Financial Instruments 26 октября 2002 Стратегии
Plan n n Evolution of the forms of business organization Stocks and bonds – Cash flow vs control rights – Hybrid instruments n Derivatives – Options, forwards, futures, and swaps n Typical investment strategies NES FF 2005/06 2
Forms of Business Organization Sole proprietorship n Partnership n Corporation Evaluate by n The life of the entity n The ability to raise capital n The owners' liability n FF 2005/06 NES 3
Modern Corporation n. Advantages – Limited liability • 1811: general act of incorporation in NY – Easy transfer of ownership – Unlimited life – Ability to raise large amounts of money NES FF 2005/06 4
Equity vs Debt n Shareholders – – n Control rights (e. g. , elect directors) Limited liability Residual claim on assets (after paying up liabilities) Dividends (fully taxable) Debtholders – – – Fixed contractual claim against the corporation No voting power unless the debt is not paid Interest on debt is tax-deductible FF 2005/06 NES 5
Modern Corporation n. Disadvantages – Start-up can be costly – Earnings subject to double taxation – The agency problem • Separation of control and ownership • The leverage effect of debt NES FF 2005/06 6
Securities n Characteristics – Contingent contractual claim – Marketability – Necessary conditions: record-keeping, legal infrastructure (contracting and enforcement) n Derivatives: second level – Payoff depends on the value of other (underlying) securities FF 2005/06 NES 7
Bond Characteristics n n Amount / date of issue, maturity, currency, par value Coupon payments – Frequency, floating vs fixed rate n Security (attachment to the property) – Debenture/note vs bond n Protective covenants – Restrictions on further indebtedness, max dividends n Seniority – Subordinated debt paid after senior debt NES FF 2005/06 8
Fixed Income Instruments n Money market: maturity below 1 year – Treasury / corporate bills • Zero-coupon / pure discount bonds – Repos (repurchase agreements) • Collateralized loan – Interbank rates • E. g. , LIBOR NES FF 2005/06 9
Fixed Income Instruments (2) n Capital market – Treasury notes and bonds • Considered risk-free – Federal agency and municipal securities • No explicit guarantee – Corporate bonds • Subject to default risk, may be callable and with collateral NES FF 2005/06 10
Options n Right to buy/sell at strike price in the future – Call / put – European / American – Long / short Asymmetric payoff n Driven by volatility of the underlying asset n Intrinsic value vs time value n NES FF 2005/06 11
Embedded Options n Common equity – Call on the value of the firm with strike equal to the face value of debt n Convertible bonds – Hybrid instrument – Mitigate the problem of excessive risk taking Executive options n Real options n NES FF 2005/06 12
Exotic Options Exchange option n Binary option n Asian option n Barrier option: n – Knock-in / knock-out – Call / put NES FF 2005/06 13
Interest Rate Options n Cap (on r with strike x): – Call on % n Floor: – Put on % n Collar of the borrower: – Long cap and short floor – Forward on % NES FF 2005/06 14
Preferred Stock n Preference over common stock in cash rights: – – n n in the payments of dividends in the assets in case of bankruptcy No voting rights, unless no dividends Is it really debt in disguise? – Fixed dividend: usually, cumulative – Stated liquidating value n Call provision: – Can be converted to common shares NES FF 2005/06 15
Forward n Obligation to buy/sell at pre-specified (delivery) price at certain time in the future – Long/short position – The forward price = delivery price that would make the contract worth exactly zero n n Symmetric payoff Low liquidity – Must be offset by the counter deal n Credit risk NES FF 2005/06 16
Futures n Standardized exchange-traded contract – Amount, quality, delivery date, place, and conditions of the settlement n Credit risk taken by the exchange – The exchange clearing-house is a counter-party – Collateral: the initial / maintenance margin – Daily marking to market n Open interest vs volume NES FF 2005/06 17
Swap n Interest rate swap – Exchange of fixed-rate and floating-rate interest payments for a fixed par value n Currency swap – Exchange of interest payments in different currencies n Motivation: comparative advantages NES FF 2005/06 18
Different Types of Swaps Currency swap n Step-up / amortizing n – Changing par n Extendable / puttable – Changing maturity n Equity swap – To avoid taxes n Swaption, credit swap, … FF 2005/06 NES 19
Major Derivative Instruments Stocks: options n Stock index: futures n Commodities: futures, forwards, options n Currency (FX): forwards, swaps, options n Interest rates: swaps, forwards, options n NES FF 2005/06 20
Indices n Aggregate picture of a particular market segment – Should be replicable by investors – Benchmark to evaluate portfolio performance n Weighting – Equal vs market cap – Free-float adjustment: exclude strategic stakes NES FF 2005/06 21
Indices (2) n Equity indices: – Small-cap vs large-cap – Value vs growth n Fixed income indices – Short-term vs long-term – High vs low credit rating NES FF 2005/06 22
Credit Derivatives n n Separate CR mgt from the underlying asset Types of insured credit risk: – Credit event, value of the underlying asset, recovery rate, maturity n Total return swap – Fixed or floating payments in exchange for the current income from the underlying asset n Credit default swap – Regular premium payments in exchange for a one-time premium in case of the credit event NES FF 2005/06 23
Role of Derivatives n To hedge risks – Make risk-offsetting bets n To speculate – Take a view on the future direction of the market n To lock in arbitrage profit – Long-short (self-financed) portfolio n To change the nature of liability/investment – Without a need to remove it n …at low cost ! NES FF 2005/06 24
Investment Strategies n n Naked forward Forward spread – Calendar / cross n n n Naked option Covered option Spread: options of one type – Bear / bull / butterfly / calendar n Combination: options of different type – Straddle / strip / strangle FF 2005/06 NES 25
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