financial markets: stocks and bonds
DESCRIPTION
TRANSCRIPT
![Page 1: Financial Markets: Stocks and Bonds](https://reader034.vdocuments.net/reader034/viewer/2022051612/54c0fe724a7959cc438b4598/html5/thumbnails/1.jpg)
Ch. 15: Financial Markets
• Financial markets – link borrowers and lenders. – determine interest rates, stock prices, bond prices,
etc.• Bonds
– a promise by the bond-issuer to pay some specified amount(s) in the future in exchange for some payment (the bond price) today.
• Stocks (equities)– legal rights of ownership in an incorporated firm.– promise the stockholder a share of the corporte
profits (dividends)
![Page 2: Financial Markets: Stocks and Bonds](https://reader034.vdocuments.net/reader034/viewer/2022051612/54c0fe724a7959cc438b4598/html5/thumbnails/2.jpg)
The Bond Market.
Maturity date: • A bond's maturity date refers to the specific future date on which the
maturity value will be paid to the bond holder. Bond maturity dates when issued generally range from 3 months up to 30 years.
Coupon rate• Between the date of issuance and the maturity date, the bond-holder
receives an annual interest payment equal to the coupon rate times the maturity value.
Yield to maturity• represents the effective interest rate that the bond-holder earns if the bond
is held to maturity.Bond price• The price that the bond sells for. This fluctuates over the life of the bond.
– *If the bond price is equal to 100% of its maturity value, the bond sold at “par”. – If the bond price is below 100% of its maturity value, the bond price sold “below
par”.
![Page 3: Financial Markets: Stocks and Bonds](https://reader034.vdocuments.net/reader034/viewer/2022051612/54c0fe724a7959cc438b4598/html5/thumbnails/3.jpg)
The Bond Market
• 20 year bond with maturity value of $1000 and coupon rate of 5% promises– 20 annual payments of .05*1000=$50– $1000 payment at maturity (20 years from
now). – If price is $1000 for this bond, the bond sold
for par.
![Page 4: Financial Markets: Stocks and Bonds](https://reader034.vdocuments.net/reader034/viewer/2022051612/54c0fe724a7959cc438b4598/html5/thumbnails/4.jpg)
The Bond Market.• Computing yields on a bond.
• The yield on a bond is the same as the internal rate of return. To calculate the yield to maturity, define NPV as follows:
• NPV = CP1/(1+r) + CP2/(1+r)2 + .... + CPT/(1+r)T + MV/(1+r)T - P
• where CP1, CP2, ... CPT are the interest or coupon payments in periods 1 through T
• MV is the payment received at maturity• P is the price paid for the bond.
• The yield to maturity is the interest rate that makes the NPV on the bond purchase zero.
![Page 5: Financial Markets: Stocks and Bonds](https://reader034.vdocuments.net/reader034/viewer/2022051612/54c0fe724a7959cc438b4598/html5/thumbnails/5.jpg)
The Bond Market.One year bonds
– NPV = MV(1+cr)/(1+r) - P where cr is the coupon rate.
– setting NPV=0 and solving for r provides the yield to maturity:– yield = [MV(1+cr)/P] - 1
• For example, suppose you buy a one-year bond for $900. It has a maturity value of $1000 and a coupon rate of 5%. What is the yield?
• yield = [(1000)(1.05)/900] - 1=1050/900 -1
=16.67%
As the price paid for a bond increases, the yield on the bond falls.
![Page 6: Financial Markets: Stocks and Bonds](https://reader034.vdocuments.net/reader034/viewer/2022051612/54c0fe724a7959cc438b4598/html5/thumbnails/6.jpg)
The Bond Market.Zero Coupon Bonds.
• With zero coupon bonds, no interest payments are made between the sale of the bond and its maturity. That is, there is a zero coupon rate. For such bonds, the yield calculations is straightforward.
NPV = MV/(1+r)T - P
• setting NPV=0 and solving for r provides the yield:
yield = (MV/P)1/T - 1
• For example, if you buy a zero coupon bond today for $1000 and it has a maturity value of $1500 in 10 years:
yield = (1500/1000)1/10 -1 = .0414 = 4.14%
As the price paid for a bond increases, the yield on the bond falls.
![Page 7: Financial Markets: Stocks and Bonds](https://reader034.vdocuments.net/reader034/viewer/2022051612/54c0fe724a7959cc438b4598/html5/thumbnails/7.jpg)
The Bond Market.
• Determinants of bond yields– Higher expected inflation will drive up yields.– Higher risk bonds must offer higher yields.
• Default risk.– Debt rating agencies:
» Moody’s & Standard and Poors» AAA=superior quality» C=imminent default
– Diversification to reduce risk.
• Inflation risk.
– Term• Longer term bonds have greater inflation and default risk.
![Page 8: Financial Markets: Stocks and Bonds](https://reader034.vdocuments.net/reader034/viewer/2022051612/54c0fe724a7959cc438b4598/html5/thumbnails/8.jpg)
The Bond Market.
• Yield curve– Shows relationship between yield and term on
government bonds– Slope of yield curve reflects
• Expectations of future short term interest rates• Greater risk of long term bonds
– If short term interest rates are expected to be constant in the future, yield curve will slope upward reflecting risk premia for longer term bonds.
– A steepening of the yield curve suggests that financial markets believe short term interest rates will be rising in the future.
• The bond market• The dynamic yield curve
![Page 9: Financial Markets: Stocks and Bonds](https://reader034.vdocuments.net/reader034/viewer/2022051612/54c0fe724a7959cc438b4598/html5/thumbnails/9.jpg)
The Stock Market
• Stocks (equities):– legal rights of ownership in an incorporated
firm.– promise the stockholder a share of the
corporte profits (dividends)
![Page 10: Financial Markets: Stocks and Bonds](https://reader034.vdocuments.net/reader034/viewer/2022051612/54c0fe724a7959cc438b4598/html5/thumbnails/10.jpg)
The Stock Market
• The “fundamental value” of a stock is the expected present value of all future dividends from a stock.
• P = d1/(1+r) + d2/(1+r)2 + d3/(1+r)3 + ....dT/(1+r)T
– where T is the end of the firm’s life (which might be infinite)
– d1, d2, ... dT represent dividend payments in years 1 through T.
– r is the interest rate
![Page 11: Financial Markets: Stocks and Bonds](https://reader034.vdocuments.net/reader034/viewer/2022051612/54c0fe724a7959cc438b4598/html5/thumbnails/11.jpg)
The Stock Market
• Given the fundamental value theory, stock prices will rise with:– lower interest rates.– an increase in future expected dividends.– A lower tax rate on dividends.
![Page 12: Financial Markets: Stocks and Bonds](https://reader034.vdocuments.net/reader034/viewer/2022051612/54c0fe724a7959cc438b4598/html5/thumbnails/12.jpg)
The Stock Market
• Efficient markets hypothesis: – All stock prices represent their fundamental
value at each point in time. – When new “information” arrives about a stock,
its price immediately adjusts to reflect that new information.
– It is impossible to consistently predict which way a stock price will move in the future and to consistently “beat the market”.
![Page 13: Financial Markets: Stocks and Bonds](https://reader034.vdocuments.net/reader034/viewer/2022051612/54c0fe724a7959cc438b4598/html5/thumbnails/13.jpg)
The Stock Market.
• If the efficient markets hypothesis is true, – financial advisors can assist you only in evaluating the
risk and tax consequences of different stocks and concerns regarding income or growth, etc.
– Financial advisors will not be able to consistently find stocks that will “beat the market”.
• The validity of the efficient markets hypothesis is controversial among economists.
![Page 14: Financial Markets: Stocks and Bonds](https://reader034.vdocuments.net/reader034/viewer/2022051612/54c0fe724a7959cc438b4598/html5/thumbnails/14.jpg)
The Stock Market
• Stock quotes– Price– PE ratio (price-earnings ratio)– Volume (number of shares sold in previous
day)– Change (change in from previous day)– 52 week high and low– Beta (measures stock movements relative to
market)
![Page 15: Financial Markets: Stocks and Bonds](https://reader034.vdocuments.net/reader034/viewer/2022051612/54c0fe724a7959cc438b4598/html5/thumbnails/15.jpg)
The Stock Market
• Performance measures– Broad indexes
• Dow Jones Industrial Average• Standard and Poor 500• NASDAQ
• For stock quotes and information– http://money.cnn.com/
![Page 16: Financial Markets: Stocks and Bonds](https://reader034.vdocuments.net/reader034/viewer/2022051612/54c0fe724a7959cc438b4598/html5/thumbnails/16.jpg)
Options
• Options are contracts in which the terms of the contract are standardized and give the buyer the right, but not the obligation, to buy (call) or sell (put) a particular asset at a fixed price (the strike price) for a specific period of time (until expiration).
![Page 17: Financial Markets: Stocks and Bonds](https://reader034.vdocuments.net/reader034/viewer/2022051612/54c0fe724a7959cc438b4598/html5/thumbnails/17.jpg)
Options Market
• Call option on a security: – the right to call (buy) a security at the strike
price up until the expiration date of the option from the person that issued the call.
– If I sell you a call option on IBM with a strike price of $190 and an expiration date of 1/1/2009, you have the right to exercise the option until its expiration and force me to sell you IBM for $190. You will exercise the option only if IBM rises above the strike price of $190.
![Page 18: Financial Markets: Stocks and Bonds](https://reader034.vdocuments.net/reader034/viewer/2022051612/54c0fe724a7959cc438b4598/html5/thumbnails/18.jpg)
Options Market
• Put option on a security: – the right to put (sell) a security at the strike price up
until the expiration date of the option to the person that issued the put.
– If I sell you a put option on IBM with a strike price of $150 and an expiration date of 1/1/2009, then at any time between now and 2009 you can force me to buy a share of IBM for $150. You would exercise your put option only if the price of IBM falls below the strike price of $150.
![Page 19: Financial Markets: Stocks and Bonds](https://reader034.vdocuments.net/reader034/viewer/2022051612/54c0fe724a7959cc438b4598/html5/thumbnails/19.jpg)
Options Market
• The options market can be used for:– speculation– reducing exposure to risk.
![Page 20: Financial Markets: Stocks and Bonds](https://reader034.vdocuments.net/reader034/viewer/2022051612/54c0fe724a7959cc438b4598/html5/thumbnails/20.jpg)
Futures Market• A market for contracts that provide for future delivery of a good at
some pre-specified price. Futures markets exist for commodities, bonds, and foreign currencies.
• Example: If I agree to a 1/1/2009 futures contract to buy 1000 bushels of corn at $3.00 per bushel, I am committed to buying corn on that date at that price. The other party to the contract is committed to sell 1000 bushels at $3.00 per bushel. The person who agrees to buy corn has “bought” a futures contract. The person who agrees to sell the corn has “sold” a futures contract.
• If the expected price of a commodity in the future rises, the futures price will rise.
• The price in futures contracts provides an indicator of what people believe about the movement of prices in the future.
![Page 21: Financial Markets: Stocks and Bonds](https://reader034.vdocuments.net/reader034/viewer/2022051612/54c0fe724a7959cc438b4598/html5/thumbnails/21.jpg)
Mutual FundsMutual Funds: a firm that pools money from many small investors to
buy and manage a portfolio of assets and pays the earnings back to the investors. Mutual funds can be categorized in several ways. For example:– index funds (S&P 500 or Willshire 5000)– international funds (invest in foreign securities; exchange rate risk)– bond funds (invest in bonds)– balanced funds (invest in bonds and stocks)– growth funds (invest in companies viewed as having high growth
potential)– sector funds (invest in a particular sector of the economy; e.g. health, or
financial services).– tax-exempt income funds (invest in tax exempt bonds)– money market funds (invest in short term government securities)
• The major advantage of mutual funds is that it allows a person to invest in the stock market and be diversified.