Chapter 2

Asset Classes and Financial

Instruments

1
 Markets and Instruments
Money Market:includes short-term, marketable,
liquid, low risk debt securities (cash equivalents)
Debt Instruments
Derivatives
Capital Market: includes longer-term riskier securities
Fixed income capital markets (longer-term):
Treasury bonds & notes, Federal agency debts, Municipal bonds,
Corporate bonds, Mortgage-backed securities. Bonds
Equity markets
common stocks, preferred stocks
Derivatives
options, futures
2
 Money Market Instruments
Treasury bills
Certificates of deposit
Commercial Paper
Bankers Acceptances
Eurodollars
Repurchase Agreements (RPs) and Reverse RPs
Federal Funds

3
 Treasury Bills
The government raises money by selling bills to the
public. Investors buy the bills at a discount from the
stated maturity value.
most marketable; discount bond
maturities: 4, 13, 26, or 52-week bills
minimum denomination: common $10,000, min $100
interest (income): exempt from all state and local
taxes (not from federal tax)
T.B yields are quoted as the bank discount yield

4
 Treasury Bills
Sales are conducted by an auction where investors
can submit competitive or noncompetitive bids.
A competitive bid is an order for a given quantity of
bills at specified offered price. The order is filled only
if the bid is high enough relative to other bids to be
accepted.
A noncompetitive bid is an unconditional offer to
purchase bills at the average price of the successful
competitive bids. The Treasury ranks bids by offering
price and accepts bids in order of descending price until
the entire issue is absorbed by the competitive plus
noncompetitive bids.
5
 Bank Discount Yield
rBD = 10,000 - P x 360
10,000 n
where P = the bond price; n = the maturity in days; rBD =
the bank discount yield; $10,000 = par value.
To determine the T-bills true market price:
P = 10,000 x [ 1 - rBD x n/360 ]
Ex. T-bill sold at $9,500 with a maturity of a half year
(182 days):
rBD= (500/10,000) x (360/182) = 0.0989 (9.89%)
Effective annual yield: reay
( 1 + 500/9,500 )2 - 1 = 0.1080 (10.8%)
6
 Bond Equivalent Yield
Cant compare T-bill directly to bond:
360 vs 365 days
Return is figured on par vs. price paid
Adjust the bank discounted rate to make it
comparable.
The bond equivalent yield of the T-bill = APR (annual
percentage rate)
rBEY = (10,000 - P)/P x (365/n) = (500/9,500) x
(365/182) = 10.555% (< 10.8%)
note: rBD < rBEY < rEAY
7
 Certificate of Deposits (CD)
a time deposit with a bank
The bank pays interest and principal to the
depositor only at the end of the fixed term of the
CD.
denomination > $100,000 are usually negotiable
Can be sold to another investor if the owner needs to
cash in the CD before its maturity date.
insured up to $100,000 by the FDIC

8
 Commercial Paper (CP)
short-term, unsecured debt (promissory) notes issued
by large corporations with strong credit ratings
the biggest source of short-term funding for blue-chip
U.S. corporations
maturities up to 270 days. Bought by money market
funds, insurance companies, and any firm needing to
park extra cash
issued in multiples of $100,000,
Small investors can invest in commercial paper only indirect, via money
market mutual funds.
fairly
safe, the yield on CP depends on its time to
maturity and credit rating
9
 Bankers Acceptance
widely used in foreign trade (creditworthiness)
an order to a bank by a banks customer to pay a
sum of money at a future date
the bank endorses the order for payment
(accepted)
The acceptance may be traded in secondary
markets like any other claims on the bank.
Acceptances sell at a discount from the face value
of the payment order.

10
 Eurodollars (CD)
dollar-denominated deposits at foreign
banks or foreign branches of American
banks
Despite the tag Euro, these accounts need
not be in European banks.
the liability of a non-US branch of a bank:
less liquid, riskier than domestic CDs, offer
higher yields, no FDIC protection.

11
 Repos and Reverses
Repurchase agreement
Short-term, usually overnight borrowing
the dealer sells government securities to an
investor on an overnight basis, with an
agreement to buy back these securities the next
day at a slightly higher price.
A reverse repo is the mirror image of a repo.
Buy government securities from an investor and
agree to sell them back at a specified higher
price on a future date
12
 Brokers Call
Individualswho buy stocks on margin
borrow part of the funds to pay for the
stocks from their brokers.
The broker in turn may borrow the funds
from a bank, agreeing to repay the bank
immediately (on call) if the banks requesta
it.

13
 Federal Funds
member bank maintains reserve requirement in
federal funds
arise as a way for banks to transfer balances to
meet reserve requirement
F. F. rate: on very short-term loans among
Financial Institutions.
While the Fed Funds rate is not directly relevant to
investors, it is used as one of the barometers of the
money market and so is widely watched by them.

14
 LIBOR market (London
Interbank Offered Rate)
the rate at which large banks in London are
willing to lend $ among themselves
serves as a reference rate, in the European
money market

15
 Note
The risk premium over T-bills (i.e., the spread)
increases with economic uncertainty (or crisis)
because investors demand a greater premium on
debt subject to default risk.
The risk premium increases with economic crises
such as the energy price shocks associated with
the OECD disturbances, the failure of Penn Square
Bank, the stock crash in 1987, or the collapse of
Long Term Capital Management in 1998.

16
Figure 2.3 Spreads on CDs and
Treasury Bills

17
2-17
 MMMF and the Credit Crisis of 2008
Between 2005 and 2008 money market mutual funds
(MMMFs) grew by 88%.
MMMFs had their own crisis in 2008 when Lehman Brothers
filed for bankruptcy on September 15.
Some funds had invested heavily in Lehmans commercial
paper.
On Sept. 16, Reserve Primary fund broke the buck. What
does this mean?
A run on money market funds ensued.
The U.S. Treasury temporarily offered to insure all money
funds to stop the run
- (up to $3.4 trillion in these funds.)
18
2-18
Major Components of the Money Market

19
2-19
 Capital Market -
Fixed Income Instruments
Publicly Issued Instruments
require registration with the OSC with proper disclosure
involve considerable accounting, legal, and selling costs
US Treasury Bonds and Notes
Agency Issues (Fed Gov)
Municipal Bonds
Privately Issued Instruments
avoid regulation and costs
Corporate Bonds
Mortgage-Backed Securities

20
 Treasury Notes and Bonds
maturities: up to 10 years/ 10 - 30 years
The treasury announced inlate 2001 that it would no longer
issue bonds with maturity beyond 10 years.
denominations of $1,000 or more
coupon bonds: semiannual payments
T. bonds (not notes) may be callable, usually the last
five years of the bonds life.
Quoations
Coupon 43/4%=47.50/year
Bid 9112/32=91.375% of par value
Ask 9114/32 =91.4375% of par value
YTM=6.08% based on the ask price
21
 Inflation-Protected Treasury Bonds

Government issued bonds that are linked to an

index of the cost of living in order to provide their
citizens with an effective way to hedge inflation
risk.
TIPS ( Treasury Inflation Protected Securities)
Provide a constant stream of income in real dollars, and
the real interest rates you earn on these securities are
risk-free if you hold them to maturity.

22
 Federal Agency Debt
Home mortgages: FHLB, FNMA (Fannie Mae),
GNMA (Ginnie Mae), FHLMC (Freddie Mac)
FHLB: borrow money by issuing sec. and lend
this money to S&L to be lent in turn to individual
home buyers
Farm Credit related agencies (banks)
If the agencies are government owned, their debt
is fully free of default risk.
Implied backing by the government
In September 2008, Federal government took over

FNMA and FHLMC.

23
 International Bonds
Borrow money abroad
A Eurobond is a bond denominated in a currency
other than that of the country in which it is issued.
A dollar-denominated bond sold in London
A foreign bond is to issue bonds in foreign
countries but in the currency of the investors.
Yankee bonds
Samurai bonds

24
 Municipal Bonds
issued by state and local governments
general obligation bonds and revenue bonds (airport,
hospital, turnpike, etc)
GO bonds are backed by thefull faith and credi of the
issuer.
Revenue bonds are issued to finance particular projects
and are backed either by the revenue from the project or
by the municipal agency operating the project.
tax-exempt: interest income is exempt from federal
income tax; also is exempt from state & local
taxation in the issuing state; capital gains are not
exempt
25
 Equivalent Taxable Yield
the equivalent taxable yield of the municipal:
r = rm / (1 - t),
where rm = the rate on municipal bonds; t = the investors
marginal tax bracket; r = the total before-tax rate of return on
taxable bonds.

Ex. rm = 10%; t = 28% : then r = 13.89%,

if t = 36%: then r = 15.625%
the higher the bracket, the more valuable the tax-exempt
feature of municipals.

Ex. A municipal bond carries a coupon of 6% and is trading at

par; to a taxpayer in a 36% tax bracket, this bond would provide a
taxable equivalent yield of 9.375%.

26
Tax-Exempt Debt Outstanding
 Tax-Exempt Yield Table

The equivalent taxable yield is simply the tax-free rate,

rm, divided by (1 - t).
If r(1 - t ) > rm, then the taxable bond gives a higher return;
otherwise, the municipal bond is preferred.
Figure 2.6 Ratio of yields on tax exempt to
taxable bonds

29
2-29
 Corporate Bonds
semiannual coupons
defaultrisk
secured bonds: collateral
unsecured bonds (= debentures)
subordinated debentures
lower priority claim
callable bonds
The option to repurchase the bond from the holder at a
stipulated call price
convertible bonds

30
 Mortgages & Mortgage-backed securities
fixed rate/ adjustable rate
Ex, 2% above the current rate on one-year T-bills and might
be adjusted once a year.
Set a cap
securitization of mortgage loans: ex. A 10% coupon
GNMA
called pass-throughs
An ownership claim in a pool of mortgages
Rights to cash-inflows are sold
The mortgage originator continues to service the loan
Collateral:
Traditionally all mortgages were conforming mortgages but
since 2006, subprime mortgages were included in pools
31
 Mortgage-Backed Securities
Politicalencouragement to spur affordable
housing led to increase in subprime lending

Privatebanks began to purchase and sell

pools of subprime mortgages

Pool issuers assumed housing prices would

continue to rise, but they began to fall as far
back as 2006 with disastrous results for the
markets.
32
Figure 2.6 Mortgage-Backed Securities
Outstanding
The U.S. Bond Market

34
 Equity Securities
Common stock
ownership shares in a corporation
Residual claim
Limited liability
A corporation is controlled by a board of directors
elected by the shareholders. The board selects
managers who run the corporation on a day-to-day
basis. Managers have the authority to make business
decisions without the boards approval. The boards
mandate is to oversee management to ensure that it
acts in the best interests of shareholders.

35
 Equity Securities
Preferred stock
hybrid of equity & debt
like a bond, pays fixed dividends (perpetuity), but no voting
power
like a stock, the failure to pay dividends no bankruptcy;
dividends are cumulative (non-cumulative exists);
not tax-deductible expenses for the firm
corporations (not individuals) may exclude 70% of
dividends received from domestic corporations in the
computation of their taxable income (advantage over bonds)
a firm's preferred stock often sells at yields below its bond
may be callable (redeemable) by the issuing firm
may be convertible into common stock
36
 Depository Receipts
American Depository Receipts (ADRs) are
certificates traded in US markets that
represent ownership in shares of a foreign
company.
Each ADR may correspond to ownership of
a fraction of a foreign share, one share, or
several shares of the foreign corporations.
ADRs were created to make it easier for
foreign firms to satisfy US security
registration requirements.
37
 Capital Market - Equity
Capital Gains and Dividend Yields
You buy a share of stock for $50, hold it for one year,
collect a $1.00 dividend and sell the stock for $54. What
were your dividend yield, capital gain yield and total
return? (Ignore taxes)
Dividend yield: = Dividend / P buy
$1.00 / $50 = 2%
Capital gain yield: = (Psell Pbuy)/ Pbuy
($54 - $50) / $50 = 8%
Total return: = Dividend yield + Capital gain yield
2% + 8% = 10%

38
2-38
 Understand the Different Types and
Uses of Indices
Key Types of Indices:
Asset Class
Stocks: large cap, small cap., mid cap., international,
emerging markets, etc.
Bonds: long-term, short-term, corporate bonds,
government bonds, convertible bonds, etc.
Other Asset Classes: real estate, currencies,
Geographical
Global, Regional, Country, Industry
Investment Style
Growth, Blend, Value
39
 Geographical Indices
Global
Follows the performance of a set of assets from a specific set
of countries, i.e., MSCI World, MSCI AC Free. International
includes only countries outside the US
Regional
Follows the performance of a set of assets from a specific
region of the world , i.e., MSCI EAFE, DJ Asia
Country
Follows the performance of a specific set of assets from a
specific country , i.e., S&P 500, Russell 5000, Dow Jones
Industry
Follows the performance of a set of assets from a specific
industry, whether global, regional, or country. 40
 Investment Style Indices
Growth
These indices follow a portfolio of stocks that
are expected to achieve accelerated growth,
whether because of increased earnings,
dominant market position, or other factors
Value
This indices follow on stocks that are currently
undervalued by the market. It is generally
determined by using price-book or price-
earnings ratios, discounted cash flow models,
or other means.
41
 Uses of Indices
Uses:
1. Tracks average returns for a specific asset class
2. Used to compare performance of mutual fund
managers in similar asset classes
3. Use as a base on which derivatives are structured
Key Questions in Constructing or using an Index:
Is it representative of the performance or assets desired?
Is it broad or narrow, i.e. how many securities in the
index?
How is it constructed, i.e. price, market cap, equal, or
float weighted?
42
 How they are Indexes
Constructed
How are stocks weighted?
Price weighted: DJIA, Nikkei
Market-value weighted: S&P 500, NASDAQ,
some MSCI country/regional indices
Equally weighted: Value Line Index, MSCI
Equal Weighted Indices

43
 How They Are Used:
The Importance of Understanding Indices
Indices are the standard from which an analyst or
portfolio manager is judged
Get to know your standard in detailyour career
(and bonus) depends on it!
How is it weighted?
How often are the constituents changed?

Which are the biggest companies in the index?

What strategies can help you to beat the index?

If you dont know what is in your index and how

it is calculated, how can you ever expect to beat it
(and hence advance in your job)?
Knowledge is power! 44
 Stock Market Indexes
Dow Jones Averages
DJIA: 30 large blue chip corporations since 1896
1896: 12 stocks; 1916: 20 stocks; 1928: 30 stocks
price-weighted average
DJIAt = P/30 : simple average
1 of prices
the % in the DJIA measures the return on a portfolio
that invests one share in each of the 30 stocks in the
index 1 30
Pit
DJIAt = Div i 1
the divisor : adjusted for stock splits & replacements
the only company remaining from the original 12 is
General Electric.
45
 What is a Blue Chip Stock?
Blue chip stocks is a general term that is loosely
applied to companies that are generally considered
to be leaders in their industry, are typically very
large in terms of market capitalization (the number
of shares outstanding multiplied by their current
market price), are considered to be mature (ie. they
are not necessarily rapidly growing in terms of sales
or stock price) and often pay a substantial and
consistent cash dividend.

46
 Dow Jones Averages
Companies included in the average are those selected
by Dow Jones & Company, publisher of the Wall Street
Journal
The composition of the average changes over time as
companies are dropped because of a merger or
bankruptcy has occurred, because a companys trading
activity is low, or because a company not in the average
becomes very prominent.
When a company is replaced by another company, the
average is readjusted in such a way as to provide
comparability with earlier values.
47
 Dow Jones Averages
The use of the DJIA as a performance
benchmark is sometimes criticized for the fact
that high-priced stocks have a greater impact on
the value of the index than low-price stocks.
That is, changes in the price of a $100 stock
like IBM will have a greater impact on the
value of the DJIA than changes in the price of a
$30 stock like Intel.

48
 Dow Jones Averages
Example: If firm B were to split two for one (*)
___________________________________________
firm initial final shares(mil) initial final
price(0) price(1) value value
A $20 $25 20 $400 $500
B $40 $30 5 $200 $150
B* $20 $15 10 $200 $150

DJIA0 = (20+40)/2=30; DJIA1 =(25+30)/2=27.5

After a split: (20 +20)/d = 30 ,
d* = 1.333 (new divisor)
After a split:
DJIA0 = (20 + 20)/d* = 40/1.333 = 30 (= DJIA0 w/o split)
DJIA1 = (25+ 15)/d* = 40/1.333 = 30 ( DJIA1 w/o split)
History:
10.03.05 0.12493117
7.14.05 0.12560864
6.13.05 0.13033708
11.15.04 0.13532775
6.21.04 0.13561241
49
 Dow Jones Averages
Example: If firm B were to split two for one (*)
___________________________________________
firm initial after shares(mil) final final
price split price shares
A $25 $25 200 $30 200
B $100
B* $50 $45 20 $45 20

DJIA0 = (25+100)/2=62.5;
After a split: (25 +50)/d = 62.5 ,
d* = 1.2 (new divisor)
DJIA1=(30+45)/1.2=62.5
If stock XYZ had not split 2 for 1, the level of the price-weighted index at
the close of trading on date 1 would have been
DJIA1=(30+90)/2=60
50
 Citicisms of the DJIA
Limited sample size
30 nonrandomly selected blue-chip stocks make up the
average
the stocks selected are the largest and most pretigious
companies in various industries.
The DJIA, therefore, probably reflects price movements
for large, mature, blue-chip firms rather than the typical
company listed on the NYSE
Several studies have pointed out that the DJIA has not
been as volatile as other market indexes and that the
long-run returns on the DJIA are not comparable to
other NYSE stock indexes.
51
 DJIA divisor
The current value of the Dow Divisor was
0.15571590501117 as of Sep 27, 2013.
Every $1 change in price in a stock within the
average, results in a 6.42 (1/0.15571590501117 )
change in the DJIA.

52
 Citicisms of the DJIA
Weighting Scheme
because the DJIA is price weighted, when
companies split their stock, their prices decline, and
therefore their weight in the DJIA is reduced - even
though they may be large and important.
Therefore, the weight scheme casues a downward
bias in the DJIA, because the stocks that have higher
growth rates will have higher prices, and because
such stocks tend to split, they will consistently lose
weight within the index.

53
 Dow Jones Averages
Dow Jones Averages: 30 industrials, 20 transportation, 15
utilities 65 composite
the DJIA: based on small number of firms ; not value-weighted
as of Nov. 1, 1999:
In: Microsoft Corp., Intel Corp., Home Depot Inc., and SBC
Communications inc.
Out: Chevron, Goodyear, Sears Roebuck, Union Carbide
as of April 1, 2004:
Out: AT&T Corp., Eastman Kodak Co., and International Paper,
In: Verizon Communications Inc., a company formed after the breakup of
the old AT&T, insurer American International Group Inc., and Pfizer Inc.,
the nation's biggest drugmaker.
recognize trends within the U.S. stock market, including the continued
growth of the financial and health care sectors,"

54
 Dow Jones Averages
3M, Alcoa, Allied Signal, American Express, AT&T, Bank
of America, Boeing, Caterpillar, Chevron, Travelers, Coca-
Cola, DuPont, Exxon, General Electric, Cisco Systems,
Hewlett-Packard, Home Depot, IBM, Intel, Johnson &
Johnson, Kraft FOODS, McDonald, Merck, Microsoft, JP
Morgan, Pfizer, Proctor& Gamble, SBC Communications,
United Technologies, Verizon Communications, Wal-Mart
Stores, Walt Disney.

55
 Replacement
On September 22, 2008, Kraft Foods replaced the
American International Group (AIG) in the index.
On June 8, 2009, General Motors and Citigroup were
replaced by The Travelers Companies and Cisco
Systems.
On September 24, 2012, United Health Group replaced
Kraft
On September 20, 2013, Goldman Sachs, Nike, and
Visa replaced Alcoa, Bank of America, and Hewlett-
Packard
56
 Replacement
On March 19, 2015, Apple replaced AT&T,
which had been a component of the DJIA
since November 1916.

57
 Standard & Poors Indexes
the S&P 500: improvement over the DJIA
a more broadly based index of 500 firms
a market-value-weighted index: unaffected by stock
splits
400 industrials, 20 transportation, 40 utilities, 40 financial
indexes
the S&P index funds provide a low-cost passive
investment strategy
S&P 500 Index = P it Q it / P it-1 Q it-1
= total mkt value today/ total mkt value on prev. day
81% of the mkt value of companies on the NYSE

58
 Value-Weighted Stock Indexes
Ifwe set VWI0 (date 0 index level) equal to
100, the closing level of the value-weighted
index at date 1, VWI1 , will be
N11P11 N 21P21
100
N10 P10 N 20 P20

which is equal to 115, giving a return for the

value-weighted index of 15%.

59
 Example of a Computation of a Value-
weighted index
Stock Share Price Number of Shares Market Value
March 1, 2006
A $10.00 1,000,000 $10,000,000
B 15.00 6,000,000 90,000,000
C 20.00 5,000,000 100,000,000
Total $200,000,000
Base Value Equal to an Index of 100
March 2, 2006
A $12.00 1,000,000 $12,000,000
B (2 for 1 split) 10.00 12,000,000 120,000,000
C (10% stock dividend)
20.00 5,500,000 110,000,000
Total $242,000,000
New Index Value = [Current MV] / [Base Value] Beginning Index Value
= [$242 M / $200 M] 100 = 121
60
 Value-Weighted Stock Indexes
In a value-weighted series, there is an automatic
adjustment for stock splits and other capital changes
(since the decreased price of the share is offset by an
equal and opposite effect of an increase in the number
of shares outstanding).
In a value-weighted index, the importance of
individual stocks in the sample depends on the market
value of the stocks. Therefore, a specified percentage
change in the value of a large company has a greater
impact than a comparable percentage change in a
small company.
61
 Value-weight Indexes
Price changes for the large market value
stocks in a value-weighted index will
dominate changes in the index over time.
This value-weighted effect was prevalent on
U.S. stock markets (NYSE, OTC) in 1998
when the market was being driven by large
growth stocks - that is, almost all of the gain
for the year was attributable to the largest 50
of the S&P 500 Index.

62
 Buy Market Indexes

To purchase shares in mutual funds that

hold shares in proportion to their
representation .
Index funds
Exchange-traded funds or ETF, which is a
portfolio of shares that can be bought or
sold as a unit, just as a single share would
be traded.
63
 Other market indexes
the NYSE Index: a mkt value-weighted composite
index of all NYSE listed stocks
the AMEX Index: also mkt value-weighted
the NASDAQ (National Assoc. Sec. Dealers
Automatic Quotations): mkt value-weighted
the Wilshire 5,000 Index: the mkt-value of all NYSE
& AMEX stocks plus actively traded OTC stocks:
called total mkt index
includes about 6,000 stocks
Russell2000: small stock ( mkt capitalization
below $1.5 bill) performance

64
 Equally Weighted Index
places equal weight on each return
corresponds to an implicit portfolio strategy that places
equal dollar value on each stock
Ex. Stocks A B C
return 10% -6% 15%
An equally weighted arithmetic avg: r A
rA = (0.10 - 0.06 + 0.15)/3 = 0.06333
An equally weighted geometric avg: r G
rG = [(1.10)(0.94)(1.15)] 1/3 - 1.0 = 0.0594
The Value Line Index: an equally weighted geometrical
avg of the performance of about 1,700 firms
65
 Construction of Indexes
How are stocks weighted?
Price weighted: DJIA, Nikkei
Market-value weighted: S&P 500, NASDAQ,
some MSCI country/regional indices
Equally weighted: Value Line Index, MSCI
Equal Weighted Indices
How returns are averaged?
Arithmetic (DJIA and S&P500)
Geometric (Value Line Index)
66
 Foreign Stock Mkt Indexes
the Nikkei 225: a price-weighted average of the largest
Tokyo Stock Exchange stocks
the Nikkei 300 is a value-weighted index
Topix: market value -weighted index
The Tokyo Stock Price Index('TOPIX') is a composite index
of all common stocks listed on the First Section of the Tokyo
Stock Exchange (TSE).
The index is basically a measure of the changes in aggregate
market value of TSE common stocks. The base for each of
the index is the aggregate market value of its component
stocks as of the close on January 4, 1968, the first trading
day of the year.
67
 Foreign Stock Mkt Indexes
the FTSE 100 (footsie)
a value-weighted index of 100 of the largest London
Stock Exchange corporations; published by Financial
Times of London
theDAX index is the premier German stock index
MSCI (Morgan Stanley Capital International) stock
indexes
computes over 50 country indexes and several regional
indexes; market-value weighted indexes of other non-US
stock markets
EAFE (Europe, Australia, Far East), the World Index

68
 Derivatives Markets

A derivative is a security that gets its value

from the values of another asset, such as
commodity prices, bond and stock prices, or
market index values
 Derivatives Markets

Options
Call: Right to buy underlying asset at the strike or
exercise price
Value of calls decreases as strike price increases
Put: Right to sell underlying asset at the strike or
exercise price
Value of puts increase with strike price
Value of both calls and puts increases with time
until expiration
 Derivatives Markets

Futures Contracts
An agreement made today regarding the
delivery of an asset (or in some cases, its cash
value) at a specified delivery or maturity date
for an agreed-upon price, called the futures
price, to be paid at contract maturity
Long position: Take delivery at maturity
Short position: Make delivery at maturity
 Comparison
Option Futures Contract
Right, but not obligation, Obliged to make or take
to buy or sell; option is delivery; long position
exercised only when it is must buy at the futures
profitable price, short position must
Options must be sell at futures price
purchased Futures contracts are
The premium is the price entered into without cost
of the option itself.