Financial Instruments: Types, Characteristics and Valuation
Candidates must know the MiFID II categories of financial instruments: transferable securities (shares, bonds, depositary receipts), money-market instruments, units in collective investment schemes, options, futures, swaps, forwards and other derivatives, and emission allowances. Key characteristics to master: for equities, voting and dividend rights and residual claim; for bonds, coupon, maturity, issuer credit risk and yield; for derivatives, underlying, notional, leverage, margining and counterparty risk. Distinguish debt from equity, and listed from non-listed instruments.
Valuation concepts appear frequently. Bond price moves inversely to yield; clean price excludes accrued interest, dirty price includes it. Yield to maturity assumes reinvestment at the same rate. For shares, dividend discount and multiples (P/E, P/B) are standard. For derivatives, intrinsic value plus time value explains option premia, and the moneyness terms in-the-money, at-the-money and out-of-the-money must be secure. Trap: confusing a bond's coupon with its yield, or assuming a higher coupon always means higher yield when price differs. Another trap: treating a warrant or convertible as pure equity when it carries derivative features.
Rule of thumb: price and yield move in opposite directions; a bond trading above par has a yield below its coupon.
Worked example: a bond with a 5% coupon trades at 102. Its current yield is below 5% because the investor pays more than par for the same coupon stream; if held to maturity, yield to maturity is lower still once the premium is amortised.