characteristics of derivative investments

 characteristics of derivative investments (e.g., options, futures).

Equity Options are the right to buy or sell common stock at a specific price for a specific period of time. There are two kinds of equity option instruments:

Warrants are options issued by a firm that allow the holder to buy the firm's common stock  from  the  firm  at  a  specific  price  within  a  given  period.  Warrants  do  not constitute ownership of the stock.

Puts and Calls:

o  Call options are the right to buy the common stock of a firm within a given period at a specific price (called the striking price). It is not issued by the firm but by another investor who is willing to assume the other side of the transaction.

o Put options are the right to sell a stock during a given period at a specific price.

They are useful to investors who expect a stock price to decline during the

specific period, or own the stock and want protection from a price decline.

o  Options are generally valid for a shorter time period than warrants. Call options are typically valid for less than a year, while warrants extend over five years.

Futures contracts provide for the delivery of an asset at a specified delivery date, with payment being made at the time of delivery. The current price of a futures contract is determined by investors' belief about the future price of the asset. If an investor expects the price of the asset to rise, she will buy a futures contract. If the investor expects the price to fall, she will sell a futures contract. Later when the price has dropped, she will buy a similar contract to cover her obligation.

Financial futures are futures contracts on financial instruments such as T-bills, T-bonds and Eurobonds.  They  allow  investors  to  protect  against  changes  in  interest  rates.  Certain currency futures allow investors to speculate on or to protect against changes in currency exchange rates. In addition, there are certain futures contracts on stock market series such as the S&P 500 or the Value Line Index. Differences between buying a futures contract and buying the asset itself:

Use of leverage: when buying a futures contract, the investor only puts up a small proportion of the contract value. Thus, a small change in the price of the underlying asset can lead to the significant change in the return on the investment.

Term of the investment: futures contracts typically expire in less than a year, while stocks can have infinite maturities.

the characteristics of various alternative investments (e.g., investment companies, real estate, low-liquidity investments).

Investment Companies

An investment company sells shares in it and uses the proceeds of this sale to acquire stocks, bonds or other investment instruments. It is also called mutual fund. The shares issued to the investors entitle them to a pro rata portion of the income generated by these assets.

Money market funds: they acquire high-quality, short-term investments such as T- bills, high-grade commercial paper and large CDs. The yields on the money market portfolio always surpass those on normal bank CDs, and you can always withdraw funds from your money market fund without penalty. They are also quite safe (although they are not insured, they typically limit their investments to high-quality, short-term investments).

Bond funds: they generally invest in various long-term government, corporate, or municipal bonds. They differ by type and quality of the bonds included in the portfolio as assessed by various rating services.

Common stock funds: they invest in common stocks to achieve stated investment objectives which can include aggressive growth, income, precious metal investments, and international stocks. They offer smaller investors the benefits of diversification and professional management.

Balanced funds: they invest in a combination of bonds and stocks of various sorts of depending on their stated objectives.

Index funds: they match the performance of a market index (e.g. S&P 500), and thus appeal to passive investors.

Exchange-traded  funds:  ETFs  are  traded  continuously,  while  mutual  funds

(particularly index funds) are only priced daily at the close of the market.

Real Estate can provide significant diversification benefits due to their low correlation with stocks and bonds.

Real Estate Investment Trusts (REITS): a real estate investment trust is similar to a stock or bond mutual fund, but the money is invested in property and buildings. Construction and development trusts lend money to builders. Mortgage trusts provide long-term financing for properties. Equity trusts own various income-producing properties.

Direct real estate investment: the most common type is the purchase of a home by an individual.

Raw land: purchase it now and plan to sell it later at a profit.

Land development: it typically involves buying raw land, dividing it into individual lots, and building houses on it.

Rental property: acquire apartment buildings or houses with low down payments, with the intention of deriving enough income from the rents to pay the expenses of the structure (including mortgage payments).

Low-Liquidity Investments

Financial institutions do not typically acquire them since they are considered to be fairly illiquid with high transaction costs and high price volatility. Typically there is no national market for low-liquid assets.

Antiques: many serious collectors enjoy substantial rates of return on them.

Art: investing in art requires substantial knowledge of art and the art world, a large amount of capital, patience and the ability to absorb high transaction costs.

Coins and stamps: Collecting coins and stamps is viewed by many people as a hobby, not an investment. The market for coins and stamps is more liquid than the market for art and antiques.

Diamonds: diamonds are highly illiquid. The grading process that determines their quality is quite subjective. They generate no positive cash flows during the holding period until they are sold, but incur insurance and storage costs. There are also appraisal costs before selling.