Financial Assets

(Instruments)
 Assets
 Tangible asset
 a physically observable, or touchable, item
 Assets
 Financial asset
 an asset that represents a promise to
distribute cash flows some time in the
future

Promissory
Note
Major Financial Instruments
 Treasury bills  Treasury notes/bonds
 Repurchase agreements  Municipal bonds
 Federal funds  Term loans
 Bankers’ acceptances  Mortgages
 Commercial paper  Corporate bonds
 Negotiable CDs  Preferred stock
 Eurodollars  Common stock
 Money market funds
 Financial Instruments and
the Firm’s Balance Sheet
 Firm issues financial instruments so it
can purchase the tangible assets
necessary to produce income
 Balance Sheet - Equity
 Common equity
 stockholder’s total investment in the firm
 Par value
 nominal or face value of a stock or bond
 Retained earnings
 earnings the firm has not paid out as dividends
throughout its history
 Additional paid-in capital
 difference between the value of newly issued stock
and its par value
 Debt
 A loan to an individual, company, or
government
 Debt features
 Principal value
 Face value
 Maturity value
 Par value
 More Debt Features
 Interest payments or discounted
securities
 Maturity date
 Priority to assets and earnings
 Control of the firm (voting rights)
 Short-Term Debt
 Treasury Bills (T-bills)
 Repurchase Agreement (Repo)
 Federal Funds
 Banker’s Acceptance
 Commercial Paper
 Certificate of Deposit
 Eurodollar Deposit
 Money Market Mutual Funds
 Long-Term Debt
 Term Loans
 Bonds
 Government bonds
 Treasury bonds
 Municipal bonds
– Revenue bonds
– General obligation bonds
 Corporate bonds
 Mortgage bonds
 Bonds
 Debenture
 Subordinated debenture
 Income bond
 Putable bond
 Indexed (purchasing power) bond
 Floating rate bond
 Zero coupon bond
 Junk bond
 Bond Contract Features
 Bond Indenture
 Trustee
 Restrictive covenant
 Call provision
 Sinking fund
 call for redemption by annual lottery
 buy bonds on the open market
 Convertible
 Bond Ratings
 Moody’s Investors Service (Moody’s)
 Standard & Poor’s Corporation (S&P)
 Investment grade bonds
 triple B or better
 Criteria for rating bonds
 Importance of bond ratings
 Changes in ratings
 Stock (Equity)
 Preferred stock has preference over common
stock in distribution of dividends and assets;
dividend payments are fixed
 Preferred stock may provide for cumulative
dividends, conversion into common stock,
voting rights, dividend participation, sinking
funds, call provisions, and even maturity
 Stock (Equity)
 Common stock
 represents ownership in a corporation
 common stockholders vote for members of
the board of directors
 has last claim on distribution of earnings
and assets
 may have preemptive rights to purchase
any additional shares sold by the firm
 Stock (Equity)
 Classified stock
 special purpose stock
 Closely held corporations
 Publicly owned corporations
 Derivatives
 Value depends on some underlying asset
such as a stock or bond
 Option - contract that gives the right to
buy or sell an asset at a set price within a
specified period of time
 Call: holder has the right to buy
 Put: holder has the right to sell
 Striking price: exercise price of the option
 Derivatives
 Covertibles - bonds or preferred stocks
that can be exchanged for common stock
at the option of the holder
 Conversion ratio defines the number of
shares of stock the convertible holder
receives upon conversion
 Futures - arrangement for delivery of an
item at a set future date at a set price
 Derivatives
 Swaps - an agreement to exchange cash
flows or assets at a set time in the future
Rationale for Using Different
Types of Securities
 Differences in trade-off between risk and
expected after tax return
 Appeal to broad market and different
investment needs
 Differences in popularity through time
 Which Financial Instrument
is Best?
 Issuer’s or investor’s viewpoint ?
 Bonds
 fixed interest payments
 does not represent ownership
 may have restrictions on dividends
 interest expense is deductible
 Which Financial Instrument
is Best?
 Preferred stock
 fixed payment - but not obligated
 no voting rights
 higher after-tax cost since dividends are
not deductible expenses
Which Financial Instrument
is Best?
 Common Stock
 no obligation of dividend payments
 no maturity date for “repayment”
 sales increases creditworthiness
 prospects affect terms
 gives control to stockholders
 shares the income of the firm
 higher costs of distribution than debt
 dividends are not deductible
 Financial Instruments in
International Markets
 American Depository Receipts (ADRs)
 represent ownership in stocks of foreign
countries that are held in trust by a bank
located in the country the stock is traded
 Foreign debt
 sold by a foreign borrower but
denominated in the currency of the country
in which it is sold
 Financial Instruments in
International Markets
 Eurodebt
 debt sold in a country other than the one in
whose currency the debt is denominated
 Eurobonds
 Eurocredits: usually tied to London
InterBank Offer Rate (LIBOR)
 Euro-commercial paper (Euro-CP)
 Euronotes
 Financial Instruments in
International Markets
 Equity instruments
 Euro stock is traded in countries other than
the “home” country of the company, not
including the United States
 Yankee stock is stock issued for foreign
companies that is traded in the United
States