Equity Investments I
Reading 36. Market Organization and Structure
Learning Outcome Statements
b. describe classifications of assets and markets;
c. describe the major types of securities, currencies, contracts, commodities, and real assets that trade in organized markets, including their distinguishing characteristics and major subtypes;
CFA Curriculum, 2020, Volume 5
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Subject 2. Assets and Contracts
These have a contractually mandated payment schedule. Their investment contacts promise specific payments at predetermined times. Investors who acquire fixed-income securities are really lenders to the issuers. Specifically, you lend some amount of money (the principal) to the borrower. In return, the borrower promises to make periodic interest payments and to pay back the principal at the maturity of the loan.
Bonds, notes, bills, CDs, commercial paper, repo agreements, loan agreements, and mortgages are examples of fixed-income investments.
Preferred stock is classified as a fixed-income security because its yearly payment is stipulated as either a coupon (e.g., 5% of the face value) or a stated dollar amount. Although preferred dividends are not legally binding (as are the interest payments on a bond), they are considered practically binding because of the credit implications of a missed dividend.
Equities differ from fixed-income securities because their returns are not contractual. They represent residual ownership in companies after all claims-including any fixed-income liabilities of the company - have been satisfied.
Common stocks represent ownership of a firm. Owners of the common stock of a firm share in the company's successes and problems.
A warrant allows the holder to purchase a firm's common stock from the firm at a specified price for a given time period. It provides the firm with future common stock capital when the holder exercises the warrant.
Rather than directly buying an individual stock or bond, you may choose to acquire these investments indirectly by buying shares in an investment company that owns a portfolio of individual stocks, bonds, or a combination of the two. People invest in pooled investment vehicles to benefit from the investment management services of their managers. Examples of these pooled investments include money market funds, bond funds, stock funds, balanced funds, etc.
The currency market is a worldwide decentralized over-the-counter financial market for the trading of currencies. Market participants include commercial banks, central banks, retail brokers, etc.
Financial contracts include the following:
- Forward contracts allow buyers and sellers to arrange for future sales at pre-determined prices. They represent a commitment to buy or sell.
- Futures contracts are standardized forward contracts guaranteed by clearing houses. They are traded on a futures exchange.
- Swap contracts are derivative securities in the form of agreements between two counterparties to exchange cash flows over a period of time, depending on the values of specified market variables.
- Options are rights to buy or sell an underlying instrument at a specified price within a designated time period.
Commodities include agricultural products, energy, metals, etc. Commodities complement investment opportunities offered by shares of corporation that extensively use these raw materials in their production processes.
Real assets include tangible assets such as real estate, airplanes, machinery, or lumber stands. They are often illiquid and have high transaction costs compared to stocks and bonds.