M.

Com 4th
Semester

Q 4: Discuss in detail the major types of financial assets?

Financial Assets

Non-
Marketable Marketable
Direct Investing

Treasury Bills
Negotiable COD  Saving Deposits
Commercial Paper  Certificate of
Money Market
Repurchase Deposits
Chapter # 02: Investment Alternatives: Generic Principles All investors Must Know
Agreements  Money Market
 Banker’s deposit accounts
Acceptances  Saving Bonds

Fixed Income

 Treasuries
 Agencies
 Municipals
Capital Market  Corporates

Equities

 Preferred Stock
 Common Stock

Derivatives  Options
Market  Future Contracts
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Nonmarketable Financial Assets:

A distinctive characteristic of these assets is that they represent personal transaction between the
owner and the issuer. That is you as the owner of a savings account at a credit union must open
the account personally, and you must deal with the credit union in maintaining the account or in
closing it. In contrast marketable securities trade in impersonal markets--- the buyer (Seller) does
Chapter #not02: Investment
know Alternatives:
who the seller (Buyer) is, andGeneric
does not Principles
care. All investors Must Know
These are “safe” investments, occurring at (typically) insured financial institutions or issued by
the U.S government. At least some of these assets offer the ultimate in liquidity, which can be
defined as the ease with which an asset can be converted into cash. Thus, we know we can get all
of our money back from a savings account, or a money market deposit account, very quickly.

(i) Saving Accounts: Undoubtedly the best-known type of investment in Pakistan.

Saving accounts in insured institutions offer a high degree of safety on both principal
and interest earned on that principal. Liquidity is taken for granted and, together with
the safety feature, probably accounts substantially for the popularity of saving
accounts.
(ii) Non-negotiable certificate of deposit: Commercial banks and other institutions offer
a variety of saving certificates known as certificate of deposit. These certificates are
available for any amount and for various maturities, with high rates offered as
maturity increases.
(iii) Money Market deposit accounts: A money market account (MMA) or money
market deposit account (MMDA) is a financial account that pays interest based on
current interest rates in the money markets. Money market accounts typically have a
relatively high rate of interest.
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Money Market Securities:

Money markets include short-term, highly liquid, relatively low risk debt instruments sold by
governments, financial institutions and corporations to investors with temporary excess funds to
invest. This market is dominated by financial institutions, particularly banks, and governments.
The maturities of money market instruments range from one day to one year and are often less
than 90 days.

Treasury Bills: Treasury bills are zero coupon instruments issued by the Government of
Pakistan and sold through the State Bank of Pakistan via fortnightly auctions. T-Bills are issued
with maturities of 3-months, 6-months and 1 Year and are priced at a discount.
T-bills are issued through a competitive bidding process at a discount from par, which means
that rather than paying fixed interest payments like conventional bonds, the appreciation of the
bond provides the return to the holder.

 Negotiable certificate of deposit (CDs): A deposit instrument; a receipt issued by a

bank as an evidence of a deposit specifying the amount, the period of the deposit, and the
rate of the interest. There are several types of deposit certificates issued in domestic or
foreign currency; since certificate of deposits are negotiable instruments, these are freely
traded in secondary money market. The CODs that are not negotiable would be treated as
other deposits.
Chapter # 02: Investment Alternatives: Generic Principles All investors Must Know
 Commercial Paper: An unsecured, short-term debt instrument issued by a corporation,
typically for the financing of accounts receivable, inventories and meeting short-term
liabilities. Maturities on commercial paper rarely range any longer than 270 days. The
debt is usually issued at a discount, reflecting prevailing market interest rates.
Commercial paper is not usually backed by any form of collateral, so only firms with
high-quality debt ratings will easily find buyers without having to offer a substantial
discount (higher cost) for the debt issue. A major benefit of commercial paper is that
it does not need to be registered with the Securities and Exchange Commission (SEC) as
long as it matures before nine months (270 days), making it a very cost-effective
means of financing. The proceeds from this type of financing can only be used on current
assets (inventories) and are not allowed to be used on fixed assets, such as a new plant,
without SEC involvement.

 Repurchase Agreement (RPs). An agreement between a borrower and a lender

(typically institutions) to sell and repurchase U.S government securities. The borrower
initiates an RP by contracting to sell securities to a lender and agreeing to repurchase
these securities at a pre specified price on a stated date. The effective interest rate is given
by the difference between the two prices. The maturity of RPs is generally very short
from three to 14 days, and sometimes overnight. The minimum denomination is typically
$100,000.
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Semester

 Banker’s acceptance: A short-term credit instrument created by a nonfinancial firm and

guaranteed by a bank as to payment. Acceptances are traded at discounts from face value
in the secondary market on the basis of the credit quality of the guaranteeing banks.
These instruments have become a popular investment for money market funds. Also
called acceptance.

Capital Market Securities:

Traditionally, this has referred to the market for trading long-term debt instruments (those that
mature in more than one year). That is, the market where capital is raised. More recently, capital
markets is used in a more general context to refer to the market for stocks, bonds, derivatives and
other investments. Both the primary market for new issues and the secondary market for existing
securities are part of the capital market.

Fixed income securities: An investment that provides a return in the form of fixed periodic
payments and the eventual return of principal at maturity. Unlike a variable-income security,
where payments change based on some underlying measure such as short-term interest rates, the
payments of a fixed-income security are known in advance. 
An example of a fixed-income security would be a 5% fixed-rate government bond where a
$1,000 investment would result in an annual $50 payment until maturity when the investor
would receive the $1,000 back. Generally, these types of assets offer a lower return on
Chapter #investment
02: Investment Alternatives:
because they Generic Principles All investors Must Know
guarantee income.

 Bonds: A debt instrument issued for a period of more than one year with the purpose of
raising capital by borrowing. The Federal government, states, cities, corporations, and
many other types of institutions sell bonds. Generally, a bond is a promise to repay the
principal along with interest (coupons) on a specified date (maturity). At the time of
purchase, the bond buyer knows the future stream of cash flows to be received from
buying and holding the bond to maturity. Some bonds do not pay interest, but all bonds
require a repayment of principal. When an investor buys a bond, he/she becomes a
creditor of the issuer. However, the buyer does not gain any kind of ownership rights to
the issuer, unlike in the case of equities. On the hand, a bond holder has a greater claim
on an issuer's income than a shareholder in the case of financial distress (this is true for
all creditors).

A bond has clearly defined legal ramifications. Failure to pay either interest or principal on a
bond constitutes default for that obligation. Default, unless quickly remedied by payment or a
voluntary agreement with the creditor, leads to bankruptcy.

Bond Characteristics:
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1- Face Value/Par Value:

The face value (also known as the par value or principal) is the amount of money a holder
will get back once a bond matures. A newly issued bond usually sells at the par value.
Corporate bonds normally have a par value of $1,000, but this amount can be much
greater for government bonds.
What confuses many people is that the par value is not the price of the bond. A bond's
price fluctuates throughout its life in response to a number of variables (more on this
later). When a bond trades at a price above the face value, it is said to be selling at a
premium. When a bond sells below face value, it is said to be selling at a discount.
2- Coupon (The Interest Rate):
The coupon is the amount the bondholder will receive as interest payments. It's called a
"coupon" because sometimes there are physical coupons on the bond that you tear off and
redeem for interest. However, this was more common in the past. Nowadays, records are
more likely to be kept electronically.
As previously mentioned, most bonds pay interest every six months, but it's possible for
them to pay monthly, quarterly or annually. The coupon is expressed as a percentage of
the par value. If a bond pays a coupon of 10% and its par value is $1,000, then it'll pay
$100 of interest a year. A rate that stays as a fixed percentage of the par value like this is
a fixed-rate bond. Another possibility is an adjustable interest payment, known as a
floating-rate bond. In this case the interest rate is tied to market rates through an index,
Chapter # 02: Investment Alternatives:
such as the rate Generic Principles All investors Must Know
on Treasury bills.
3- Maturity:
The maturity date is the date in the future on which the investor's principal will be repaid.
Maturities can range from as little as one day to as long as 30 years (though terms of 100
years have been issued).
A bond that matures in one year is much more predictable and thus less risky than a bond
that matures in 20 years. Therefore, in general, the longer the time to maturity, the higher
the interest rate. Also, all things being equal, a longer term bond will fluctuate more than
a shorter term bond.
4- Issuer:
The issuer of a bond is a crucial factor to consider, as the issuer's stability is your main
assurance of getting paid back. For example, the U.S. government is far more secure than
any corporation. Its default risk (the chance of the debt not being paid back) is extremely
small - so small that U.S. government securities are known as risk-free assets. The reason
behind this is that a government will always be able to bring in future revenue through
taxation. A company, on the other hand, must continue to make profits, which is far from
guaranteed. This added risk means corporate bonds must offer a higher yield in order to
attract investors - this is the risk/return tradeoff in action.

Types of Bonds:
 M.Com 4th
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There are four major types of bonds based on the issuer involved;
(i) U.S Government
(ii) Federal Agency
(iii) Municipal
(iv) Corporate Bonds

Treasury Securities: The U.S government, in the course of financing its operations through
the treasury department, issues numerous notes and bonds with maturities greater than one
year. The U.S government is considered the safest credit risk because of its power to print
money.
An investor purchases these securities with the expectation of earning a steady stream of
interest payments with full assurance of receiving the par value of the bonds when they
mature.
Treasury Bonds & Notes: Traditionally have had maturities of 10 to 30 years, although a
bond can be issued with any maturity. The treasury also sells treasury notes, issued for a term
of 2, 5 or 10 years. Interest is paid every six months.
TIPS: A treasury security that is indexed to inflation in order to protect investors from the
negative effects of inflation. TIPS are considered an extremely low-risk investment since
they are backed by the U.S. government and since their par value rises with inflation, as
measured by the Consumer Price Index, while their interest rate remains fixed. Interest on
Chapter # 02: Investment
TIPS Alternatives:
is paid semiannually. TIPS canGeneric Principles
be purchased directlyAll
frominvestors Mustthrough
the government Know the
Treasury Direct system in $100 increments with a minimum investment of $100 and are
available with 5, 10 and 20 years maturities.

Federal Agency Securities:

Since the 1920s, the federal government has created various federal agencies designed to help
certain sectors of the economy, through either direct loans or guarantee private loans. These
credit agencies compete for funds in the marketplace by selling government agency securities.
(Securities issued by federal credit agencies fully (Fully guaranteed) or by government
sponsored agencies (not guaranteed).

Two types of government agencies have existed in the U.S financial system:
1- Federal agencies
2- Government sponsored enterprises
1- Federal agencies: are part of the federal government, and their securities are fully
guaranteed by the Treasury. The most important agency for investors is the
Government National Mortgage Association.( often referred to as “Ginnie Mae”).
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2- Government sponsored enterprises: Government sponsored enterprises (GSE) are

privately owned, publicly chartered entities. They were created by Congress to help
students, farmers and homeowners. They sell their own securities in the
marketplace in order to raise funds for their specific purposes. Although these
agencies have access to credit lines from the government, their securities are not
explicitly guaranteed by the government as to principal or interest. The six GSEs
that issue debentures are;
1- Federal Farm Credit System,
2- Federal Home Loan Bank System,
3- Federal National Mortgage Association (Fannie Mae),
4- Federal Home Loan Mortgage Corporation (Freddie Mac),
5- Federal Agricultural Mortgage Corporation (Farmer Mac)
6- Student Loan Marketing Association (Sallie Mae).

Municipal Securities: Securities issued by political entities other than the federal government
and its agencies. Such as States and Cities. A prime feature of these securities is that interest or
other investment earnings on them usually are excluded from gross income of the holder for
federal income tax purposes.  Issuers of municipal securities are exempt from most federal
securities laws.

Chapter #Two
02:basic
Investment Alternatives:
types of municipals Generic
are general Principles
obligation bonds, All investors
which Must
are backed by theKnow
“full faith
and credit of the issuer” and revenue bonds, which are repaid from the revenues generated by
the project they were sold to finance (e.g, a toll road or airport improvements).

Most Long-term municipals are sold as serial bonds, which means that a specified number of
original issue matures each year until the final maturity date. For example a 10 year serial issue
might have 10 percent of the issue maturing each year for the next years.

A majority of municipals sold are insured by one of the major municipal bond insurers. By
having the bonds insured, the issuers achieve a higher rating for the bond. And therefore a lower
interest cost. Investors trade some yield for protection.

The Taxable Equivalent Yield (TEY). The distinguishing feature of most municipals is their
exemption from federal taxes. Because of this feature, the stated interest rate on these bonds will
be lower than that on comparable, nonexempt bonds because, in effect, it is an after-tax rate. The
higher an investors tax bracket, the more attractive municipals become.
TEY shows the before-tax interest rate on a municipal bond that is equivalent to the stated (after-
tax) interest rate on the bond, given any marginal tax rate.

Taxable Equivalent Yield = Tax free yield

1-Marginal tax rate
 M.Com 4th
Semester

Example: An investor in the 28 percent marginal tax bracket who invests in a 5 % municipal
bond would have to receive 0.05/(1-0.28)= 6.94% from a comparable taxable bond to be as well
off.
Corporates: Most of the larger corporations issue corporate bonds to help finance their
operations.

Corporate Bonds: Corporate bonds are debt securities issued by private and public
corporations. Companies issue corporate bonds to raise money for a variety of purposes, such as
building a new plant, purchasing equipment, or growing the business.

When you buy a corporate bond, you lend money to the "issuer," the company that issued the
bond. In exchange, the company promises to return your money, also known as "principal," on a
specified maturity date. Until that date, the corporation usually pays you a stated rate of interest,
generally semiannually. While a corporate bond gives you an IOU from the company, you do not
have an ownership interest in the issuing corporation—unlike when you purchase the company's
stock.

Corporate bonds are senior securities. That is, they are senior to any preferred stock and to the
common stock of a corporation in terms of priority of payment and in case of bankruptcy and
liquidation. However, within the bond category itself there are various degrees of security.
Chapter # 02: Investment Alternatives: Generic Principles All investors Must Know
The most common type of unsecured bond is the debenture, a bond only backed by the issuer’s
overall financial soundness.

New Types of Corporate Bonds: in an attempt to make bonds more accessible to individuals,
high credit-quality firms have begun selling direct access notes (DANs). DANs are issued at
par ($1000) with fixed coupon rates, and maturities ranging from 9 months to 30 years.

Convertible Bonds: The holders of these bonds have the option to convert the bonds into
common stock whenever they choose. Convertible bonds are two securities simultaneously: a
fixed-income security paying a specified interest payment and a claim on the common stock.

Junk Bonds: Bonds that carry ratings of BB or lower, with correspondingly higher yield.

Callable Bonds: A bond that can be redeemed by the issuer prior to its maturity. Usually a
premium is paid to the bond owner when the bond is called.
The main cause of a call is a decline in interest rates. If interest rates have declined since a
company first issued the bonds, it will likely want to refinance this debt at a lower rate of
interest. In this case, company will call its current bonds and reissue them at a lower rate of
interest.
 M.Com 4th
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The Zero Coupon Bonds: A bond sold with no coupons at a discount and redeemed for face
value at maturity.

Equity Securities

Unlike fixed income securities, equity security represents an ownership interest in a corporation.
These securities provide a residual claim--- after payment of all obligations to fixed income
claims ---- on the income and assets of a corporation. There are two forms of equities

(i) Preferred Stock

(ii) Common Stock

Preferred Stock: Although technically an equity security, Preferred Stock is known as a hybrid
security, because it resembles both equity and fixed income instruments. As equity security
preferred stock has an infinite life and pays dividends. Preferred Stock resembles fixed income
securities in that the dividend is fixed in amount and known in advance, providing a stream of
income very similar to that of a bond.

Preferred stockholders are paid after the bondholders but before the common stockholder in
terms of priority of payment of income and in case of corporation are liquidated.

Cumulative Preferred Stock 

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must be paid off before any dividend payments are made to the common stockholders. 

Non- Cumulative Preferred Stock 

A type of preferred stock that does not pay the holder any unpaid or omitted dividends. If the
corporation chooses to not pay dividends in a given year, the investor does not have the right to
claim any of those forgone dividends in the future.
Convertible Preferred Stock:
Preferred stock that includes an option for the holder to convert the preferred shares into a fixed
number of common shares, usually any time after a predetermined date. 

Common Stock: Common stock represents the ownership interest of corporations, or the equity
of the stockholders, and we can use the term equity Securities interchangeably. Companies sell
common stock through public offerings, and it's traded among investors on the secondary
market. Those who hold the stock hope to earn dividends from their share of company profits. As
the residual claimants of the corporation, stockholders are entitled to income remaining after the
fixed-income claimants have been paid.
 M.Com 4th
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As owners, the holders of the common stock are entitled to elect the directors of the corporation
and vote on major issues. Each owner usually allowed to cast votes equal to the number of shares
owned for each director being elected in the annual meeting. Most stockholders vote by proxy,
meaning that the stockholder authorizes someone else (Typically Management) to vote his or her
shares.

Stockholders also have limited liability, meaning that investors cannot lose more than their initial
investment .The obvious risk with common stock is that the price may fall.

Characteristics of Common Stocks:

Dividends

 Common shareholders also have the right to receive dividends, if and when they are
authorized by the corporation's board of directors. Although dividends are not
guaranteed, and many corporations do not pay them, all holders of common stock receive
the same dividend amount per share when they are authorized. Although there is no fixed
schedule for the payment of dividends, most corporations pay them on a quarterly basis.
Dividends may be periodically increased, decreased or discontinued depending upon the
financial success of the corporation. Dividends are normally paid in cash, although they
may also be paid in additional shares of stock.
Chapter # 02: Investment Alternatives: Generic Principles All investors Must Know
Merger Consideration

 If and when a corporate merger is approved by shareholders, they have the right to
receive financial consideration for the shares they own. Typically they will receive a cash
payment for their shares, or in the case of an acquisition of the corporation by another
company, they may receive shares in the acquiring company in exchange for the shares
they currently own. Normally, shareholders must vote to approve a merger before they
receive any such consideration.

Dissolution and Liquidation

 In the event that a corporation is dissolved and/or liquidated, its common shareholders
will have final claim on its assets. It's important to note, however, that this claim is
secondary to the claims of creditors, bondholders and preferred stockholders. Once these
stakeholders have been paid, any amount remaining from the liquidation of corporate
assets will be distributed to the holders of its common shares.
 M.Com 4th
Semester

Price Volatility

 Investors in common stocks should be aware that they are one of the riskiest types of
investments. No return is guaranteed to the shareholder, and the price of common shares
may fluctuate greatly, much more so than the price of corporate bonds or preferred
stocks. Nevertheless, the common stock of a successful corporation tends to rise
significantly over time, and its shareholders are entitled to realize these gains at any time
through the sale of their stock.

Voting Rights

 Common stockholders normally have the right to vote on issues affecting the corporation,
with each share entitling the owner to one vote. Typical voting issues include the election
of directors, approval of mergers with other corporations and corporate takeovers,
changes to corporate bylaws, and other issues as specified in the corporate charter.
Voting is done at the corporation's annual meeting, but can also occur at special meetings
as determined by the corporation's directors.

Derivative Securities:

A derivative security is a financial instrument whose price is dependent on one or a number of

Chapter #underlying
02: Investment Alternatives:
financial assets. Generic
In itself, the Principles
derivative Allmore
security is no investors
than an Must Know
agreement
between two contracted parties to buy or sell an asset at a fixed price on or before a date of
expiration. The value of the security is dictated by the value of the underlying asset, which is
usually a stock, a commodity, a bond, currency, interest rates or markets indexes.

Warrant: A Corporate Created option to purchase a stated number of common shares at a

specified price within a specified period of time.

 Options: A financial derivative that represents a contract sold by one party (option

writer) to another party (option holder). The contract offers the buyer the right, but not
the obligation, to buy (call) or sell (put) a security or other financial asset at an agreed-
upon price (the strike price) during a certain period of time or on a specific date (exercise
date).

 Call options the right to buy a futures contract at a given price (strike price).

 Put option: the right to sell a futures contract at a given price (strike price).

Buyers of calls are betting that the price of the underlying common stock will rise, making the
call option more valuable. Put buyers are betting that the price of the price of underlying
common stock will, making the put option more valuable. Both put and call options are written
(created) by other investors who are betting the opposite of their respective purchasers. The
 M.Com 4th
Semester

Seller (writers) receives an option premium for selling each new contract while the buyer pays
this option premium.
Once the option is created and the writer receives the premium from the buyer, it can be traded
repeatedly in the secondary market.

Using Puts and Calls: Puts and calls allow both buyers and sellers to speculate on the short-term
movements of certain common stock. Buyers obtain an option on the common stock for a small,
known premium, which is the maximum that the buyer can lose. If the buyer is correct about the
price movements on the common, gins are magnified in relation to having bought or (sold short)
the common because a smaller investment is required. However the buyer has only a short time
in which to be correct. Writers (Sellers) earn the premium as income, based on their beliefs about
a stock. They win or lose, depending on whether their beliefs are correct or incorrect.

The Following four types of options trading.

1. Buying a Call Option.

2. Selling a Call Option (also sometimes called as writing a Call Option).
3. Buying a Put Option.
4. Selling a Put Option (also sometimes called as writing a Put Option).

Whether it is stock options or commodity options, the underlying concept is the same. So let us
start by understanding an example.
Chapter # 02: Investment Alternatives: Generic Principles All investors Must Know
Simple Call Option example - How call option works?.
Suppose you are interested in buying 100 shares of a company. For the sake of this example let
us say that the company is Coca Cola and the current price of its stock is $50. However instead
of just buying the shares from the market what you do is the following: You contact your friend
John and tell him "Hey John, I am thinking of buying 100 shares of Coca Cola from you at the
price of $52. However I want to decide whether to actually buy it or not at the end of this month.
Would that be OK?". Of course what you have in mind is the following.

1. If the stock price rises above $52, then you will buy the shares from John at $52 in which
case you will gain by simply buying from John at $52 and selling it in the market at the
price which is above $52. John will be at a loss in this situation.
2. If the stock price remains below $52 then you simply wont buy the shares from him.
After all, what you are asking John is the 'option' to buy those shares from him - you are
not making any commitment.

In order to make the above deal 'fair' from the viewpoint of John you agree to pay John $2 per
share, i.e. $200 in total. This is the (risk) premium or the money you are paying John for the
risk he is willing to take - risk of being at a loss if the price rises above $52. John will keep this
money irrespective of whether you exercise your option of going ahead with the deal or not. The
price of $52, at which you would like to buy (or rather would like to have the option to buy) the
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shares is called the strike price of this deal. Deals of this type have a name- they are called a
Call Option. John is selling (or writing) the call option to you for a price of $2 per share. You
are buying the call option. John, the seller of the call option has the obligation to sell his shares
even if the price rises above $52 in which case you would definitely buy it from him. You on the
other hand are the buyer of the call option and have no obligation- you simply have the option
to buy the shares.

Simple Put Option Example - How put option works?

Let us consider a situation where now John wants the option to sell you his 100 shares of Coca
Cola at $48. He agrees to pay you $2 per share in order to be able to have the 'option' to sell you
his 100 shares at the end of the month. Of course what he has in mind is that he will sell them to
you if the price falls below $48, in which case you will be at a loss by buying the shares from
him at a price above the market price and he will be relatively better off rather than selling the
shares in the market. The $2 he is willing to pay you is all yours to keep irrespective of whether
John exercises the option or not. It is the risk premium. In this case John is buying a Put Option
from you. You are writing or selling a Put Option to John. $48 is the strike price of the Put
Option. In this case, you the seller or writer of the Put Option have the obligation to buy the
shares at the strike price. John, the buyer of the Put Option has the option to sell the shares to
you. He has no obligation.

Difference between above option examples and 'real life options'

Chapter # 02: Investment Alternatives: Generic Principles All investors Must Know
The above examples illustrate the basic ideas underlying, writing a call, buying a Call, writing a
Put and selling a Put. In real life you sell (or write) and buy call & put options directly on the
stock exchange instead of 'informally dealing' with your friend. Here are some key points to
remember about real life options trading.

1. Options trading is directly or automatically carried through at the stock exchange, you do
not deal with any person 'personally'. The stock exchange acts as a 'guarantor' to make
sure the deal goes through.
2. Each Options contract for a particular stock has a specified LOT SIZE, decided by the
stock exchange.
3. The writers or sellers of Call and the Put option are the ones who are taking the risk and
hence have to pay 'margin' amount to the stock exchange as a form of guarantee. This is
just like the margin money you pay while buying or selling a futures contract and as
explained in the post on futures trading. The buyers of Call and Put options on the other
hand are not taking any risk. They do not pay any margin. They simply pay the Options
premium.

Examples of Situations where Options are traded

Why buy options rather than buying the underlying stock or commodity? there are several
situations where buying or writing an option can help. Here are some examples (but please bear
in mind, options trading is very dangerous and unless you know what you are doing you should
avoid it)
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1. If you speculate that the price of a stock is going to rise, you buy a call option. This is
merely speculative trading in case of options.
2. Last month, I had kept money aside to buy the stock which was selling for Rs. 55. I was
prepared to buy it for up to Rs. 60. However, there was a possibility that the price might
fall sharply. However, I did not just want to wait and see if the price falls, after all, what
if the price rises sharply? So what I did was to buy a call option for strike price Rs. 60
and wait for a month. If the price rises, I still get to buy the stock at Rs. 60 (+ a small
premium I paid to buy the option). If the price falls sharply during this month, I get to
buy the stock for even cheaper. I usually use this strategy which limits risk in situations
where I have some anticipation of market movements.
3. If you have a stock say whose current price is $50. You have decided to sell it if the price
rises above $52, if not then keep it. In this case you can profit by writing a Call option for
Strike price of $52. To know more about this situation and example, read covered call.
(note to beginners: writing options is even more dangerous than buying options).

Chapter # 02: Investment Alternatives: Generic Principles All investors Must Know

Strike Price Relationship to Current

Futures Price
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Futures Contracts:

A contractual agreement, generally made on the trading floor of a futures exchange, to buy or
sell a particular commodity or financial instrument at a pre-determined price in the future.
Futures contracts detail the quality and quantity of the underlying asset; they are standardized to
facilitate trading on a futures exchange. Some futures contracts may call for physical delivery of
the asset, while others are settled in cash.

Chapter # 02: Investment Alternatives: Generic Principles All investors Must Know