CHAPTER 2

Asset Classes and

Financial Instruments

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

Financial Markets and indexes
短 長 低
（債） （債）
期 期

（股） 風
險

（洐生性）

（少數到期日小於1年，但仍為高風險商品） 高
（各類資產的績效評估） 2-2
Major Classes of Financial Assets
or Securities
Financial market
–Money market (≦1 year)
–Capital market (>1 year)
Bond market (longer-term debt)
Equity markets
–Indexes
Derivative markets
2-3
2.1 THE MONEY MARKET
貨幣市場

2-4
 Money Market Instruments

Treasury bills (T-bills, 國庫券)

Certificates of deposits (CD, 定期存單)
Commercial Paper (CP, 商業本票)
Bankers Acceptances (銀行承兌匯票)
Eurodollars (歐洲美元)
Repos (RPs) and Reverse (附買回和附賣回)
Brokers’ Calls (經紀商融資貸款)
Federal Funds (聯邦基金)
LIBOR (London Interbank Offer Rate) Market
(倫敦銀行同業拆款利率市場)
2-5
Money Rates
“不完全是一般所認知的利率”

2-6
Components of the Money Market

2-7
 Treasury Bills
Treasury bills
– Issued by Federal Government
– Denomination $100, commonly $10,000
– Maturity 4, 13, 26, or 52 weeks
– Liquidity Highly liquid
– Default risk None
– Interest type Discount
– Taxation Federal taxes owed, exempt
from state and local taxes

2-8
 Treasury Bills
l Asked price(賣出價): 為自營商願意賣出某國庫券的
價位，是投資人買國庫券須支付的價位。

l Bid price(買進價): 為自營商願意買進某國庫券的價

位，也是投資人出售國庫券的價位。

l Asked price略高於Bid price ，其差距稱為bid-asked

spread(買賣價差)，為自營商的獲利來源。

l 其報價採用 Bank discount method(銀行折價法)

2-9
Figure 2.1: Treasury Bill Listings
Date: July 7, 2011

• The bill matures on Mar 12, 2015; and days to maturity are 177;
• The “annualized” yield under the “Asked” column is given 0.040%:
– 銀行折價法:以一年360天計算(券商’s)賣出價
– 0.040%*(177/360)=0.0197%
– $10,000*(1-0.000197)=$9,998.033
• For the bid yield of 0.045%:
– 銀行折價法:以一年360天計算(券商’s)買進價
– $10,000*[1-0.00045*(177/360)]=$9,997.788
• ASK YLD (相當於持有至到期之年化報酬率):
– (10,000/9,998.033-1)*(365/177)=0.041%
– T-bill’s bond-equivalent yield(債劵約當收益率) 2-10
 Certificates of Deposit (CD)
Certificates of Deposit
– Issued by Depository Institutions
– Denomination Any, $100,000 or more are marketable
– Maturity Varies, typically 14 day minimum
– Liquidity 3 months or less are liquid if marketable
– Default risk First $250,000 is insured (台灣300萬)
– Interest type Add on
– Taxation Interest income is fully taxable

2-11
 Commercial Paper (CP)
Commercial Paper
– Issued by Large creditworthy corporations and
financial institutions
– Maturity Maximum 270 days, usually 1 to 2 month
– Denomination Minimum $100,000
– Liquidity 3 months or less are liquid if marketable
– Default risk Unsecured, Rated, Mostly high quality
– Interest type Discount
– Taxation Interest income is fully taxable
New Innovation:
Asset backed commercial paper is issued by financial firms, and is
backed by a loan or security.
In summer 2007, asset backed CP market collapsed when subprime
collateral values fell. 2-12
 Bankers Acceptances &
Eurodollars
Bankers Acceptances (類郵局匯票)
– Originates when a purchaser of goods authorizes its
bank to pay the seller for the goods at a date in the
future (time draft). (多用於 國際貿易 的支付工具)
– When the purchaser’s bank ‘accepts’ the draft, it
becomes a contingent liability of the bank and becomes
a marketable security.
Eurodollars
– Dollar denominated (time) deposits held outside the U.S.
– Pay a higher interest rate than U.S. deposits.

2-13
 Federal Funds and LIBOR
Federal Funds
– Depository institutions must maintain deposits with the
Federal Reserve Bank.
– Federal funds represents trading in reserves held on
deposit at the Federal Reserve.
– Key interest rate for the economy
LIBOR (London Interbank Offer Rate)
– Rate at which large banks in London (and elsewhere)
lend to each other.
– Base rate for many loans and derivatives.
EURIBOR (European Interbank Offer Rate)
2-14
 Repurchase Agreements and
Reverses
Repurchase Agreements (RPs or repos)
and Reverse RPs
– Short term sales of securities arranged with an
agreement to repurchase the securities a set higher
price.
– A RP is a collateralized loan, many are overnight,
although “Term” RPs may have a one month maturity.
– A Reverse Repo is lending money and obtaining
security title as collateral.
– “Haircuts” may be required depending on collateral
quality
※ 以券商的觀點來理解這些商品：
借入 -- 先低賣再高買（附買回）；
貸出 -- 先低買再高賣（附賣回） 2-15
 Brokers’ Calls
Call Money Rate
– Investors who buy stock on margin borrow money
from their brokers to purchase stock. The borrowing
rate is the call money rate. (T-B + 1%)
– The loan may be ‘called in’ by the broker (or by the
bank).

2-16
Money Market Instrument Yields

Yields on money market instruments

are not always directly comparable
Factors influencing “quoted” yields:
– Par value vs. investment value (Market
Price)
– 360 vs. 365 days assumed in a year (366
leap year)
– Simple vs. Compound Interest

2-17
Figure 2.1 Treasury Bills (T-Bills)

Treasury Bills
DAYS TO ASKED
MATURITY MATURITY BID ASKED CHG YIELD

28-Nov-2014 73 0.010 0.005 -0.005 0.005

2-Jan-2015 108 0.015 0.010 0.000 0.010
12-Mar-2015 177 0.045 0.040 0.000 0.041
28-May-2015 254 0.045 0.040 -0.005 0.041
23-Jul-2015 310 0.080 0.075 0.000 0.076

Source: The Wall Street Journal Online, September 14, 2014.

For example, 0.040% vs. 0.041%

2-18
 Money Market Instrument Yields
• Bank Discount Rate (T-bill quotes)
• Example: 90-day T-bill, P = $9,875

r = $10,000 − P x 360 $10,000 = Par

BD n
$10,000

rBD = bank discount rate

P = market price of the T-bill
n = number of days to maturity

$10,000 - $9,875 360

r BD = × = 5%
$10,000 90

2-19
Money Market Instrument Yields

Bond Equivalent Yield

– Can’t compare T-bill directly to bond
360 vs. 365 days
Return is figured in par vs. price paid
– Adjust bank discount rate to make it
comparable
– 若要更精確與bond比較可計算 Effective
Annual Yield (EAY)

2-20
Money Market Instrument Yields
• Bond Equivalent Yield
P = price of the T-bill
rBD = 5%
n = number of days to maturity

• Example Using Sample T-Bill

10,000 − P 365
r = ×
BEY P n

r = 10,000 − 9,875 365

×
BEY 90
9,875

rBEY = .0127 × 4.0556 = .0513 = 5.13%

2-21
Money Market Instrument Yields
• Effective Annual Yield
rBD = 5%

rEAY = rBEY = 5.13%

rEAY = 5.23%
P = price of the T-bill
n = number of days to maturity

• Example Using Sample T-Bill

rEAY =

rEAY = 5.23%
2-22
Money Market Instrument Yields

Money Market Instrument Instrument Yield

Treasury Bills Discount (利息內含)
Certificates of Deposit Bond Equivalent Yield (利息外加)
Commercial Paper Discount
Bankers’ Acceptances Discount
Eurodollars Bond Equivalent Yield
Federal Funds Bond Equivalent Yield
Repurchase Agreements Discount
Reverse RPs Discount

2-23
Yields on Money Market Instruments

Except for Treasury bills, money market

securities are not free of default risk
Figure 2.2 shows the CDs, for example,
consistently have paid a premium over T-
bills.
The premium often become greater during
periods of economic crisis. For example,
the two OPEC disturbances in 1973 and
1979 and Credit Crisis in 2008.

2-24
 Figure 2.2: The spread
between 3-month CD and T-Bill rates
5.0
OPEC I

4.5

4.0
Financial crisis

3.5
OPEC II
Percentage points

3.0
Penn Square

2.5

Market crash
2.0

1.5
LTCM

1.0

0.5

0.0
1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

2014
2-25
The Money Market: Credit Crisis
MMMF and the Credit Crisis of 2008
– 2005-2008: Money market mutual funds
(MMMFs) grew 88%
– MMMFs had their own crisis in 2008: Lehman
Brothers
– Reserve Primary Fund “broke the buck”
– Run on money market funds ensued
– U.S. Treasury temporarily offered to insure all
money funds

2-26
2.2 THE BOND MARKET
債券市場

2-27
 Bond Market

Treasury Notes and Bonds (政府公債)

Inflation-Protected Bonds (抗通膨政府公
債)
Federal Agency Debt (聯邦政府機構債券)
International Bonds (國際債券)
Municipal Bonds (地方政府公債)
Corporate Bonds (公司債)
Mortgages and Mortgage-Backed
Securities (抵押貸款及抵押擔保證券)
2-28
 Treasury Notes and Bonds

Maturities
– Notes – maturities up to 10 years
– Bonds – maturities in excess of 10 years (<30)
Par Value - $1,000
Semiannual Interest payments (coupon
payments)
Quotes – percentage of par

2-29
 Figure 2.3
Listing of Treasury Issues
現在以1/128為最小變動單，
ASKED YLD
但報價採十進位方式4捨5入至小數點第4位
MATURITY COUPON BID ASKED CHG TO MATURITY
15-Feb-2015 4.000 101.6250 101.6328 -0.0078 0.046
15-May-2017 4.500 109.3516 109.3750 0.0234 0.927
15-Feb-2020 3.625 108.8906 108.9375 0.0938 1.880
15-Feb-2025 7.625 146.1719 146.2500 0.2031 2.541
15-May-2030 6.250 141.3125 141.3906 0.2734 2.934
舊報價以1/32為最小變動單位以”:”區隔
15-Feb-2036 4.500 121.3359 121.4141 0.2578 3.121
15-Aug-2044 3.125 95.9297 95.9922 0.1875 3.338
Source: Compiled from data from The Wall Street Journal Online, September 16, 2014.

2-30
Inflation-Protected Treasury Bonds

In U.S., inflation-protected Treasury bonds

are called TIPS (Treasury Inflation-
Protected Securities).
The issued bonds are linked to an index of
the cost of living, and their holders hedge
inflation risk.
The principal amount on these bond is
adjusted in proportion for increases in
Consumer Price Index.
2-31
 Federal Agency Debt

Major issuers
– Federal Home Loan Bank (FHLB)
– Federal National Mortgage Association
(FNMA, Fannie Mae；房利美)
– Government National Mortgage Association
(GNMA, Ginnie Mae)
– Federal Home Loan Mortgage Corporation
(FHLMC, Freddie Mac；房地美)

2-32
Cash Flows in a Mortgage
Pass-Through Security

2-33
 International Bonds

企業從事境外融資借款而發行的國際債券
(international bond)分為二種:
– 歐式債券(Eurobonds): 以發行公司所屬國家幣
別計價的債券
Eurodollar Bonds: 美國公司在美國境外發行以美金
計價的債券
Euroyen Bons: 日本公司在日本境外發行以日元計
價的債券
– 海外債券(Foreign bonds): 公司在海外發行以
當地幣別計價的債券
洋基債券、武士債券
2-34
 Municipal Bonds

Issued by state and local governments

Types
– General obligation bonds: Backed by taxing
power of issuer
– Revenue bonds: Backed by project’s
revenues or by the municipal agency
operating the project.
Industrial development bonds
Maturities – range up to 30 years

2-35
 Figure 2.4
Outstanding Tax-Exempt Debt
3,000

2,500

2,000
$ billion

1,500

1,000

500

0
2005

2006

2007

2008

2009

2010

2011

2012

2013

2014
Industrial revenue bonds General obligation

2-36
 Municipal Bond Yields

Interest income on municipal bonds is not

subject to federal and sometimes state
and local tax (利息不用課稅)
To compare yields on taxable securities a
Taxable Equivalent Yield is constructed
(對稅率高的投資比較有吸引力)

2-37
 Municipal Bond Yields
Let t equal the investor’s marginal tax
bracket
Let r equal the before-tax return on the
taxable bond and rm denote the municipal
bond rate.
If r(1 - t ) > rm then the taxable bond gives
a higher return; otherwise, the municipal
bond is preferred.

2-38
 Equivalent Taxable Yields

Tax-Exempt Yield
Marginal Tax Rate 1% 2% 3% 4% 5%
20% 1.25% 2.50% 3.75% 5.00% 6.25%
30 1.43 2.86 4.29 5.71 7.14
40 1.67 3.33 5.00 6.67 8.33
50 2.00 4.00 6.00 8.00 10.00

The equivalent taxable yield is simply

the tax-free rate, rm , divided by (1-t).
Namely, rm /(1-t)

2-39
 Figure 2.5 Yield Ratio:
Tax-Exempt to Taxable Bonds
1.0

0.9

0.8
Ratio

0.7

0.6

t = 1- rm/r , where rm/r is the yield ration.

0.5
1953

1956

1959

1962

1965

1968

1971

1974

1977

1980

1983

1986

1989

1992

1995

1998

2001

2004

2007

2010

2013

2016
2-40
 Corporate Bonds

Issued by private firms

Semi-annual interest payments
Subject to larger default risk than
government securities
– Secured bonds: 有擔保品
– Unsecured bonds (debentures): 無擔保品
Options in corporate bonds
– Callable
– Convertible
2-41
 Investment Grade Bond Listings

投資等級債券：Baa(Moody穆迪)或BBB(S&P標準普爾及Fitch 惠譽)(含)以上

2-42
 Mortgages and
Mortgage-backed Securities(MBS)
Mortgage-backed securities (MBS) are called
pass-throughs because the cash flows produced
by homeowners paying off their mortgages are
passed through to investors
Such securities are developed in the 1970s to
help liquidity of financial institutions (房貸證券化)
Proportional ownership of a pool or a specified
obligation secured by a pool
Market has experienced very high rates of
growth
2-43
 Mortgages and
Mortgage-backed Securities

Most mortgage-backed securities were

issued by Fannie Mae and Freddie Mac.

Traditionally, pass-throughs were

comprised of conforming mortgages,
which met standards of creditworthiness.

2-44
 Mortgages and
Mortgage-backed Securities
Eventually, “Private-label” issuers
securitized large amounts of subprime
mortgages, made to financially weak
borrowers.
Finally, Fannie and Freddie were allowed
and even encouraged to buy subprime
mortgage pools.
September, 2008: Fannie and Freddie got
taken over by the federal government.
2-45
 Figure 2.6
Mortgage-Backed Securities Outstanding
9,000

8,000

7,000 Private issuers

Federal agencies
6,000

5,000
$ billion

4,000

3,000

2,000

1,000

0
1979

1982

1985

1988

1991

1994

1997

2000

2003

2006

2009

2012

2015
2-46
 Figure 2.9
The U.S. Fixed-Income Market

Values in $ billion
2-47
2.3 EQUITY SECURITIES

2-48
 Equity Markets

Common stock (普通股)

– Residual claim
– Limited liability
Preferred stock (特別股)
– Fixed dividends - limited
– Priority over common
– Tax treatment
Depository receipts (信託憑証)

2-49
 Equity Markets
-- Common stock
Common stock (Equity Security)
– Residual claim
Cash flows to common stock?
In the event of bankruptcy, what will stockholders
receive?

– Limited liability
What is the maximum loss on a stock purchase?

2-50
 Equity Markets
-- Preferred stock
Preferred stock
– Fixed dividends: limited gains, non-voting

– Priority over common

– Tax treatment
Preferred & common dividends are not tax
deductible to the issuing firm
Corporate tax exclusion on 70% dividends earned

2-51
 Equity Markets
-- Depository Receipts

Depository Receipts
– American Depository Receipts (ADRs) also
called American Depository Shares (ADSs)
are certificates traded in the U.S. that
represent ownership in a foreign security.

2-52
Stock Market Listings

2-53
 Capital Gains and Dividend
Yields
Capital Gains and Dividend Yields
– You buy a share of stock for $50, hold it for one
year, collect a $1.00 dividend and sell the stock for
$54. What were your dividend yield, capital gain yield
and total return? (Ignore taxes)
– Dividend yield: = Dividend / Pbuy
$1.00 / $50 = 2%
– Capital gain yield: = (Psell – Pbuy)/ Pbuy
($54 - $50) / $50 = 8%
– Total return: = Dividend yield + Capital gain yield
2% + 8% = 10%
2-54
2.4 STOCK AND BOND MARKET
INDEXES

2-55
 Stock and Bond Indexes
Uses
Track average returns
Comparing performance of managers
Base of derivatives

Factors in constructing or using an index

Representative?
Broad or narrow?
How is it constructed?
2-56
 Construction of Indexes
How are stocks weighted? How much money
do you put in each
– Price weighted (DJIA) stock in the index?

– Market-value weighted (S&P500, NASDAQ)

– Equally weighted (Value Line Index)

2-57
Constructing market indices
a) What stocks to include
b) Weighting schemes
Price weighted average assumes buy 1 share each
stock and invest cash and dividends proportionately
based on stocks’ prices.
Value weighted average considers not only price but
also the number of outstanding shares:
– dollars ($) invested in each stock are proportional
to market value of each stock
Equal weighted average considers not only price but
also the number of shares:
– invest same amount of dollars ($) in each stock
regardless of market value of stock
2-58
 Stock Price0 Quantity0 Price1 Quantity1
A $ 10 40 $ 15 40
B 50 80 25 160
C 140 50 150 50

a) Price weighted series (DJIA)

Time 0: index value is (10+50+140)/3 = 200/3 = 66.67
Time 1: index value = 190/3 = 63.33 Problem?
Refigure denominator (10+25+140) / Denom = 66.67
Denominator = 2.624869
Time 1: index value = (15+25+150) / 2.624869 = 72.38

Other problems
– similar % change movements in higher price stocks
cause proportionately larger changes in the index

– splits arbitrarily reduce weights of stocks that split in

index 2-59
 Stock Price0 Quantity0 Price1 Quantity1
A $ 10 40 $ 15 40
B 50 80 25 160
C 140 50 150 50

b) Value weighted series (S&P’s Composite 500)

c) Equal weighted series (Value Line):

we invest $300 in each

d) Why do the two differ?

2-60
 Case 1 Case 2
Stock P0 Q1 P1 Q1 P1 Q1
A $ 10 40 $ 12 40 $ 10 40
B 100 80 100 80 100 80
C 50 200 50 200 60 200

d) Why do the two differ?

Case 1: 20% change in price of small cap firm.

Assume that we invest $100 in each stock

2-61
 Case 1 Case 2
Stock P0 Q0 P1 Q1 P1 Q1
A $ 10 40 $ 12 40 $ 10 40
B 100 80 100 80 100 80
C 50 200 50 200 60 200

Case 1 VW = 100.43
Case 1 EW = 106.67
d) Why do the two differ?
Case 2: 20% change in price of large cap firm.

Assume that we invest $100 in each stock

2-62
 Examples of Indexes - USA

Dow Jones Industrial Average (30 Stocks)

Standard & Poor’s 500 Composite
NASDAQ Composite (> 3000 firms)
NYSE Composite
Wilshire 5000 (> 6000 stocks)

2-63
 Comparative Performance of
Several Stock Market Indices

Why has performance differed for the indices?

2-64
Examples of International Indices

2-65
 Examples of Other Indexes
International Indexes:
Nikkei 225 & Nikkei 300 (日本)
FTSE (Financial Times of London)
Dax (德國), Hang Seng (香港), TSX (加拿大
Toronto)
Region and Country Indexes
– EAFE, Far East, United Kingdom
Bond Indexes:
Indexes are mainly from Merrill Lynch, Barclays
(formerly Lehman Brothers), and Salomon Smith
Barney (of Citigroup)
2-66
2.5 DERIVATIVE MARKETS

2-67
 Derivative Securities

Options and futures provide payoffs

that depend on the values of other
assets such as commodity prices,
bond and stock prices, or market index
values.

A derivative is a security that gets its

value from the values of another asset.

2-68
 Options
Call: Right to buy underlying asset at the
strike or exercise price on or before specified
expiration date.
– Value of calls decrease as strike price increases;
– 到期Call價格=max(股價-執行價, 0)
Put: Right to sell underlying asset at the
strike or exercise price on or before specified
expiration date.
– Value of puts increase with strike price increases;
– 到期Put價格=max(執行價-股價, 0)
Value of both calls and puts increase with
time until expiration. (時間價值)
2-69
Figure 2.9 Stock Options on Apple

新
發
行
或
交
易
稀
少

What does the term ‘strike’ or exercise price refer to?

What is an option premium (權利金)?
2-70
Using the Stock Options on Apple
購買日:July 7, 2011 (t=0); 到期日: Jul 2011 (第三個星期五+1) (t=T)
X=355
t=0 Call Put
S0=357.20 357.20-355 355-357.20
=2.20 > 0 =-2.20< 0
In the money(價內) Out the money(價外)

t=T Call Put

ST=350 Max(350-355,0) Max(355-350,0)
=0 =5 > 0
不執行 執行

ST=360 Max(360-355,0) Max(355-360,0)

=5 =0
執行 不執行
2-71
Using the Stock Options on Apple
The right to buy 100 shares of stock at a stock price of
$560
$355 using the July contract would cost _____.
(Ignoring commissions)
Is this contract “in the money?” (357.20-355)=2.2 > 0 價內
When should you buy this contract?
Option exercise (or strike) price was equal to $355 & you
will make money if the stock price increases above $355
+ $5.6 = $360.6 by contract expiration.

When should you write it?

預期股價到期不會漲超出 $355 + $5.6 = $360.6
2-72
Using the Stock Options on Apple

The right to sell 100 shares of stock at a stock price of

$90
$355 using the July contract would cost ______.
(Ignoring commissions)

Is this contract “in the money?”

(355-357.2) = -2.2 < 0 價外 (out the money)

Why do the two option prices differ? (5.60 vs. 0.9)

內含價值不同 (價內 vs. 價外)

2-73
Using the Stock Options on Apple
Look at Figure 2.9 to answer the following
questions:
1. How does the exercise or strike price affect the
value of a call option? A put option? Why?

2. How does a greater time to contract expiration

affect the value of a call option? A put option?
Why?

3. How is ‘volume’ different from ‘open interest?’

2-74
 Futures Contracts
In a futures contract：
• The purchaser of the contract (the long) agrees to
purchase the specified quantity of the underlying
commodity at contract expiration (delivery or maturity
date) at the price (futures price) set in the contract.
(Long position)

• The contract seller (the short) agrees to deliver the

underlying commodity at contract expiration in
exchange for receiving the agreed upon price. (Short
position)

Futures are a ___________

commitment to buy or sell in the future
at a preset price, whereas options give the holder the
right to buy or sell in the future.
______ 2-75
 Figure 2.10 Futures Contracts

Corn futures prices in the Chicago Board of Trade, July 8, 2011

MATURITY

PS. 5,000 bushels/per contract

2-76
Figure 2.11 Futures Contracts
Contract size: 5000 bushels of corn
Price quote for Jul 11 contract: 672’2 translates to
a price of 672 + 2/8 = 672.25 cents per bushel or
$6.7225 = (672.25/100) per bushel.
If you bought the Jul 11 contract what would you
be agreeing to do?
– Purchase 5000 bushels of corn in July for 5,000 x
$6.7225 = $33,612.5
What would be your obligation if you sold the Jul
11 contract?
The profit for the long position is $1,000 =
5,000*(6.9225-6.7225) if the corn price is
$6.9225/per bushel at maturity.
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 Derivative Securities

How does this contract differ from an option?

Options Futures
Basic Positions Basic Positions
– Call (多) – Long (多)
– Put (空) – Short (空)
Terms Terms
– Exercise Price – Futures Price
(外生給定) (供需內生決定)
– Expiration Date – Delivery Date (交割日)
– Assets – Assets
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