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Chapter
Security Types

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Security Types
Our goal in this chapter is to introduce
the different types of securities that are
Goal routinely bought and sold in financial
markets around the world.

 For each security type, we will


examine:
 itsdistinguishing characteristics,
 the potential gains and losses from
owning it, and 2
Classifying Securities

Basic Types Major Subtypes


Money market instruments
Interest-bearingFixed-income securities

Common stock
Equities Preferred stock
Options
Derivatives Futures
Interest-Bearing Assets
Money market instruments
Short-term debt obligations of large
corporations and governments that
mature in a year or less.
Fixed-income securities
Longer-term debt obligations, often
of corporations or governments,
that promise to make fixed
payments according to a preset
schedule. 4
Money Market Instruments
• Examples: U.S. Treasury bills (T-bills), bank
certificates of deposit (CDs), corporate and
municipal money market instruments.
• Potential gains/losses: Fixed future payment,
except when the borrower defaults.
• Price quotations: Usually, the instruments are sold
on a discount basis, and only the interest rates
are quoted. So, some calculation is necessary to
convert the rates to prices.

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Fixed-Income Securities
• Examples: U.S. Treasury notes, corporate
bonds, car loans, student loans.
• Potential gains/losses:
– Fixed coupon payments and final payment at
maturity, except when the borrower defaults.
– Possibility of gain/loss from fall/rise in interest
rates.
– Can be quite illiquid.

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Fixed-Income Securities
• Price quotations: The bond will
AT&T, the issuer of the bond. mature in the
CUR year 2022.
NET
BONDS YLD. VOL CLOSE
CHG.
NEW YORK BONDS
Corporation Bonds
ATT 81/8 22
ATT 73/407…… 7.8 56 100 + 1/4
ATT 81/822…… 8.6 433 94 1/8 + 5/8
The bond’s
ATT 8annual coupon rate. 93
1/824…… 8.7 453
You3/4
will receive

81/8% of the bond’s face value each year in 27
semiannual coupon payments.
Fixed-Income Securities
• Price quotations: The closing price
annual for the day is
Currentyield= 94.125% of face
coupon CUR value.
NET
currentBONDSprice YLD. VOL CLOSE
CHG.
NEW YORK BONDS
Corporation Bonds
8. 43 941/8 + 51/8
ATT 7 /407…… 7.8 56 100
3 + /4
6 3
ATT 81/822…… 8.6 433 94 1/8 + 5/8
The actual
ATT 8of
number The8.7
1/824…… closing
453 price
93 3/4is up –by 5/8
bonds traded of 8
1% from the previous
Equities
Common stock
Represents ownership in a
corporation. A part owner receives
a pro rated share of whatever is left
over after all obligations have been
met in the event
Preferred stockof a liquidation.
The dividend is usually fixed and
must be paid before any dividends
for the common shareholders. In
the event of a liquidation, preferred
shares have a particular face value.
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Common Stock
• Examples: IBM shares, Microsoft shares,
etc.
• Potential gains/losses:
– Many companies pay cash dividends to their
shareholders. However, neither the timing nor
the amount of any dividend is guaranteed.
– The stock value may rise or fall depending on
the prospects for the company and market-
wide circumstances.

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Preferred Stock
• Example: Citigroup preferred stock.
• Potential gains/losses:
– Dividends are “promised.” However, there
is no legal requirement that the dividends
be paid, as long as no common dividends
are distributed.
– The stock value may rise or fall depending
on the prospects for the company and
market-wide circumstances.

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Derivatives
Primary asset
Security originally sold by a
business or government to raise
money.
Derivative asset
A financial asset that is derived
from an existing traded asset
rather than issued by a business or
government to raise capital. More
generally, any financial asset that
is not a primary asset. 12
Derivatives
Futures contract
An agreement made today
regarding the terms of a trade that
will take place later.
Option contract
An agreement that gives the owner
the right, but not the obligation, to
buy or sell a specific asset at a
specified price for a set period of
time.
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Futures Contracts
• Examples: financial futures, commodity
futures.
• Potential gains/losses:
– At maturity, you gain if your contracted price is
better than the market price of the underlying
asset, and vice versa.
– If you sell your contract before its maturity, you
may gain or lose depending on the market
price for the contract.
– Note that enormous gains/losses are possible.

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Option Contracts
• A call option gives the owner the right, but
not the obligation, to buy an asset, while a
put option gives the owner the right, but
not the obligation, to sell an asset.
• The price you pay to buy an option is
called the option premium.
• The specified price at which the
underlying asset can be bought or sold is
called the strike price, or exercise price.

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Option Contracts
• An American option can be exercised anytime
up to and including the expiration date, while
a European option can be exercised only on
the expiration date.
• Options differ from futures in two main ways:
 There is no obligation to buy/sell the underlying
asset.
 There is a premium associated with the contract.

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Option Contracts
• Potential gains/losses:
– Buyers gain if the strike price is better
than the market price, and if the
difference is greater than the option
premium. In the worst case, buyers lose
the entire premium.
– Sellers gain the premium if the market
price is better than strike price. Here,
the gain is limited but the loss is not.

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Investing in Stocks versus
Options
Example:
• Suppose you have $10,000 for investments. Macron
Technology is selling at $50 per share.
 Number of shares bought = $10,000 / $50 = 200
 If Macron is selling for $55 per share 3 months later, gain =

($55 × 200) – $10,000 = $1,000


 If Macron is selling for $45 per share 3 months later, gain =
($45 × 200) – $10,000 = – $1,000

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Investing in Stocks versus
Options
Example: …continued
• A call option with a $50 strike price and 3 months to
maturity is also available at a premium of $4.
 A call contract costs $4 × 100 = $400, so number of
contracts bought = $10,000 / $400 = 25 (for 25 × 100 =
2500 shares)
 If Macron is selling for $55 per share 3 months later, gain
= {($55 – $50) × 2500} – $10,000 = $2,500
 If Macron is selling for $45 per share 3 months later, gain
= ($0 × 2500) – $10,000 = – $10,000

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Chapter Review
• Classifying Securities
• Interest-Bearing Assets
– Money Market Instruments
– Fixed-Income Securities
• Equities
– Common Stock
– Preferred Stock
– Common and Preferred Stock Price Quotes

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Chapter Review
• Derivatives
– Futures Contracts
– Futures Price Quotes
– Gains and Losses on Futures Contracts
• Option Contracts
– Option Terminology
– Options versus Futures
– Option Price Quotes
– Gains and Losses on Option Contracts
– Investing in Stocks versus Options
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