Asset classes and financial instruments

As mentioned in previous post, there are many different types of investments. They are traded on various markets and distinct natures of each type must be considered when you invest. Hence, investor needs to think about his/her investment goal/objective in order to make proper investments and wisely use their resources.

Major Classes of Financial Assets or Securities include,
Money market
Bond market
Equity markets
Indexes
Derivative markets

In this blog, I will solely focus on equity markets, covering basics of stock.
To briefly go over each market, let us take a look at the money market first.

Money Market Instruments include but are not limited to,

Treasury bills
Certificates of deposits
Commercial Paper
Bankers Acceptances
Eurodollars
Repurchase Agreements (RPs) and Reverse RPs
Brokers’ Calls
Federal Funds
LIBOR Market

Money market instruments are generally considered low risk; hence their returns are low accordingly. They provide liquidity to companies and can be good investment option for those who are risk-aversive.
Here's the chart illustrating rates on money market.

Generally, a bond is a promise to repay the principal along with interest (coupons) on a specified date (maturity).
Bond Market includes but are not limited to,

Treasury Notes and Bonds
Federal Agency Debt
International Bonds
Inflation-Protected Bonds
Municipal Bonds
Corporate Bonds
Mortgages and Mortgage-Backed Securities

Maturities for bonds:
Notes – maturities up to 10 years
Bonds – maturities in excess of 10 years
Par Value - $1,000
Quotes – percentage of par




The picture below shows the list of treasury issues.

Municipal bonds are the ones issued by state and local government. They can be classified into general obligation and revenue bonds Their maturities range up to 30 years. Interest income on municipal bonds is not subject to federal and sometimes state and local tax. To compare yields on taxable securities, a Taxable Equivalent Yield is constructed.

Corporate bonds are issued by private firms. Most likely, they pay semi-annual interest payments and are subject to larger default risk than government securities. Some of the options in corp bonds are callable and convertible. The chart below shows the investment grade bond list.

Mortgages and Mortgage-backed Securities are developed in the 1970s to help liquidity of financial institutions. Investors have proportional ownership of a pool or a specified obligation secured by a pool. The market has experienced very high rates of growth and has been a hot issue past few years during the financial crisis.







Equity Markets include,

Common stock, which is a residual claim and has limited liability.
Preferred stock, which has fixed dividends and priority over common stock.









Stocks are traded on the markets such as NYSE, AMEX and NASDAQ.
Stock market indexes represent the stocks in the market and show their movement as well as their returns.
There are several indexes worldwide such as Dow Jones Industrial Average (DJIA) and Nikkei average of Japan. They offer ways to compare performance. Several factors must be taken into account when constructing stock indexes. Some of the questions that must be answered are: Are the representative? Broad or narrow? How is it weighted?
 Stock indexes can be weighted in various ways. For instance, DJIA is price weighted whereas SP 500 and NASDAQ are market weighted. Let's look at the data below to compute price weighted average.

Using data from Table
    Initial value    =    $25 + $100 = $125
    Final value       =    $30 + $  90 = $120
    Percentage change in portfolio value =
    Initial index value = (25 + 100)/2 = 62.5
    Final index value = (30 + 90)/2 = 60

    Percentage change in index =
    -2.5/62.5 = -.04 = -4%

Using data from Table, ABC would have five times the weight given to XYZ.

Graph below shows the comparative performance of different market indexes.