Investments
Economics school of JiLin
University
Dingzhaoyong
主要参考书目
[美 ]兹维 ·博笛、罗伯特 ·C ·莫顿（ 2000）,,金融学,,中国人民大学出版社。
[美 ]艾伦 ·加特（ 1999）,,管制、放松与重新管制,,
经济科学出版社。
[美 ]查里斯 ·R ·吉斯特（ 1998）,,金融体系中的投资银行,,经济科学出版社。
[美 ] J·弗雷德 ·威斯通等（ 1998）,,兼并、重组与公司控制,,经济科学出版社。
[美 ]洛伦兹 ·格利茨（ 1998）,,金融工程学,,经济科学出版社李扬、王国刚主编（ 1998）,,资本市场导论,,经济管理出版社
Chapter 1 Introduction
In this text we will to study investing in
marketable securities,So we should
focuses on the investment environment
and investment process.
The investment environment encompasses the
kinds of marketable securities that exist and where
and how they are bought and sold.
The investment process is concerned with how
an investor should proceed in making decisions
about what marketable securities to invest in,how
extensive the investments should be,and when
the investments should be made.
Chapter 1 Introduction
Definition of investment
Investment,in its broadest sense,means the
sacrifice of current dollars for future dollars.
There are tow different attributes are generally
involved,time and risk.
A distinction is often made between investment
and savings,Savings is defined as foregone
consumption; investment is restricted to ―real‖
investment of the sort that increases national
output in the future,And that it useful to make a
distinction between real and financial investment.
Chapter 1 Introduction
Real investments
Real investments generally involve some kind of
tangible asset,such as land,machinery,or
factories.
Financial investments
Financial investments involve contracts written on
pieces of paper,such as common stocks and
bonds,
In primitive economies most investments is of the real
variety; in a modern economy,such investments is
the financial variety.
Chapter 1 Introduction
The investment environment
Securities
The term security will be used to refer to a legal
representation of the right to receive prospective
future benefits under stated conditions,
Treasury bills
Long-term bonds
Common stocks
Security market
Financial intermediaries
Chapter 1 Introduction
Direct method
Corporation General Public
Issues securities
Provides funds
Indirect method
Corporation Financial Intermediary General Public
Issues
Securities
Provides
Funds
Offers
Accounts
Provide
Funds
Chapter 1 Introduction
The investment process
There is a five-step procedure decisions form for
investment process:
o Set investment policy
o Perform security analysis
o Construct a portfolio
o Revise the portfolio
o Evaluate the performance of the portfolio
Investment policy
When an investor set investment policy,he or she
must determining the objectives and the amount of
his or her investable wealth.
Chapter 1 Introduction
Investment objectives should be stated in terms of
both risk and return.
This step concludes with the identification of the
potential categories of financial assets for
consideration in the ultimate portfolio,
Security analysis
Securities analysis involves examining a number
of individual securities (or groups of securities)
within the broad categories of financial assets
previously identified.
One purpose for conducting such examinations
is to identify those securities that currently
appear to be mispriced.
Chapter 1 Introduction
There are tow classifications approaches to securities
analysis.
Technical analysis
Fundamental analysis
Portfolio construction
Portfolio construction is to identifying those
specific assets in which to invest,as well as
determining the proportions of the investor’s
wealth to put into each one.
Portfolio revision
Portfolio performance evaluation
Asset ownership by individual investors
Institutional investor and individual investor
Chapter 1 Introduction
The relationship between investment and
speculation
Function of securities
Resources collocation– capital control right competition
Make property right distinct
Push forward national industry policy
Factors of investment
Revenue,income or yield
Risk or uncertainty
Liquidity
Chapter 1 Introduction
Law of investment
Prospective income lead law
Yield and risk symbiosis law
Security and money syntony law
Investments establishment
Harry Markowitz publish his famous article ―Portfolio
Selection‖ in Journal of Finance(December 1952)
William Sharpe ―single-index model‖,see ―A
simplified Model of Portfolio Analysis”,in
Management Science (January 1963).
Chapter 1 Introduction
Sharpe(1964),Lintner(1965),Mossin(1966) developed the
famous Capital Asset Pricing Model.
Sharpe,W.F,―Capital Asset Prices,A Theory of Market
Equilibrium Under Conditions of Risk,‖ Journal of Finance
(Sept.1964).
Lintner,J.,― The Valuation of Risk Asset and the Selection of
Risky Investments in Stock Portfolios and Capital Budgets,‖
Review of Economics and Statistics (Feb.1965).
Mossin,J.,―Equilibrium in a Capital Market‖,Econometrica
(Oct,1966).
Steve Ross(1976) & Richard Roll(1977,1978),Arbitrage
Pricing Theory,
Ross,S.A.,―The Arbitrage Theory of Capital Asset of
Pricing,‖ Journal of Economic Theory (Dec.1976).
Chapter 2 Security Market
A security market can be defined as a mechanism
for bringing together buyers and sellers of
financial assets in order to facilitate trading.
As opposed to primary market,security market are
secondary market,because the financial assets
traded on on them were issued at some previous
point in time.
One of their main function is price discovery,that
is,to cause prices to reflect currently available
information,
The quicker this is done,the more efficiently
financial market will see that capital is allocated
to its most productive opportunities,
Chapter 2 Security Market
Structure of security market
The primary market
The primary market can be subdivided into
seasoned and unseasoned new issues,A
seasoned new issues refers to the offering of an
additional amount of an already existing security,
whereas an unseasoned new issue involves the
initial offering of a security to the public,So the
unseasoned new issues are often referred to as
initial public offerings,or IPO’s.
The secondary market
Chapter 2 Security Market
Call and continuous market
Call markets
In call markets,trading is allowed only at certain
specified times,
Continuous markets
In continuous markets,trades may occur at any
time,In a continuous market,financial
intermediaries’ function are so important for
investors,
Organized exchanges markets
Securities or stock exchange is the most important
part of security market.
Chapter 2 Security Market
Exchange market has a charter and a set of rules
and regulations that govern its operation and the
activities of its members.
In order to become a member,a seat (comparable to
a membership card) must be purchased from a
current member.
The stock that is available for trading on the
exchange is known as a listed security,in other
ways,it also can be called public traded security,In
order for a company’s stock to be listed,the
company must apply to the exchange,The initial
application is usually informal and confidential,If
approved,the company then makes the formal
application that is announced publicly.
Chapter 2 Security Market
In U.S.A NYSE,some international securities are
traded such as American Depository Receipts
(ADRs),ADRs are financial assets that are issued
by U.S.banks and represent indirect ownership of a
certain number of shares of a specific foreign
company that are hold on deposit in a foreign bank,
Security exchange members
Commission brokers These brokers take orders
that the public has placed with brokerage firms and
see to it that they are executed on the exchange,
The brokerage firms that they work for are paid
commissions by the customers for their services.
Chapter 2 Security Market
Floor broker,Also known as tow– dollar brokers,
They assist commission brokers when there are too
many orders flowing into the market for the
commission brokers to handle alone,For their
assistance,they receive part of the commissions paid
by the investor.
Floor trader,These brokers trade solely for
themselves and prohibited by exchange rule from
handling public orders.
Specialists,These brokers perform tow roles,First,
any limit order that the commission broker cannot
execute immediately because the current market
price is not at or better than the specified price will be
left with the specialist for possible execution in the
future.
Chapter 2 Security Market
In this capacity the specialist can be called ―broker’s
broker‖.
Second,the specialist acts as a dealer in certain stocks
(in particular,for the same stocks in which he or she
acts as a broker),This means that the specialist buys
and sells certain stocks for he or she own account
and its allowed to seek a profit in doing so,In this
capacity the specialist is required by the exchange to
maintain a ―fair and orderly market‖,
How to trade security
Chapter 2 Security Market
Chapter 2 Security Market
Chapter 2 Security Market
Over– the – counter market
The transactions that are not executed on an
organized exchange market but involve the use of
dealer are called
Third and fourth market
Third market refers to the trading of any exchange–
listed security in the over– the – counter market,The
existence of third market is its trading hours are not
fixed and flexible trading fee or cost,
Fourth market refers to the market that institutional
investors trading directly with each other,
Chapter 2 Security Market
Information– motivated and liquidity–
motivated traders
There are tow reasons for most security transactions,
An investor may believe that a security has become
mispriced– meaning that its value is outside the
current bid and asked prices,Anybody who feels
this way believes that he or she has information not
known to (or understood by) the market in general
and may be referred to as an information– motivated
trader.
On the other hand,an investor may simply want to
sell some securities in order to buy something or buy
some securities with some newly acquired money,
Chapter 2 Security Market
Anybody acting in this manner may be referred to as
a liquidity – motivated trader.
Prices as information sources
The value of any financial asset depends on future
prospects that are almost always uncertain,Any
information that bears on such prospects may lead
to a revised estimate of the security’s value,
Commissions
Fixed commissions
Competitive commissions
Chapter 2 Security Market
Investment banking
Private placements
Public sale
Public sale syndicate & Selling group,
underwrite
Competitive bidding
Registration statement--prospectus & red herring
Shelf registration– the SEC allowed firms to
register securities in advance of Rule 415,
securities may be sold up to tow years later,With
securities ―on the shelf‖,the corporation can
achieve more benefits,
Rule 144A
Regulation of security markets
Chapter 3 The Valuation of
Riskless Securities
A useful first step in understanding security valuation is to
consider those fixed– income securities that are certain
of making their promised payments in full and on time.
And there is a degree of uncertainty as to the purchasing
power of the promised payments,so we should
discuss the relationship between nominal and real
interest rates.
Nominal versus real interest rates
The rate at which an investor can trade present
money for future money is the nominal(or monetary)
interest rate– usually simply called the interest rate.
Chapter 3 The Valuation of
Riskless Securities
We usually employ cost—of –living index or consumer
price index to estimate the real interest rate.
C0(1+NIR)/C1=1+RIR
Where:
C0 = level of the cost– of – living index at the
beginning of the year
C1 = level of the cost– of –living index at the end of
the year
NIR= the nominal interest rate
RIR=the real interest rate
Chapter 3 The Valuation of
Riskless Securities
Yield –to –maturity
There are many ways that interest rates can be
calculated,one is the yield– to– maturity,another
is the spot rate.
In describing yield– to—maturity and spot rates,
three hypothetical Treasury securities that are
available to the public for investment will be
considered,Such securities are widely believed to
be free from default risk,meaning that investment
have no doubts about being paid fully and on time.
Chapter 3 The Valuation of
Riskless Securities
The yield– to– maturity on any fixed– income
security is the single interest rate(with interest
compounded at some specified interval) that
would enable the investor to obtain all the
payments promised by the security in question,
It is a simple matter to determine the yield– to–
maturity on the one– year security,
Spot rates
A spot rate is measured at a given point to time as
the yield– to maturity on a pure– discount security,
and can be thought of as the interest rate
associate with a spot contract,
Chapter 3 The Valuation of
Riskless Securities
In general,the t-year spot rate st is the solution to the
following equation:
Pt=Mt/(1+ st)t
Where Pt is the current market price of a pure– discount
bond that matures in t years and has a maturity value
of Mt,
Spot rate can be determined in another manner if only
coupon—bearing bonds are available for longer
maturities,Generally the one—year spot rate(st) is
known,as there typically is a one—year pure—
discount security available for making this calculation.
Chapter 3 The Valuation of
Riskless Securities
P2=C1/(1+ s1)1+M2/(1+ s2)2
Where P2 is current market price,M2 is maturity value,
and a coupon payment one year from now equal to
C1.
Discount factor
Having determined a set of spot rates,it is a
straightforward matter to determine the
corresponding set of discount factors,
A discount factor dt is equivalent to the present
value of $1 to be received t years in the future
from a special security,and is equal to,
dt =1/(1+st)t
Chapter 3 The Valuation of
Riskless Securities
The set of these factor is sometimes referred to as
the market discount function,and it changes day
to day as spot rates change,
No matter how complex the pattern of payments,
this procedure can be used to determine the value
of any default– free bond of this type,The general
formula for a bond’s present value(PV) is
PV=Σdt ct
Compounding
Compounding is the payment of ―interest on
interest‖,At the end of each compounding interval,
interest is computed and added to principal,
n
t=1
Chapter 3 The Valuation of
Riskless Securities
Future value=$1× (1+r)t
FV= P(F/P,i,n)
Term structure theories
The unbiased expectations theory
The unbiased expectations theory(or pure
expectations theory) holds that the forward rate
represents the average opinion of the expected
future spot rate for the period in question,
A set of spot rates that is rising can be explained
by arguing that the marketplace believes that
the spot rates will be rising in the future.
Chapter 3 The Valuation of
Riskless Securities
The liquidity preference theory
The liquidity preference theory starts with the notion
that investors are primarily interested in purchasing
short– term securities,
This is because these investors realize that they may
need their funds earlier than anticipated and
recognize that they face less ―price risk‖(that is
interest rate risk) if they invest in shorter– term
securities.
The market segmentation theory
The market is divided by different investors,and spot
rates are determined by supply and demand
conditions in each market.
Chapter 4 The Valuation of
Risky Securities
Payments received from riskless securities can be
accurately predicted,neither their amounts nor their
timing is uncertain,But many securities do not meet such
high standards,
The security analyst must try to evaluate the circumstances
affecting a risky investment’s payments and enumerate
the key events upon which such payments are contingent.
Market versus personal valuation
One approach to the valuation of risky securities
focuses on the investor’s personal attitudes and
circumstance,Such an approach would be appropriate
Chapter 4 The Valuation of
Risky Securities
If there were only one investment in the world,Current
market values of other securities provide important
information,because a security is seldom so unique
that nothing else is comparable,
Key to this approach is the comparison of one investment
or combination of investments with others having
comparable characteristics,
If people are willing to purchase combination A for VA,
they should be willing to purchase combination B for
the same amount,thus VA =VB,And VB = Vx + Vc,
Then VA = Vx + Vc,and Vx = VA - Vc
Chapter 4 The Valuation of
Risky Securities
(a)
Investment or
Combination of
Investments
A
Investment or
Combination of
Investments
B
(B)
Investment or
Combination of
Investments
A
Security X
Investment or
Combination of
Investment C
Investment or
Combination of
Investments
B
Chapter 4 The Valuation of
Risky Securities
Chapter 4 The Valuation of
Risky Securities
0.2
0.4
0.3
0.1
Chapter 4 The Valuation of
Risky Securities
Probability distribution graphs
Chapter 4 The Valuation of
Risky Securities
Chapter 4 The Valuation of
Risky Securities
Probabilistic forecasting
Assessing probabilities
The analyst expresses its assessment of the likelihood
of every relevant event as a probability,
Probability distributions
It is often convenient to probabilistic forecasts
graphically,The possible outcomes are represented
on the horizontal axis and the associated
probabilities on the vertical axis,
Event trees
Chapter 4 The Valuation of
Risky Securities
Event trees
When events follow one another over
time or in any sense dependent on one
another,it is often to describe the
alternative sequences with a tree
diagram.
Event trees can describe many
uncertain events,
Chapter 4 The Valuation of Risky
Securities
Now One year hence Two years hence Probability of
sequence Pro.=0.10
0.40*0.10=0.04
Probability=0.40
Pro.=0.90
0.40*0.90=0.36
Start
Pro.=0.50
0.60*0.50=0.30
Probability=0.60
Pro.=0.50
0.60*0.50=0.30
Pay
$15
Pay
$10
Pay
$8
Pay
$6
Pay
$4
Pay
$8
Chapter 4 The Valuation of
Risky Securities
Expected value
We summarize the uncertain situation with the
central tendency of the distribution outcomes and
the relevant risk.
The Mode,the most likely value
The Median,the ―50-50‖ number
The Mean,the expected value
Also knows as the mean,that is a measure of
central tendency of the probability distribution of a
random variable that equals the weighted average
of all possible outcomes using their probabilities as
weights.
Chapter 4 The Valuation of Risky
Securities
A n n ou n c e m n t P r o,E ( P a ) E ( P b) E ( P a b)
A 0.10 40.00 62.00 102.00
B 0.20 42.00 65.00 107.00
C 0.10 40.50 60.00 100.50
D 0.25 41.00 61.00 102.00
E 0.15 38.00 65.00 103.00
F 0.10 40.50 59.00 99.50
G 0.05 45.00 58.00 103.00
H 0.05 40.50 58.00 98.50
E x pe c t e d V a l u e 40.73 61.90 102.63
A n a l y s i s of E f f e c t s of a n n ou n c e m e n t s on t w o s e c u r i t i e s
a n d a por t f ol i o of bot h s e c u r i t i e s
Chapter 4 The Valuation of
Risky Securities
The expected value of the return for a portfolio is
related in a straightforward way to the expected
value of the returns for its individual securities.
Expected versus promised yield– to– maturity
Expected holding– period return
Calculating holding– period return
rhp= -1
Holding—period return can be converted to an
equivalent return per period,
Value at the end of the holding period
Value at the beginning of the holding period
Chapter 4 The Valuation of
Risky Securities
(1+rg)N = 1+ rhp
Or rg = (1+rhp)1/N -1
Where,N= the number of periods in the holding period
rhp= the holding period return
rg= the equivalent return per period,
compounded every period
Expected return and security valuation
Expected holding period return = expected end– of –
period value /current value –1
Current value =expected end—of – period
value/(1+expected holding –period return)
Chapter 5 Fixed– income Security
The term fixed– income is commonly used to cover the
types of securities which promised the investor will
receive certain specified cash flows at certain
specified times in the future.
It may be one cash flow,in which case the security is
known as a pure– discounted security,And it may
involve multiple cash flows,If all cash flows are of the
same size,they are generally referred to as coupon
payment,The specified date beyond which the
investor will no longer receive cash flows is known as
the maturity date,On this date,investor receives the
principle along with the last coupon payment.
Chapter 5 Fixed– income Security
Government securities
Treasury bill
Treasury bills are issued on a discount basis,with
maturities of up 52 weeks and in denominations of
$10000 or more,All are issued in book– entry
form,.
Although treasury bills are sold at discount,their
nominal yield (the difference between the
purchase price and the face value if the bill is held
to maturity) is treated as interest income for tax
purposes,
Treasury bills are offered by auction,
Chapter 5 Fixed– income Security
Bids may be entered on either a competitive or a
noncompetitive basis,
Treasury notes
Treasury notes are issued with maturities from one
to ten years and generally make coupon payments
semiannually,Treasury notes can be sold in
bearer form or registered form.
Treasury notes are issued in denominations of
$1000 or more,Coupon payments are set at an
amount so that the notes will initially sell close to
par value,In most cases an auction is held,with
both competitive and noncompetitive bids.
Chapter 5 Fixed– income Security
Treasury notes are traded in a active secondary market
made by dealers in government securities,
Treasury bonds
Treasury bonds have maturities greater than ten years
at the time of issuance.
Treasury bonds could be issued in bearer or registered
form.
Unlike treasury notes,treasury bond issues have call
provisions that allow them to be called during a
specified period(usually the period begins five to ten
years prior to maturity and ends at the maturity date),
Chapter 5 Fixed– income Security
This means that at any scheduled coupon payment
date during this period,the Treasury has the right
to force the investor to sell back the bonds to
government at par value.
Zero coupon treasury security receipts
In effect,a noncallable treasury note or bond is a
portfolio of pure– discount bonds(or equivalently a
portfolio of zero coupon bonds),That is,each
coupon payment,as well as the principal,can be
viewed as a bond unto itself; the investor who
owns the bond can therefore be viewed as holding
a number of individual pure– discount bonds.
Chapter 5 Fixed– income Security
In 1982,a number of brokerage firms began
separating these component,using a process
known as coupon stripping.
Coupon stripping is a new investment manner,in this
process brokerage firm divide the coupon security into
tow individual part—corpus or principals and coupons.
And sell them as zero– corpus securities,
The famous example is the STRIPS(separate trading of
registered interest and principal securities) in 1985,
This program allows purchasers of certain coupon—
bearing treasury securities to keep whatever cash
payments they want and to sell the rest,
Chapter 5 Fixed– income Security
With this process,treasury bonds of a given issue
are purchased and placed in trust with a custodian
or a bank,Sets of receipts are then issued,one
set for each coupon date.
An other set of receipts would be issued that mature
on the date the principal of the securities held in
trust is due,
The Internal Revenue Service(IRS,美国国内税务署 )
requires that taxes be paid annually on the
accrued interest earned on such securities,That is,
such securities are treated for tax purposes as
original issue discount securities,
Chapter 5 Fixed– income Security
For example,a STRIP that matures in tow years for $1000
might be purchased currently for $900,Thus the investor
would earn $100 in interest over tow years,realizing it
when the STRIP matures,However,the IRS would make
the investor pay taxes on a portion of the $100 each year,
The amount to be recognized must be calculated using
the constant interest method that reflects the the actual
economic accrual of interest,This meanings that the
investor cannot report $50 per year as interest income,
First the yield needs to be calculated is 5.4% [(1000/900)1/2-
1],that is at the end of the first year the value of STRIP
would be $948.60,the amount of interest income is 48.60.
The second year the income is 51.40.
Chapter 5 Fixed– income Security
Federal agency security
Bonds of federal agencies
Bonds issued by federal agencies provide funds to
support such activities as housing(through either
direct loans or the purchase of existing mortgages);
export and import activities; the postal service; and
so on,
Many issues are guaranteed by the full faith and credit
of the government,but some are not.
Bonds of federally sponsored agencies
Federally sponsored agencies are privately owned
agencies that issue securities and use the proceeds
Chapter 5 Fixed– income Security
to support the granting of certain types of loans to
farmers,homeowners,and others.
Although the debts of agencies of this type are usually
not guaranteed by the government,governmental
control is designed to ensure that each debt issue is
backed by extremely safe assets,
Participation certificates
To support credit for home purchases,the government
has authorized the issuance of participation
certificates,A group of assets is placed in a pool,and
certificate representing ownership of those assets are
issued to pay for them,
Chapter 5 Fixed– income Security
The holders of the certificates receive the interest
and principal payments as they are made,minus a
small service charge.
The most important certificates of this type are those
issued by U.S.A,Government National Mortgage
Association and are known as GNMA Modified
Pass—Through Security,This security is
guaranteed by GNMA and backed by full faith and
credit of the government,
The pass—through security is a special kind of securities
that investor receive the income from debtor through
some financial intermediate institution,
Chapter 5 Fixed– income Security
State and local government securities
Issuing agencies
Type of municipal bonds
General obligation bonds are backed by the full
faith and credit(and thus the full taxing power)
of the issuing agency,Most are issued by
agencies with unlimited taxing power,although
in a minority of cases the issuer is subject to
limits on the amount of taxes or the tax rate.
Revenue bonds are backed by revenues from a
designated project,authority,or agency or by
the proceeds from a specific tax,
Chapter 5 Fixed– income Security
In many cases,such bonds are issued by agencies
that hope to sell their services,pay the required
expenses,and have enough left over to meet
required payments on outstanding debt,
Expect for the possible granting of monopoly
powers,the authorizing state and local
government may provide no future assistance to
the issuer,
Many revenue bonds are issued to finance capital
expenditures for publicly owned utilities,Others
are issued to finance quasi—utility operations,
Industry development bonds(IDBs) are used to
Chapter 5 Fixed– income Security
finance the purchase or construction of industrial
facilities that are to be leased to firms on a
favorable basis,In effect,such bonds provide
cheap financing to businesses choosing to locate
in the geographical area of the issuer.
Although most municipal financing involves the
issuance of long—term securities,a number of
different types of short—term securities have been
issued in order to meet short—term demands for
cash,
Traditionally used types include tax anticipation
notes(TANs),revenue anticipation notes(RANs),
grant anticipation notes(GANs),tax and revenue
anticipation notes(TRANs).
Chapter 5 Fixed– income Security
Tax treatment
Through a reciprocal arrangement with the
federal government,coupon payments on state
and local government securities are exempt
from federal taxation,and coupon payments on
treasury and agency (except FNMA) securities
are exempt from state and local taxation,
However,a different tax treatment is generally
given to coupon—bearing securities that were
issued at par value but were subsequently
bought at a discount in the marketplace.
An other interesting tax feature of municipals is
Chapter 5 Fixed– income Security
that if the investor resides in the state of the
issuer,then he or she is generally exempt not
only from paying federal taxes on the coupon
payments,but also from paying state taxes.
The market for municipal bonds
Municipals are issued as serial bonds,where one
prespecified group matures a year issue,
another tow years after issue,another three
years after,and so on,
Unlike corporate bonds,municipal bonds do not
need to be registered before public issuance.
Chapter 5 Fixed– income Security
Municipals may be callable at specified dates and
prices,Occasionally the issuer is obligated to
make designated payments into sinking fund,
which is used to buy similar bonds,
A secondary market in municipals is made by
various dealers,
Corporate bonds
Tax treatment
The indenture
An issue of bonds is generally covered by an indenture,
in which the issuing corporation promises a specified
trustee that it will comply with a number of stated
provisions.
Chapter 5 Fixed– income Security
Chief of these is the timely payment of required
coupons and principal on the issue,Other terms
are often included to control the sale of pledged
property,the issuance of other bonds,and the like.
The trustee for a bond(often a bank or a trust
company) issue acts on behalf of the bondholders,
Some actions many be required by the indenture,
while others may be done at the trustee’s
discretion.
If the corporation defaults on an interest payment,
then after a relatively short period of time the
entire principal typically becomes due and payable.
Chapter 5 Fixed– income Security
Types of bonds
Mortgage bonds
Mortgage bonds represent debt that is secured by
the pledge of specific property,In the event of
default,the bondholders are entitled to obtain the
property in question and sell it to satisfy their
claims on the firm.
Collateral trust bonds
Collateral trust bonds are backed by other
securities that are usually held by the trustee,A
common situation of this sort arises when the
securities of a subsidiary firm are pledged as
collateral by the parent firm,
Chapter 5 Fixed– income Security
Equipment obligations
Known also as equipment trust certificates,
Equipment obligations are backed by specific
pieces of equipment,If necessary,the equipment
can be readily sold and delivered to a new owner.
Debentures
Debentures are general obligations of the issuing
corporation and thus represent unsecured credit,To
protect the holders of such bonds,the indenture will
usually limit the future issuance of secured debt as
well as any additional unsecured debt.
Chapter 5 Fixed– income Security
Subordinated debentures
Subordinated debentures are junior to unsubordinated
debentures,meaning that in the event of bankruptcy,
junior claims are to be considered only after senior
claims have been fully satisfied.
Other types of bonds
Income bonds are more like preferred stock(described
in a later section) than bonds,Payment of interest in
full and on schedule is not absolutely required,and
failure to do so need not send the corporation into
bankruptcy,This type of bond has rarely been used,
expect in reorganizations of bankrupt railroads.
Chapter 5 Fixed– income Security
Guaranteed bonds are issued by one corporation
but backed in some way by another,such as by
a parent firm.
Participating bonds require stated interest
payments and provide additional amounts if
earnings exceed some stated level,
Voting bonds unlike regular bonds,given the
holders some voice in management,
Serial corporate bonds
Convertible bonds,at the holder’s option,may be
exchanged for other securities,often common
stock.
Exchangeable bonds
Chapter 5 Fixed– income Security
Call provisions
Management would like to have the right to pay off
the corporation’s bonds at par at any time prior to
maturity,This would provide management with
flexibility,as debt could be reduced or its maturity
altered via refunding,Most important,expensive
high—coupon debt that was issued during a time
of high interest rates could be replaced with
cheaper low—coupon debt if rates decline.
Despite the cost of obtaining this sort of flexibility,
many corporations include call provisions in their
bond indentures that give the corporation the
Chapter 5 Fixed– income Security
option to call some or all of the bonds from their
holders at stated prices during specified periods
prior to maturity,
Accordingly,some recently corporate issues have
given the investor the option of forcing the issuer
to call the security.
The indenture usually gives investors tow kinds of
call protection,First of all,during the first few
years after being issued,a bond may not be
callable,Secondly,a call premium may be
specified in the call provision,
Chapter 5 Fixed– income Security
Such a premium indicates that if the issue is called,
the issuer must pay the bondholders a call price
that is a stated amount above par.
Sinking funds
A bond indenture will often required the issuing
corporation to make annual payments into a
sinking funds,The idea is to pay part of the
principal of the debt(as well as the interest) each
year,thereby reducing the amount outstanding at
maturity.
Sinking funds operate by having the corporation
transmit cash to the trustee or itself,who can then
purchase bonds in the open market.
Chapter 5 Fixed– income Security
Private placements
The direct sale of a newly issued security to a small
number of large institutional investors.
Bonds intended for eventual public sale are usually
issued in denominations of $1000 each,
Bankruptcy
Foreign bonds
Eurobonds
The term eurobond is loosely applied to bonds that
are offered outside the country of the borrower and
outside the country in whose currency the securities
are denominated,
Chapter 5 Fixed– income Security
Preferred stock
Preferred stock is a hybrid form of security that has
characteristics of both common stocks and bonds.
In some respects,preferred stock is like a perpetual
bond,A given dollar amount is to be paid each
year by the issuer to the investor,This amount
may be stated as a percent of the stock’s par
value.
Because the security is a ―stock‖,such ―stated‖
payments are called dividends instead of interest
and hence do not qualify as a tax—deductible
expense for the issuing corporation,
Chapter 5 Fixed– income Security
Adjustable rate preferred stock (ARPS)
ARPS is a newly innovation form of preferred stock,
where the dividend is reset periodically in terms of
a applicable rate,
Related to ARPS are the Dutch auction rate
preferred stocks,where the dividend is reset
periodically at a level determined by bidding from
current and potential owners,
Preferred stock generally receives preferential
treatment when it comes to dividends,Specified
payments must be made on the preferred stock
before any dividends may be paid to common stock
holders.
Chapter 5 Fixed– income Security
Cumulative preferred stocks
Failure to pay a preferred dividend in full dose
not constitute default,but unpaid dividends are
usually cumulative,This means that all
previously unpaid preferred stock dividends
must be paid before any dividends may be paid
on the common stocks.
No indenture is provided with a preferred stock issue,
Various provisions protecting the preferred
stockholders against potentially harmful actions
may be written into the corporation charter,
Chapter 5 Fixed– income Security
Although preferred stockholders typically do not
have voting rights,there may be another provision
that gives them voting rights when the corporation
is in arrears on its preferred dividends.
Many preferred stock are callable at a stated
redemption price,
Participating preferred stock entitles the holder
to receive extra dividends when earnings permits.
Convertible preferred stock at the option of the
holder may be converted into another security
such as common stocks on stated terms.
Chapter 5 Fixed– income Security
Likely bonds holders,when in the event of a
dissolution of the corporation,preferred stock
often receives preferential treatment as to assets
after bondholder but before common stockholder,
Economics school of JiLin
University
Dingzhaoyong
主要参考书目
[美 ]兹维 ·博笛、罗伯特 ·C ·莫顿（ 2000）,,金融学,,中国人民大学出版社。
[美 ]艾伦 ·加特（ 1999）,,管制、放松与重新管制,,
经济科学出版社。
[美 ]查里斯 ·R ·吉斯特（ 1998）,,金融体系中的投资银行,,经济科学出版社。
[美 ] J·弗雷德 ·威斯通等（ 1998）,,兼并、重组与公司控制,,经济科学出版社。
[美 ]洛伦兹 ·格利茨（ 1998）,,金融工程学,,经济科学出版社李扬、王国刚主编（ 1998）,,资本市场导论,,经济管理出版社
Chapter 1 Introduction
In this text we will to study investing in
marketable securities,So we should
focuses on the investment environment
and investment process.
The investment environment encompasses the
kinds of marketable securities that exist and where
and how they are bought and sold.
The investment process is concerned with how
an investor should proceed in making decisions
about what marketable securities to invest in,how
extensive the investments should be,and when
the investments should be made.
Chapter 1 Introduction
Definition of investment
Investment,in its broadest sense,means the
sacrifice of current dollars for future dollars.
There are tow different attributes are generally
involved,time and risk.
A distinction is often made between investment
and savings,Savings is defined as foregone
consumption; investment is restricted to ―real‖
investment of the sort that increases national
output in the future,And that it useful to make a
distinction between real and financial investment.
Chapter 1 Introduction
Real investments
Real investments generally involve some kind of
tangible asset,such as land,machinery,or
factories.
Financial investments
Financial investments involve contracts written on
pieces of paper,such as common stocks and
bonds,
In primitive economies most investments is of the real
variety; in a modern economy,such investments is
the financial variety.
Chapter 1 Introduction
The investment environment
Securities
The term security will be used to refer to a legal
representation of the right to receive prospective
future benefits under stated conditions,
Treasury bills
Long-term bonds
Common stocks
Security market
Financial intermediaries
Chapter 1 Introduction
Direct method
Corporation General Public
Issues securities
Provides funds
Indirect method
Corporation Financial Intermediary General Public
Issues
Securities
Provides
Funds
Offers
Accounts
Provide
Funds
Chapter 1 Introduction
The investment process
There is a five-step procedure decisions form for
investment process:
o Set investment policy
o Perform security analysis
o Construct a portfolio
o Revise the portfolio
o Evaluate the performance of the portfolio
Investment policy
When an investor set investment policy,he or she
must determining the objectives and the amount of
his or her investable wealth.
Chapter 1 Introduction
Investment objectives should be stated in terms of
both risk and return.
This step concludes with the identification of the
potential categories of financial assets for
consideration in the ultimate portfolio,
Security analysis
Securities analysis involves examining a number
of individual securities (or groups of securities)
within the broad categories of financial assets
previously identified.
One purpose for conducting such examinations
is to identify those securities that currently
appear to be mispriced.
Chapter 1 Introduction
There are tow classifications approaches to securities
analysis.
Technical analysis
Fundamental analysis
Portfolio construction
Portfolio construction is to identifying those
specific assets in which to invest,as well as
determining the proportions of the investor’s
wealth to put into each one.
Portfolio revision
Portfolio performance evaluation
Asset ownership by individual investors
Institutional investor and individual investor
Chapter 1 Introduction
The relationship between investment and
speculation
Function of securities
Resources collocation– capital control right competition
Make property right distinct
Push forward national industry policy
Factors of investment
Revenue,income or yield
Risk or uncertainty
Liquidity
Chapter 1 Introduction
Law of investment
Prospective income lead law
Yield and risk symbiosis law
Security and money syntony law
Investments establishment
Harry Markowitz publish his famous article ―Portfolio
Selection‖ in Journal of Finance(December 1952)
William Sharpe ―single-index model‖,see ―A
simplified Model of Portfolio Analysis”,in
Management Science (January 1963).
Chapter 1 Introduction
Sharpe(1964),Lintner(1965),Mossin(1966) developed the
famous Capital Asset Pricing Model.
Sharpe,W.F,―Capital Asset Prices,A Theory of Market
Equilibrium Under Conditions of Risk,‖ Journal of Finance
(Sept.1964).
Lintner,J.,― The Valuation of Risk Asset and the Selection of
Risky Investments in Stock Portfolios and Capital Budgets,‖
Review of Economics and Statistics (Feb.1965).
Mossin,J.,―Equilibrium in a Capital Market‖,Econometrica
(Oct,1966).
Steve Ross(1976) & Richard Roll(1977,1978),Arbitrage
Pricing Theory,
Ross,S.A.,―The Arbitrage Theory of Capital Asset of
Pricing,‖ Journal of Economic Theory (Dec.1976).
Chapter 2 Security Market
A security market can be defined as a mechanism
for bringing together buyers and sellers of
financial assets in order to facilitate trading.
As opposed to primary market,security market are
secondary market,because the financial assets
traded on on them were issued at some previous
point in time.
One of their main function is price discovery,that
is,to cause prices to reflect currently available
information,
The quicker this is done,the more efficiently
financial market will see that capital is allocated
to its most productive opportunities,
Chapter 2 Security Market
Structure of security market
The primary market
The primary market can be subdivided into
seasoned and unseasoned new issues,A
seasoned new issues refers to the offering of an
additional amount of an already existing security,
whereas an unseasoned new issue involves the
initial offering of a security to the public,So the
unseasoned new issues are often referred to as
initial public offerings,or IPO’s.
The secondary market
Chapter 2 Security Market
Call and continuous market
Call markets
In call markets,trading is allowed only at certain
specified times,
Continuous markets
In continuous markets,trades may occur at any
time,In a continuous market,financial
intermediaries’ function are so important for
investors,
Organized exchanges markets
Securities or stock exchange is the most important
part of security market.
Chapter 2 Security Market
Exchange market has a charter and a set of rules
and regulations that govern its operation and the
activities of its members.
In order to become a member,a seat (comparable to
a membership card) must be purchased from a
current member.
The stock that is available for trading on the
exchange is known as a listed security,in other
ways,it also can be called public traded security,In
order for a company’s stock to be listed,the
company must apply to the exchange,The initial
application is usually informal and confidential,If
approved,the company then makes the formal
application that is announced publicly.
Chapter 2 Security Market
In U.S.A NYSE,some international securities are
traded such as American Depository Receipts
(ADRs),ADRs are financial assets that are issued
by U.S.banks and represent indirect ownership of a
certain number of shares of a specific foreign
company that are hold on deposit in a foreign bank,
Security exchange members
Commission brokers These brokers take orders
that the public has placed with brokerage firms and
see to it that they are executed on the exchange,
The brokerage firms that they work for are paid
commissions by the customers for their services.
Chapter 2 Security Market
Floor broker,Also known as tow– dollar brokers,
They assist commission brokers when there are too
many orders flowing into the market for the
commission brokers to handle alone,For their
assistance,they receive part of the commissions paid
by the investor.
Floor trader,These brokers trade solely for
themselves and prohibited by exchange rule from
handling public orders.
Specialists,These brokers perform tow roles,First,
any limit order that the commission broker cannot
execute immediately because the current market
price is not at or better than the specified price will be
left with the specialist for possible execution in the
future.
Chapter 2 Security Market
In this capacity the specialist can be called ―broker’s
broker‖.
Second,the specialist acts as a dealer in certain stocks
(in particular,for the same stocks in which he or she
acts as a broker),This means that the specialist buys
and sells certain stocks for he or she own account
and its allowed to seek a profit in doing so,In this
capacity the specialist is required by the exchange to
maintain a ―fair and orderly market‖,
How to trade security
Chapter 2 Security Market
Chapter 2 Security Market
Chapter 2 Security Market
Over– the – counter market
The transactions that are not executed on an
organized exchange market but involve the use of
dealer are called
Third and fourth market
Third market refers to the trading of any exchange–
listed security in the over– the – counter market,The
existence of third market is its trading hours are not
fixed and flexible trading fee or cost,
Fourth market refers to the market that institutional
investors trading directly with each other,
Chapter 2 Security Market
Information– motivated and liquidity–
motivated traders
There are tow reasons for most security transactions,
An investor may believe that a security has become
mispriced– meaning that its value is outside the
current bid and asked prices,Anybody who feels
this way believes that he or she has information not
known to (or understood by) the market in general
and may be referred to as an information– motivated
trader.
On the other hand,an investor may simply want to
sell some securities in order to buy something or buy
some securities with some newly acquired money,
Chapter 2 Security Market
Anybody acting in this manner may be referred to as
a liquidity – motivated trader.
Prices as information sources
The value of any financial asset depends on future
prospects that are almost always uncertain,Any
information that bears on such prospects may lead
to a revised estimate of the security’s value,
Commissions
Fixed commissions
Competitive commissions
Chapter 2 Security Market
Investment banking
Private placements
Public sale
Public sale syndicate & Selling group,
underwrite
Competitive bidding
Registration statement--prospectus & red herring
Shelf registration– the SEC allowed firms to
register securities in advance of Rule 415,
securities may be sold up to tow years later,With
securities ―on the shelf‖,the corporation can
achieve more benefits,
Rule 144A
Regulation of security markets
Chapter 3 The Valuation of
Riskless Securities
A useful first step in understanding security valuation is to
consider those fixed– income securities that are certain
of making their promised payments in full and on time.
And there is a degree of uncertainty as to the purchasing
power of the promised payments,so we should
discuss the relationship between nominal and real
interest rates.
Nominal versus real interest rates
The rate at which an investor can trade present
money for future money is the nominal(or monetary)
interest rate– usually simply called the interest rate.
Chapter 3 The Valuation of
Riskless Securities
We usually employ cost—of –living index or consumer
price index to estimate the real interest rate.
C0(1+NIR)/C1=1+RIR
Where:
C0 = level of the cost– of – living index at the
beginning of the year
C1 = level of the cost– of –living index at the end of
the year
NIR= the nominal interest rate
RIR=the real interest rate
Chapter 3 The Valuation of
Riskless Securities
Yield –to –maturity
There are many ways that interest rates can be
calculated,one is the yield– to– maturity,another
is the spot rate.
In describing yield– to—maturity and spot rates,
three hypothetical Treasury securities that are
available to the public for investment will be
considered,Such securities are widely believed to
be free from default risk,meaning that investment
have no doubts about being paid fully and on time.
Chapter 3 The Valuation of
Riskless Securities
The yield– to– maturity on any fixed– income
security is the single interest rate(with interest
compounded at some specified interval) that
would enable the investor to obtain all the
payments promised by the security in question,
It is a simple matter to determine the yield– to–
maturity on the one– year security,
Spot rates
A spot rate is measured at a given point to time as
the yield– to maturity on a pure– discount security,
and can be thought of as the interest rate
associate with a spot contract,
Chapter 3 The Valuation of
Riskless Securities
In general,the t-year spot rate st is the solution to the
following equation:
Pt=Mt/(1+ st)t
Where Pt is the current market price of a pure– discount
bond that matures in t years and has a maturity value
of Mt,
Spot rate can be determined in another manner if only
coupon—bearing bonds are available for longer
maturities,Generally the one—year spot rate(st) is
known,as there typically is a one—year pure—
discount security available for making this calculation.
Chapter 3 The Valuation of
Riskless Securities
P2=C1/(1+ s1)1+M2/(1+ s2)2
Where P2 is current market price,M2 is maturity value,
and a coupon payment one year from now equal to
C1.
Discount factor
Having determined a set of spot rates,it is a
straightforward matter to determine the
corresponding set of discount factors,
A discount factor dt is equivalent to the present
value of $1 to be received t years in the future
from a special security,and is equal to,
dt =1/(1+st)t
Chapter 3 The Valuation of
Riskless Securities
The set of these factor is sometimes referred to as
the market discount function,and it changes day
to day as spot rates change,
No matter how complex the pattern of payments,
this procedure can be used to determine the value
of any default– free bond of this type,The general
formula for a bond’s present value(PV) is
PV=Σdt ct
Compounding
Compounding is the payment of ―interest on
interest‖,At the end of each compounding interval,
interest is computed and added to principal,
n
t=1
Chapter 3 The Valuation of
Riskless Securities
Future value=$1× (1+r)t
FV= P(F/P,i,n)
Term structure theories
The unbiased expectations theory
The unbiased expectations theory(or pure
expectations theory) holds that the forward rate
represents the average opinion of the expected
future spot rate for the period in question,
A set of spot rates that is rising can be explained
by arguing that the marketplace believes that
the spot rates will be rising in the future.
Chapter 3 The Valuation of
Riskless Securities
The liquidity preference theory
The liquidity preference theory starts with the notion
that investors are primarily interested in purchasing
short– term securities,
This is because these investors realize that they may
need their funds earlier than anticipated and
recognize that they face less ―price risk‖(that is
interest rate risk) if they invest in shorter– term
securities.
The market segmentation theory
The market is divided by different investors,and spot
rates are determined by supply and demand
conditions in each market.
Chapter 4 The Valuation of
Risky Securities
Payments received from riskless securities can be
accurately predicted,neither their amounts nor their
timing is uncertain,But many securities do not meet such
high standards,
The security analyst must try to evaluate the circumstances
affecting a risky investment’s payments and enumerate
the key events upon which such payments are contingent.
Market versus personal valuation
One approach to the valuation of risky securities
focuses on the investor’s personal attitudes and
circumstance,Such an approach would be appropriate
Chapter 4 The Valuation of
Risky Securities
If there were only one investment in the world,Current
market values of other securities provide important
information,because a security is seldom so unique
that nothing else is comparable,
Key to this approach is the comparison of one investment
or combination of investments with others having
comparable characteristics,
If people are willing to purchase combination A for VA,
they should be willing to purchase combination B for
the same amount,thus VA =VB,And VB = Vx + Vc,
Then VA = Vx + Vc,and Vx = VA - Vc
Chapter 4 The Valuation of
Risky Securities
(a)
Investment or
Combination of
Investments
A
Investment or
Combination of
Investments
B
(B)
Investment or
Combination of
Investments
A
Security X
Investment or
Combination of
Investment C
Investment or
Combination of
Investments
B
Chapter 4 The Valuation of
Risky Securities
Chapter 4 The Valuation of
Risky Securities
0.2
0.4
0.3
0.1
Chapter 4 The Valuation of
Risky Securities
Probability distribution graphs
Chapter 4 The Valuation of
Risky Securities
Chapter 4 The Valuation of
Risky Securities
Probabilistic forecasting
Assessing probabilities
The analyst expresses its assessment of the likelihood
of every relevant event as a probability,
Probability distributions
It is often convenient to probabilistic forecasts
graphically,The possible outcomes are represented
on the horizontal axis and the associated
probabilities on the vertical axis,
Event trees
Chapter 4 The Valuation of
Risky Securities
Event trees
When events follow one another over
time or in any sense dependent on one
another,it is often to describe the
alternative sequences with a tree
diagram.
Event trees can describe many
uncertain events,
Chapter 4 The Valuation of Risky
Securities
Now One year hence Two years hence Probability of
sequence Pro.=0.10
0.40*0.10=0.04
Probability=0.40
Pro.=0.90
0.40*0.90=0.36
Start
Pro.=0.50
0.60*0.50=0.30
Probability=0.60
Pro.=0.50
0.60*0.50=0.30
Pay
$15
Pay
$10
Pay
$8
Pay
$6
Pay
$4
Pay
$8
Chapter 4 The Valuation of
Risky Securities
Expected value
We summarize the uncertain situation with the
central tendency of the distribution outcomes and
the relevant risk.
The Mode,the most likely value
The Median,the ―50-50‖ number
The Mean,the expected value
Also knows as the mean,that is a measure of
central tendency of the probability distribution of a
random variable that equals the weighted average
of all possible outcomes using their probabilities as
weights.
Chapter 4 The Valuation of Risky
Securities
A n n ou n c e m n t P r o,E ( P a ) E ( P b) E ( P a b)
A 0.10 40.00 62.00 102.00
B 0.20 42.00 65.00 107.00
C 0.10 40.50 60.00 100.50
D 0.25 41.00 61.00 102.00
E 0.15 38.00 65.00 103.00
F 0.10 40.50 59.00 99.50
G 0.05 45.00 58.00 103.00
H 0.05 40.50 58.00 98.50
E x pe c t e d V a l u e 40.73 61.90 102.63
A n a l y s i s of E f f e c t s of a n n ou n c e m e n t s on t w o s e c u r i t i e s
a n d a por t f ol i o of bot h s e c u r i t i e s
Chapter 4 The Valuation of
Risky Securities
The expected value of the return for a portfolio is
related in a straightforward way to the expected
value of the returns for its individual securities.
Expected versus promised yield– to– maturity
Expected holding– period return
Calculating holding– period return
rhp= -1
Holding—period return can be converted to an
equivalent return per period,
Value at the end of the holding period
Value at the beginning of the holding period
Chapter 4 The Valuation of
Risky Securities
(1+rg)N = 1+ rhp
Or rg = (1+rhp)1/N -1
Where,N= the number of periods in the holding period
rhp= the holding period return
rg= the equivalent return per period,
compounded every period
Expected return and security valuation
Expected holding period return = expected end– of –
period value /current value –1
Current value =expected end—of – period
value/(1+expected holding –period return)
Chapter 5 Fixed– income Security
The term fixed– income is commonly used to cover the
types of securities which promised the investor will
receive certain specified cash flows at certain
specified times in the future.
It may be one cash flow,in which case the security is
known as a pure– discounted security,And it may
involve multiple cash flows,If all cash flows are of the
same size,they are generally referred to as coupon
payment,The specified date beyond which the
investor will no longer receive cash flows is known as
the maturity date,On this date,investor receives the
principle along with the last coupon payment.
Chapter 5 Fixed– income Security
Government securities
Treasury bill
Treasury bills are issued on a discount basis,with
maturities of up 52 weeks and in denominations of
$10000 or more,All are issued in book– entry
form,.
Although treasury bills are sold at discount,their
nominal yield (the difference between the
purchase price and the face value if the bill is held
to maturity) is treated as interest income for tax
purposes,
Treasury bills are offered by auction,
Chapter 5 Fixed– income Security
Bids may be entered on either a competitive or a
noncompetitive basis,
Treasury notes
Treasury notes are issued with maturities from one
to ten years and generally make coupon payments
semiannually,Treasury notes can be sold in
bearer form or registered form.
Treasury notes are issued in denominations of
$1000 or more,Coupon payments are set at an
amount so that the notes will initially sell close to
par value,In most cases an auction is held,with
both competitive and noncompetitive bids.
Chapter 5 Fixed– income Security
Treasury notes are traded in a active secondary market
made by dealers in government securities,
Treasury bonds
Treasury bonds have maturities greater than ten years
at the time of issuance.
Treasury bonds could be issued in bearer or registered
form.
Unlike treasury notes,treasury bond issues have call
provisions that allow them to be called during a
specified period(usually the period begins five to ten
years prior to maturity and ends at the maturity date),
Chapter 5 Fixed– income Security
This means that at any scheduled coupon payment
date during this period,the Treasury has the right
to force the investor to sell back the bonds to
government at par value.
Zero coupon treasury security receipts
In effect,a noncallable treasury note or bond is a
portfolio of pure– discount bonds(or equivalently a
portfolio of zero coupon bonds),That is,each
coupon payment,as well as the principal,can be
viewed as a bond unto itself; the investor who
owns the bond can therefore be viewed as holding
a number of individual pure– discount bonds.
Chapter 5 Fixed– income Security
In 1982,a number of brokerage firms began
separating these component,using a process
known as coupon stripping.
Coupon stripping is a new investment manner,in this
process brokerage firm divide the coupon security into
tow individual part—corpus or principals and coupons.
And sell them as zero– corpus securities,
The famous example is the STRIPS(separate trading of
registered interest and principal securities) in 1985,
This program allows purchasers of certain coupon—
bearing treasury securities to keep whatever cash
payments they want and to sell the rest,
Chapter 5 Fixed– income Security
With this process,treasury bonds of a given issue
are purchased and placed in trust with a custodian
or a bank,Sets of receipts are then issued,one
set for each coupon date.
An other set of receipts would be issued that mature
on the date the principal of the securities held in
trust is due,
The Internal Revenue Service(IRS,美国国内税务署 )
requires that taxes be paid annually on the
accrued interest earned on such securities,That is,
such securities are treated for tax purposes as
original issue discount securities,
Chapter 5 Fixed– income Security
For example,a STRIP that matures in tow years for $1000
might be purchased currently for $900,Thus the investor
would earn $100 in interest over tow years,realizing it
when the STRIP matures,However,the IRS would make
the investor pay taxes on a portion of the $100 each year,
The amount to be recognized must be calculated using
the constant interest method that reflects the the actual
economic accrual of interest,This meanings that the
investor cannot report $50 per year as interest income,
First the yield needs to be calculated is 5.4% [(1000/900)1/2-
1],that is at the end of the first year the value of STRIP
would be $948.60,the amount of interest income is 48.60.
The second year the income is 51.40.
Chapter 5 Fixed– income Security
Federal agency security
Bonds of federal agencies
Bonds issued by federal agencies provide funds to
support such activities as housing(through either
direct loans or the purchase of existing mortgages);
export and import activities; the postal service; and
so on,
Many issues are guaranteed by the full faith and credit
of the government,but some are not.
Bonds of federally sponsored agencies
Federally sponsored agencies are privately owned
agencies that issue securities and use the proceeds
Chapter 5 Fixed– income Security
to support the granting of certain types of loans to
farmers,homeowners,and others.
Although the debts of agencies of this type are usually
not guaranteed by the government,governmental
control is designed to ensure that each debt issue is
backed by extremely safe assets,
Participation certificates
To support credit for home purchases,the government
has authorized the issuance of participation
certificates,A group of assets is placed in a pool,and
certificate representing ownership of those assets are
issued to pay for them,
Chapter 5 Fixed– income Security
The holders of the certificates receive the interest
and principal payments as they are made,minus a
small service charge.
The most important certificates of this type are those
issued by U.S.A,Government National Mortgage
Association and are known as GNMA Modified
Pass—Through Security,This security is
guaranteed by GNMA and backed by full faith and
credit of the government,
The pass—through security is a special kind of securities
that investor receive the income from debtor through
some financial intermediate institution,
Chapter 5 Fixed– income Security
State and local government securities
Issuing agencies
Type of municipal bonds
General obligation bonds are backed by the full
faith and credit(and thus the full taxing power)
of the issuing agency,Most are issued by
agencies with unlimited taxing power,although
in a minority of cases the issuer is subject to
limits on the amount of taxes or the tax rate.
Revenue bonds are backed by revenues from a
designated project,authority,or agency or by
the proceeds from a specific tax,
Chapter 5 Fixed– income Security
In many cases,such bonds are issued by agencies
that hope to sell their services,pay the required
expenses,and have enough left over to meet
required payments on outstanding debt,
Expect for the possible granting of monopoly
powers,the authorizing state and local
government may provide no future assistance to
the issuer,
Many revenue bonds are issued to finance capital
expenditures for publicly owned utilities,Others
are issued to finance quasi—utility operations,
Industry development bonds(IDBs) are used to
Chapter 5 Fixed– income Security
finance the purchase or construction of industrial
facilities that are to be leased to firms on a
favorable basis,In effect,such bonds provide
cheap financing to businesses choosing to locate
in the geographical area of the issuer.
Although most municipal financing involves the
issuance of long—term securities,a number of
different types of short—term securities have been
issued in order to meet short—term demands for
cash,
Traditionally used types include tax anticipation
notes(TANs),revenue anticipation notes(RANs),
grant anticipation notes(GANs),tax and revenue
anticipation notes(TRANs).
Chapter 5 Fixed– income Security
Tax treatment
Through a reciprocal arrangement with the
federal government,coupon payments on state
and local government securities are exempt
from federal taxation,and coupon payments on
treasury and agency (except FNMA) securities
are exempt from state and local taxation,
However,a different tax treatment is generally
given to coupon—bearing securities that were
issued at par value but were subsequently
bought at a discount in the marketplace.
An other interesting tax feature of municipals is
Chapter 5 Fixed– income Security
that if the investor resides in the state of the
issuer,then he or she is generally exempt not
only from paying federal taxes on the coupon
payments,but also from paying state taxes.
The market for municipal bonds
Municipals are issued as serial bonds,where one
prespecified group matures a year issue,
another tow years after issue,another three
years after,and so on,
Unlike corporate bonds,municipal bonds do not
need to be registered before public issuance.
Chapter 5 Fixed– income Security
Municipals may be callable at specified dates and
prices,Occasionally the issuer is obligated to
make designated payments into sinking fund,
which is used to buy similar bonds,
A secondary market in municipals is made by
various dealers,
Corporate bonds
Tax treatment
The indenture
An issue of bonds is generally covered by an indenture,
in which the issuing corporation promises a specified
trustee that it will comply with a number of stated
provisions.
Chapter 5 Fixed– income Security
Chief of these is the timely payment of required
coupons and principal on the issue,Other terms
are often included to control the sale of pledged
property,the issuance of other bonds,and the like.
The trustee for a bond(often a bank or a trust
company) issue acts on behalf of the bondholders,
Some actions many be required by the indenture,
while others may be done at the trustee’s
discretion.
If the corporation defaults on an interest payment,
then after a relatively short period of time the
entire principal typically becomes due and payable.
Chapter 5 Fixed– income Security
Types of bonds
Mortgage bonds
Mortgage bonds represent debt that is secured by
the pledge of specific property,In the event of
default,the bondholders are entitled to obtain the
property in question and sell it to satisfy their
claims on the firm.
Collateral trust bonds
Collateral trust bonds are backed by other
securities that are usually held by the trustee,A
common situation of this sort arises when the
securities of a subsidiary firm are pledged as
collateral by the parent firm,
Chapter 5 Fixed– income Security
Equipment obligations
Known also as equipment trust certificates,
Equipment obligations are backed by specific
pieces of equipment,If necessary,the equipment
can be readily sold and delivered to a new owner.
Debentures
Debentures are general obligations of the issuing
corporation and thus represent unsecured credit,To
protect the holders of such bonds,the indenture will
usually limit the future issuance of secured debt as
well as any additional unsecured debt.
Chapter 5 Fixed– income Security
Subordinated debentures
Subordinated debentures are junior to unsubordinated
debentures,meaning that in the event of bankruptcy,
junior claims are to be considered only after senior
claims have been fully satisfied.
Other types of bonds
Income bonds are more like preferred stock(described
in a later section) than bonds,Payment of interest in
full and on schedule is not absolutely required,and
failure to do so need not send the corporation into
bankruptcy,This type of bond has rarely been used,
expect in reorganizations of bankrupt railroads.
Chapter 5 Fixed– income Security
Guaranteed bonds are issued by one corporation
but backed in some way by another,such as by
a parent firm.
Participating bonds require stated interest
payments and provide additional amounts if
earnings exceed some stated level,
Voting bonds unlike regular bonds,given the
holders some voice in management,
Serial corporate bonds
Convertible bonds,at the holder’s option,may be
exchanged for other securities,often common
stock.
Exchangeable bonds
Chapter 5 Fixed– income Security
Call provisions
Management would like to have the right to pay off
the corporation’s bonds at par at any time prior to
maturity,This would provide management with
flexibility,as debt could be reduced or its maturity
altered via refunding,Most important,expensive
high—coupon debt that was issued during a time
of high interest rates could be replaced with
cheaper low—coupon debt if rates decline.
Despite the cost of obtaining this sort of flexibility,
many corporations include call provisions in their
bond indentures that give the corporation the
Chapter 5 Fixed– income Security
option to call some or all of the bonds from their
holders at stated prices during specified periods
prior to maturity,
Accordingly,some recently corporate issues have
given the investor the option of forcing the issuer
to call the security.
The indenture usually gives investors tow kinds of
call protection,First of all,during the first few
years after being issued,a bond may not be
callable,Secondly,a call premium may be
specified in the call provision,
Chapter 5 Fixed– income Security
Such a premium indicates that if the issue is called,
the issuer must pay the bondholders a call price
that is a stated amount above par.
Sinking funds
A bond indenture will often required the issuing
corporation to make annual payments into a
sinking funds,The idea is to pay part of the
principal of the debt(as well as the interest) each
year,thereby reducing the amount outstanding at
maturity.
Sinking funds operate by having the corporation
transmit cash to the trustee or itself,who can then
purchase bonds in the open market.
Chapter 5 Fixed– income Security
Private placements
The direct sale of a newly issued security to a small
number of large institutional investors.
Bonds intended for eventual public sale are usually
issued in denominations of $1000 each,
Bankruptcy
Foreign bonds
Eurobonds
The term eurobond is loosely applied to bonds that
are offered outside the country of the borrower and
outside the country in whose currency the securities
are denominated,
Chapter 5 Fixed– income Security
Preferred stock
Preferred stock is a hybrid form of security that has
characteristics of both common stocks and bonds.
In some respects,preferred stock is like a perpetual
bond,A given dollar amount is to be paid each
year by the issuer to the investor,This amount
may be stated as a percent of the stock’s par
value.
Because the security is a ―stock‖,such ―stated‖
payments are called dividends instead of interest
and hence do not qualify as a tax—deductible
expense for the issuing corporation,
Chapter 5 Fixed– income Security
Adjustable rate preferred stock (ARPS)
ARPS is a newly innovation form of preferred stock,
where the dividend is reset periodically in terms of
a applicable rate,
Related to ARPS are the Dutch auction rate
preferred stocks,where the dividend is reset
periodically at a level determined by bidding from
current and potential owners,
Preferred stock generally receives preferential
treatment when it comes to dividends,Specified
payments must be made on the preferred stock
before any dividends may be paid to common stock
holders.
Chapter 5 Fixed– income Security
Cumulative preferred stocks
Failure to pay a preferred dividend in full dose
not constitute default,but unpaid dividends are
usually cumulative,This means that all
previously unpaid preferred stock dividends
must be paid before any dividends may be paid
on the common stocks.
No indenture is provided with a preferred stock issue,
Various provisions protecting the preferred
stockholders against potentially harmful actions
may be written into the corporation charter,
Chapter 5 Fixed– income Security
Although preferred stockholders typically do not
have voting rights,there may be another provision
that gives them voting rights when the corporation
is in arrears on its preferred dividends.
Many preferred stock are callable at a stated
redemption price,
Participating preferred stock entitles the holder
to receive extra dividends when earnings permits.
Convertible preferred stock at the option of the
holder may be converted into another security
such as common stocks on stated terms.
Chapter 5 Fixed– income Security
Likely bonds holders,when in the event of a
dissolution of the corporation,preferred stock
often receives preferential treatment as to assets
after bondholder but before common stockholder,
