificates through which investors gain partial ownership on
an issuer’s assets until maturity. While Bonds are financial certificates
through which investors lend money to the issuer, indicating an
obligation for repayment at maturity”
• Bondholders receive regular interest payments, while Sukuk holders
receive a share of the profit generated by the underlying asset
12
Stocks
• Stocks or equities represent ownership shares in a firm
• Shareholders have voting rights and receive dividends (common stocks
versus preferred stocks)
• Residual claim: in case of bankruptcy the firm’s assets, the shareholders have
claim to what is left after paying all other claimants (tax authorities,
employees, suppliers, bondholders, and other creditors)
• Limited liability: in case of bankruptcy, corporate stockholders at worst have
worthless stock. They are not personally liable for the firm’s obligations
13
Derivative markets
• Futures and options provide payoffs that depend on the values of other
assets (stocks, bonds, exchange rate, commodities)
• These instruments are called derivative assets, as their values derive
from the values of other assets
• Main Derivatives:
➢ Options
➢ Futures
➢ Swaps
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Call option
A call option gives its holder the right to purchase an asset for a
specified price, called the exercise or strike price, on or before
some specified expiration date.
15
Put option
Put option gives its holder the right to sell an asset for a specified
exercise price on or before a specified expiration date.
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PROFITS AND LOSSES BUYER CALL
The trader who wants to hedge against rising prices must buy call options.
Example: the spot underlying price of an asset is 150 SAR and the strike price is set at 160 SAR.
The premium (purchase price of the call) amount is assumed to be 5 SAR.
Profits
15
160 165 180
-5
Spot price of the
underlying asset
Losses
17
PROFITS AND LOSSES SELLER CALL
Profits
160 165 180
-15 Spot price of the
underlying asset
Losses
18
PROFITS AND LOSSES BUYER PUT
The trader who wants to protect hedge against falling prices must buy put options.
Example: The spot underlying price of an asset A is 170 SAR and the strike price is set at 160
SAR. The amount of the premium (purchase price of the put) is assumed to be 5 SAR.
Profits
10
145 155 160
-5
Spot price of the
underlying asset
Losses
19
PROFITS AND LOSSES SELLER PUT
Profits
145 155 160
-10
Spot price of the
underlying asset
Losses
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Futures contracts
• Contrary to options, futures contract obliges traders to buy or
sell an asset at an agreed upon price at a specified future date
• The call (put) provide the trader right to buy (sell) an asset at an
agreed-upon price, however future contract obliges the trader
to buy (sell) the asset
• Options must be purchased (premium), however future contract
does not have cost
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Swaps
• A swap is a contract in which a trader swaps the values or cash
flows of one asset for another
• For example, a swap rate allows to swap fixed rate against
variable rate
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Thank you for your
attention
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