Chapter 4
Overview of Security Types
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Copyright © 2012 McGraw-Hill Ryerson
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Learning Objectives
Price quotes for all types of investments are easy to find,
but what do they mean? Learn the answers for:
1. Various types of interest-bearing assets.
2. Equity securities.
3. Futures contracts.
4. Option contracts.
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Copyright © 2012 McGraw-Hill Ryerson
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Security Types
Our goal in this chapter is to introduce the different types
of securities that investors routinely buy and sell in
financial markets around the world.
For each security type, we will examine:



Its distinguishing characteristics
Its potential gains and losses
How its prices are quoted in the financial press.
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Copyright © 2012 McGraw-Hill Ryerson
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Classifying Securities
Basic Types
Major Subtypes
Interest-bearing
Money market instruments
Fixed-income securities
Equities
Common stock
Preferred stock
Derivatives
Futures
Options
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Interest Bearing Assets
Money market instruments are short-term debt obligations of large
corporations and governments.
 These securities promise to make one future payment.
 When they are issued, their lives are less than one year.
Fixed-income securities are longer-term debt obligations of
corporations and governments.
 These securities promise to make fixed payments according to a preset schedule.
 When they are issued, their lives exceed one year.
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Money Market Instruments
Examples: U.S. Treasury bills (T-bills), bank certificates of deposit (CDs),
corporate and municipal money market instruments.
Potential gains/losses: A known future payment, except when the
borrower defaults (i.e., does not pay).
Price quotations: Usually, the instruments are sold on a discount basis,
and only the interest rates are quoted.
Therefore, investors must be able to calculate prices
from the quoted rates.
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Fixed Income Securities
Examples: Treasury notes, corporate bonds, car loans, student loans.
Potential gains/losses:
 Fixed coupon payments and final payment at maturity, except when
the borrower defaults.
 Possibility of gain (loss) from fall (rise) in interest rates
 Depending on the debt issue, illiquidity can be a problem.
Illiquidity means that you might not be able to sell
securities quickly for their current market value.
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Quote Example: Fixed Income Securities
 Price Quotations from www.wsj.com—the online version of
The Wall Street Journal (some columns are self-explanatory):
You will receive 2.20% of the bond’s face
value each year in 2 semi-annual payments.
The price (per $100 face) of the
bond when it last traded.
The Yield to Maturity (YTM) of the bond.
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Equities
Common stock: Represents ownership in a corporation. A part owner
receives a pro rated share of whatever is left over after all obligations
have been met in the event of a liquidation.
Preferred stock: The dividend is usually fixed and must be paid before
any dividends for the common shareholders. In the event of a
liquidation, preferred shares have a particular face value.
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Common Stock
Examples: RIM shares, Microsoft shares, Tim Horton's shares, Dell
shares, etc.
Potential gains/losses:
 Many companies pay cash dividends to their shareholders.
However, neither the timing nor the amount of any dividend is
guaranteed.
 The stock value may rise or fall depending on the prospects for
the company and market-wide circumstances.
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Common Stock Price Quotes
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Common Stock Price Quotes Online at
http://finance.yahoo.com
First, enter symbol.
Resulting
Screen
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Preferred Stock
Information is a bit harder to find for preferred stock versus common
stock.
Example: Bank of America (BAC) preferred stock
Find all the BAC preferred stock issues via a Google search—one source is:
quantumonline.com.
 One issue has a ticker of: BAC-J (BAC-PJ is its symbol at Yahoo!)
Potential gains/losses:
 Dividends are “promised.” However, there is no legal
requirement that the dividends be paid, as long as no common
dividends are distributed.
 The stock value may rise or fall depending on the prospects for
the company and market-wide circumstances.
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Derivatives
Primary asset: Security originally sold by a business or government to
raise money.
Derivative asset: A financial asset that is derived from an existing
traded asset, rather than issued by a business or government to raise
capital. More generally, any financial asset that is not a primary asset.
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Derivatives
Futures contract: An agreement made today regarding the terms of a
trade that will take place later.
Option contract: An agreement that gives the owner the right, but not
the obligation, to buy or sell a specific asset at a specified price for a set
period of time.
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Futures Contracts
Examples: financial futures (i.e., TSX/S&P, S&P 500, T-bonds, foreign
currencies, and others), commodity futures (i.e., wheat, crude oil,
cattle, and others).
Potential gains/losses:
 At maturity, you gain if your contracted price is better than the
market price of the underlying asset, and vice versa.
 If you sell your contract before its maturity, you may gain or
lose depending on the market price for the contract.
 Note that enormous gains and losses are possible.
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Futures Contracts:
Online Price Quotes
Source: Markets Data Center at www.wsj.com.
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Futures Price Quotes Online
Source: www.cmegroup.com
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Options Contracts
 A call option gives the owner the right, but not the obligation, to buy
something, while a put option gives the owner the right, but not the
obligation, to sell something.
 The “something” can be an asset, a commodity, or an index.
 The price you pay today to buy an option is called the option premium.
 The specified price at which the underlying asset can be bought or sold
is called the strike price, or exercise price.
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Options Contracts
 An American option can be exercised anytime up to and including
the expiration date, while a European option can be exercised only on
the expiration date.
 Options differ from futures in two main ways:



Holders of call options have no obligation to buy the
underlying asset.
Holders of put options have no obligation to sell the
underlying asset.
To avoid this obligation, buyers of calls and puts must pay a
price today. Holders of futures contracts do not pay for the
contract today.
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Options Contracts
Potential gains and losses from call options:
Buyers:
 Profit when the market price minus the strike price is greater
than the option premium.
 Best case, theoretically unlimited profits.
 Worst case, the call buyer loses the entire premium.
Sellers:
 Profit when the market price minus the strike price is less than
the option premium.
 Best case, the call seller collects the entire premium.
 Worst case, theoretically unlimited losses.
Note that, for buyers, losses are limited,
but gains are not.
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Copyright © 2012 McGraw-Hill Ryerson
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Options Contracts
Potential gains and losses from put options:
Buyers:
 Profit when the strike price minus the market price is greater
than the option premium.
 Best case, market price (for the underlying) is zero.
 Worst case, the put buyer loses the entire premium.
Sellers:
 Profit when the strike price minus the market price is less than
the option premium.
 Best case, the put seller collects the entire premium.
 Worst case, market price (for the underlying) is zero.
Note that, for buyers and sellers,
gains and losses are limited.
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Copyright © 2012 McGraw-Hill Ryerson
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Options Contracts: Online Price
Quotes for Nike (NKE) Options
Source: www.finance.yahoo.com
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Investing in Stocks versus Options
Stocks:
 Suppose you have $10,000 for investments. Macron Technology is
selling at $50 per share.
 Number of shares bought = $10,000 / $50 = 200
 If Macron is selling for $55 per share 3 months later, gain = ($55 
200) - $10,000 = $1,000
 If Macron is selling for $45 per share 3 months later, gain = ($45 
200) - $10,000 = -$1,000
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Copyright © 2012 McGraw-Hill Ryerson
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Investing in Stocks versus Options
Options:
 A call option with a $50 strike price and 3 months to maturity is
also available at a premium of $4.
 Traded option contracts are on a bundle of 100 shares.
 One call contract costs $4  100 = $400, so number of contracts
bought = $10,000 / $400 = 25 (for 25  100 = 2,500 shares)
 If Macron is selling for $55 per share 3 months later, gain = {($55 –
$50)  2,500} - $10,000 = $2,500
 If Macron is selling for $45 per share 3 months later, loss = ($0 
2,500) – $10,000 = -$10,000
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Copyright © 2012 McGraw-Hill Ryerson
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Useful Internet Sites
www.m-x.ca (Montreal Exchange)
www.nasdbondinfo.com (current corporate bond prices)
www.investinginbonds.com (bond basics)
www.finra.com (learn more about TRACE)
www.fool.com (Are you a “Foolish investor”?)
www.stocktickercompany.com (reproduction stock tickers)
www.cmegroup.com (CME Group)
www.cboe.com (Chicago Board Options Exchange)
finance.yahoo.com (prices for option chains)
www.wsj.com (online version of The Wall Street Journal)
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Copyright © 2012 McGraw-Hill Ryerson
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Chapter Review
Classifying Securities
Interest-Bearing Assets
 Money Market Instruments
 Fixed-Income Securities
Equities
 Common Stock
 Preferred Stock
 Common and Preferred Stock Price Quotes
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Chapter Review
Derivatives
 Futures Contracts
 Futures Price Quotes
 Gains and Losses on Futures Contracts
Option Contracts
 Option Terminology
 Options versus Futures
 Option Price Quotes
 Gains and Losses on Option Contracts
 Investing in Stocks versus Options
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