Chapter

3
Security Types

Fundamentals
of Investments
Valuation & Management
second edition
Charles J. Corrado Bradford D. Jordan

McGraw Hill / Irwin Slides by Yee-Tien (Ted) Fu

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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:

 its distinguishing characteristics,
 the potential gains and losses from owning it, and

 how its prices are quoted in the financial press.

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 3-3

Classifying Securities

Basic Types Major Subtypes

Money market instruments
Interest-bearing Fixed-income securities
Common stock
Equities Preferred stock
Options
Derivatives Futures

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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.

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 3-5

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 mature
AT&T, the issuer of the bond. in the year 2022.
CUR NET
BONDS YLD. VOL CLOSE CHG.
NEW YORK BONDS
Corporation Bonds
ATT 73/407 …… 7.8 56 100 + 1/4
ATT 22 …… 8.6 433 94 1/8 + 5/8
ATT 811/8822
ATT 81/824 …… 8.7 453 93 3/4 –
The bond’s annual coupon rate. You will receive 81/8% of the
bond’s face value each year in 2 semiannual coupon payments.
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 3-8

Fixed-Income Securities
 Price quotations: The closing price for
the day is 94.125% of
Current yield = annual coupon face value.
currentCUR
price NET
BONDS YLD. VOL CLOSE CHG.
NEW YORK BONDS
Corporation Bonds
ATT 73/407 …… 7.8 56 100 + 1/4
ATT 81/822 …… 8.6 8.6 433
433 94 94 11//88 + 55/88
ATT 81/824 …… 8.7 453 93 3/4 –
The actual
number of bonds The closing price is up by 5/8 of
traded that day. 1% from the previous closing price.
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 3-9

Work the Web

 Check out bond basics at:

http://www.investinginbonds.com

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 3 - 10

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 of a liquidation.
Preferred stock
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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 3 - 12

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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Equities : Price quotations

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Work the Web

 Are you a Foolish investor? Go to
“Fool School” at:
http://www.fool.com
 You can also learn more about the
“ticker tape” at:
http://www.stocktickercompany.com
 and create your own ticker at:
http://www.cnbc.com

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 3 - 15

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.

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 3 - 16

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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 3 - 17

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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Futures Contracts
 Price quotations:

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Work the Web

 You can download lots of basic

futures information from the
Knowledge Center at:
http://www.cbot.com

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 3 - 20

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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 3 - 21

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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 3 - 22

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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Option Contracts
 Price quotations:

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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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 3 - 25

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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 3 - 26

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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 3 - 27

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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