FIN 310 Class Web Page, Fall '19
Instructor: Maggie Foley
Weekly SCHEDULE, LINKS, FILES and Questions
Coverage, HW, Supplements
WSJ Papers for Discussion in class and Videos
Daily earning announcement: http://www.zacks.com/earnings/earnings-calendar
IPO schedule: http://www.marketwatch.com/tools/ipo-calendar
Chapter 1 Introduction
Flow of funds describes the financial assets flowing from various sectors through financial intermediaries for the purpose of buying physical or financial assets.
*** Household, non-financial business, and our government
Financial institutions facilitate exchanges of funds and financial products.
*** Building blocks of a financial system. Passing and transforming funds and risks during transactions.
*** Buy and sell, receive and deliver, and create and underwrite financial products.
*** The transferring of funds and risk is thus created. Capital utilization for individual and for the whole economy is thus enhanced.
For class discussion:
1. What is the business model of each player in the above graph?
2. Which player is the most important one in the financial market?
3. Can anyone of them be removed from the market?
Chapter 1 - ppt
1. What are the six parts of the financial markets
· To pay for purchases and store wealth (fiat money, fiat currency)
· To transfer resources from savers to investors and to transfer risk to those best equipped to bear it.
· Buy and sell financial instruments
· Channel funds from savers to investors, thereby promoting economic efficiency
· Affect personal wealth and behavior of business firms. Example?
· Provide access to financial markets, collect information & provide services
· Financial Intermediary: Helps get funds from savers to investors
· Monitor financial Institutions and stabilize the economy
· To provide oversight for financial system.
2. What are the five core principals of finance
3. What is stock?
4. Why do we need stock exchanges?
· Guarantee and settlement
5. What is high frequency trading? pros and cons
6. What is flash crash? (refer to the two articles on the right)
From Wikipedia, the free encyclopedia
A flash crash is a very rapid, deep, and volatile fall in security prices occurring within an extremely short time period. A flash crash frequently stems from trades executed by black-box trading, combined with high-frequency trading, whose speed and interconnectedness can result in the loss and recovery of billions of dollars in a matter of minutes and seconds.
The Flash Crash
This type of event occurred on May 6, 2010. A $4.1 billion trade on the New York Stock Exchange (NYSE) resulted in a loss to the Dow Jones Industrial Average of over 1,000 points and then a rise to approximately previous value, all over about fifteen minutes. The mechanism causing the event has been heavily researched and is in dispute. On April 21, 2015, the U.S. Department of Justice laid "22 criminal counts, including fraud and market manipulation" against Navinder Singh Sarao, a trader. Among the charges included was the use of spoofing algorithms.
2017 Ethereum Flash Crash
On June 22, 2017, the price of Ethereum, the second-largest digital cryptocurrency, dropped from more than $300 to as low as $0.10 in minutes at GDAX exchange. Suspected for market manipulation or an account takeover at first, later investigation by GDAX claimed no indication of wrongdoing. The crash was triggered by a multimillion-dollar selling order which brought the price down, from $317.81 to $224.48, and caused the following flood of 800 stop-loss and margin funding liquidation orders, crashing the market.
British pound flash crash
On October 7, 2016, there was a flash crash in the value of sterling, which dropped more than 6% in two minutes against the US dollar. It was the pound's lowest level against the dollar since May 1985. The pound recovered much of its value in the next few minutes, but ended down on the day's trading, most likely due to market concerns about the impact of a "hard Brexit"—a more complete break with the European Union following Britain's 'Leave' referendum vote in June. It was initially speculated that the flash crash may have been due to a fat-finger trader error or an algorithm reacting to negative news articles about the British Government's European policy.
What Is High-Frequency Trading? Finance, Algorithms, Software, Strategies, Firms (2014) (Video, optional)
Flash Crash 2010 - VPRO documentary – 2011 (video, optional)
Homework of the 1st week (due with first mid term):
1. What is high frequency trading (HFT)? Shall SEC ban HFT?
2. So is HFT good or bad? Why or why not?
3. What is flash crash? How does it make investors so worried? How can HFT trigger flash crash?
4. What is a flash crash in Forex? What is mini-crash? What is witching hour?
5. Can regulators protect Forex from a flash crash?
Goldman Sachs says computerized trading may make next 'flash crash' worse
· Goldman Sachs is worried the increasing dominance of computerized trading may cause more volatility during market downturns.
· The firm says high-frequency trading machines may "withdraw liquidity" at the worst possible moment in the next financial crisis.
Goldman Sachs is cautioning its clients that computerized trading may exacerbate the volatility of the next big market sell-off.
"One theory that has been proposed for why market fragility could be higher today is that because HFTs [high-frequency trading] supply liquidity without taking into account fundamental information, they are forced to withdraw liquidity during periods of market stress to avoid being adversely selected," Charles Himmelberg, co-head of global markets research at Goldman, said in a report Tuesday. "In our view, this at least raises the risk that as machines have replaced people, and speed has replaced capital, the inability of the market's liquidity providers to process complex information may lead to surprisingly large drops in liquidity when the next crisis hits."
Himmelberg noted the higher level of computerized trading has not been truly "stress tested" during the bull market since the financial crisis. He said the increasing incidents of volatility in various markets such as the VIX spike on Feb. 5, the 10-year Treasury bond on Oct. 15, 2014, and the British pound on Oct. 6, 2016, may be precursors of a bigger one to come.
"The rising frequency of 'flash crashes' across many major markets may be an important early warning sign that something is not quite right with the current state of trading liquidity," he said. "These warning signs plus the rapid growth of high-frequency trading (HFT) and its near-total dominance in many of the largest and most widely traded markets prompt us to more carefully consider the possibility (not necessarily the probability) that the long expansion accompanied by relatively low market volatility may have helped disguise an under-appreciated rise in 'market fragility.'"
The strategist said computerized trading is generally not backed by large levels of capital, which could drive the "collapse" of liquidity if the machines suffer any big losses during a significant market downturn.
"Future flash crashes may not end well," he warned. "The quality of trading liquidity for even the biggest, most heavily-traded markets should not be taken for granted."
— With reporting by CNBC's Michael Bloom.
Bump in the Night: FX Flash Crashes Put Regulators on Alert
BY SAIKAT CHATTERJEE and Trevor Hunnicutt
LONDON/NEW YORK (Reuters) - The increasing frequency of flash crashes in the $5.1 trillion-a-day foreign exchange market has regulators scrambling for answers.
Sudden, violent and often quickly reversed price moves are now a regular occurrence in world currency markets -- often during the so-called 'witching hour', a period of thin trading between 5-6 pm in New York when currency dealers there have powered off and colleagues in Tokyo have yet to sign on.
Two big crashes this year separately pummeled the yen and the Swiss franc and, given the importance of currency pricing for trade, investment flows and the global economy, policymakers are concerned a major fracturing could threaten financial stability.
"The question is, is this a new normal, or is it a canary in the coalmine sort of thing?" said Fabio Natalucci, deputy director of the Monetary and Capital Markets Department at the International Monetary Fund (IMF).
"We have seen the frequency of these events increase so this may be pointing to a major liquidity stress event coming at some point in the future."
Natalucci said liquidity strains -- market lingo for an insufficient number of buy and sell orders -- were evident days ahead of a big crash and the IMF was creating a monitoring tool that might be able to predict when the next one was coming.
Reflecting official disquiet, flash crashes have been a regular topic of discussion this year at the Federal Reserve Bank of New York's FX market liaison committee, a forum for central bankers and market players.
Bankers and policymakers agree that an industry-wide switch to machine-trading in FX markets is behind the frequency and severity of the price moves, meaning that further crashes are likely.
"Our pessimistic view is that this technology is going to become an increasing part of the FX market and we need to step up our monitoring," a G10 central bank official said, declining to be named because he is not authorized to speak publicly.
Regulators aren't pressing the panic button yet. Natalucci said there was no evidence that flash crashes so far had raised funding costs for firms or households and it made sense to study the problem before "rushing into enacting any regulatory responses".
Mini-crashes already occur roughly every two weeks in the FX market according to a study by Pragma, a company which creates computer trading models. In these incidences, a currency's price will shift dramatically followed by a swift reversal, along with a sudden and significant widening of the spread between prices quoted to buy and sell it. The spread usually narrows after a few minutes.
Computer models known as algorithms, or algos, have largely replaced humans in currency trading, helping banks to cut costs and boost the speed at which deals are done.
The models are designed to execute trades smoothly by breaking down orders into small pieces and searching for platforms where liquidity is plentiful.
But problems arise when market conditions change, for instance, when trading volumes suddenly collapse or volatility spikes as has been the case during Britain's protracted attempt to extricate itself from the European Union. At such times, algos are often programmed to shut down.
Two senior central banking officials, speaking on condition of anonymity, said such "kill switches" drained liquidity.
And, because fragmented forex markets depend on algos for a constant stream of price quotes -- by one estimate there are 70-odd trading platforms -- a widespread shutdown causes volumes to nosedive, making the price moves more dramatic.
The first of this year's notable crashes came on January 3 when the yen spiked suddenly against the dollar after Tokyo markets closed. It jumped 8% within the space of seven minutes against the Australian dollar and 10% to the Turkish lira.
The second was on February 11 when the Swiss franc gyrated frantically, with an unexplained and brief jump against the euro and dollar.
A Reserve Bank of Australia (RBA) report noted that several flash episodes have been recorded during the witching hour. It was also during this illiquid period on October 7, 2016 that sterling collapsed 9% in early Asian trading, falling to around $1.14 from $1.26 within minutes.
The RBA's analysis of all these flash crashes concluded algorithmic trading strategies likely acted as "amplifiers".
(GRAPHIC: Japan Yen Flash crash Jan 3 - https://tmsnrt.rs/2WiSDWn)
Human traders would be able to spot an opportunity from the market turmoil -- buying a currency in free fall - which would help to defuse it. But these days there are far less of them around.
Upto 70% of all FX orders on platform EBS, one of two top venues for currency trading, now originate from algorithms. In 2004, all trading was undertaken by humans.
With banks under constant pressure to cut costs and post-financial-crisis rules making it ever more expensive to trade, there is no sign of firms hiring extra staff or deploying existing employees onto a graveyard shift.
Instead, some try to avoid trading when they know volumes will be light such as major holidays.
Machines, meanwhile, are expected to become even more dominant.
Pragma has just launched an algorithm to trade non-deliverable forwards, derivatives used to hedge exposure to illiquid currencies, especially in emerging markets, according to Curtis Pfeiffer, chief business officer at the firm.
Trading in illiquid, emerging market currencies was previously the mainstay of voice traders.
"FX trading in banks is a tough business because spot trading is so commoditized and revenues are squeezed," said John Marley, a senior currency consultant at Smart Currency Business.
"Moreover, banks have rolled back their proprietary trading desks due to the extra capital required and lower risk appetite."
(GRAPHIC: G10 FX traders - https://tmsnrt.rs/2Elpkvq)
Policymakers' ability to understand and affect currency moves are hampered by the freewheeling nature of the FX market, which is unregulated, private and decentralized.
The 'FX Global Code' was developed by central banks and private sector participants to promote a fair and open FX market but it is not legally binding.
In comparison to equity markets, where regulators have been able to introduce measures to try and tame wild price swings, policymakers in the FX space are still at the discussion stage.
Flash crashes were on the agenda of two recent meetings of the Foreign Exchange Committee, an industry group sponsored by the Federal Reserve Bank of New York, and a gathering of the Global Foreign Exchange Committee (GFXC) this month.
"It’s important for us to use this forum to understand flash events, their causes, and how the principles of the Global Code can be applied to promote a fair and efficient FX market," Simon Potter, executive vice president of the Federal Reserve Bank of New York and the chair of the GFXC, told Reuters.
Central banks could potentially intervene to smooth out significant and prolonged gyrations in currency markets but that would be controversial.
"The primary mandate for most central banks is price stability and the secondary mandate is financial stability," said Nikolay Markov, senior economist at Pictet Asset Management.
"As long as these intraday big moves do not impinge on financial stability or drain interbank liquidity, central banks will monitor these developments and are not supposed to react to intraday moves."
It could also be costly -- Britain's failed defense of sterling in 1992 cost it around 3.3 billion pounds according to Treasury calculations -- and potentially futile.
"I doubt that central banks can do much to prevent the occurrences of these flash crashes as previous incidents have been a result of a complete drying up of market liquidity, resulting in some big moves," said Neil Mellor, senior FX strategist at BNY Mellon in New York. "Unless those problems are addressed, we will continue to see such price swings."
(Editing by Sujata Rao and Carmel Crimmins)
Copyright 2019 Thomson Reuters.
Chapter 2 What is Money
Part I What is Money?
· There is no single "correct" measure of the money supply: instead, there are several measures, classified along a spectrum or continuum between narrow and broad monetary aggregates.
• Narrow measures include only the most liquid assets, the ones most easily used to spend (currency, checkable deposits). Broader measures add less liquid types of assets (certificates of deposit, etc.)
· M0: In some countries, such as the United Kingdom, M0 includes bank reserves, so M0 is referred to as the monetary base, or narrow money.
· MB: is referred to as the monetary base or total currency. This is the base from which other forms of money (like checking deposits, listed below) are created and is traditionally the most liquid measure of the money supply.
· M1: Bank reserves are not included in M1. (M1 and Components @ Fed St. Louise website)
· M2: Represents M1 and "close substitutes" for M1. M2 is a broader classification of money than M1. M2 is a key economic indicator used to forecast inflation. (M2 and components @ Fed St. Louise website)
· M3: M2 plus large and long-term deposits. Since 2006, M3 is no longer published by the US central bank. However, there are still estimates produced by various private institutions. (M3 and components at Fed St. Louise website)
Let’s watch this money supply video: Khan academy money supply M0, M1, M2 (video)
· What could happen if we increase money supply?
· What about reduce money supply?
· What are the possible ways to reduce money supply?
· Among M0, M1, M2, M3, which one is the correct measure of money?
· Why M2 is >> M0?
· Why does M2 increase much faster than M1? Does it has any impact on you?
For more information, please visit http://www.data360.org/report_slides.aspx?Print_Group_Id=168
Money Supply M2 in the United States increased to 14872.10 USD Billion in July from 14755.10 USD Billion in June of 2019. oney Supply M2 in the United States averaged 4121.70 USD Billion from 1959 until 2019, reaching an all time high of 14872.10 USD Billion in July of 2019 and a record low of 286.60 USD Billion in January of 1959.
M2 of other countries
Part II What is Fractional Banking System?
In a fractional reserve banking system, banks create money when they make loans.
Bank reserves have a multiplier effect on the money supply.
Example: You deposited $1,000 in a local bank
Summary: Template here FYI
Part III: Crypto currency
What is bitcoin? By Khan Academy (video) (optional)
Bitcoin futures (BTC) https://www.cmegroup.com/trading/bitcoin-futures.html
· Bitcoin futures (BTC) are live at CME.
· Now you can hedge Bitcoin exposure or harness its performance with a futures product developed by the leading and largest derivatives marketplace: CME Group, where the world comes to manage risk.
Homework of chapter 2 (due on 9/26)
3. Imagine that you deposited $5,000 in Bank A. Imagine that the fractional banking system is fully functioning. After five cycles, what is the amount that has been deposited and what is the total amount that has been lent out? Template here FYI
4. What is bitcoin? In your view, could bitcoin become a major global currency? Could governments ban or destroy bitcoin?
5. What are bitcoin futures? How can you use BTC to improve your portfolio’s performance?
Beyond Bitcoin bubble – New York Times (FYI)
The sequence of words is meaningless: a random array strung together by an algorithm let loose in an English dictionary. What makes them valuable is that they’ve been generated exclusively for me, by a software tool called MetaMask. In the lingo of cryptography, they’re known as my seed phrase. They might read like an incoherent stream of consciousness, but these words can be transformed into a key that unlocks a digital bank account, or even an online identity. It just takes a few more steps.
On the screen, I’m instructed to keep my seed phrase secure: Write it down, or keep it in a secure place on your computer. I scribble the 12 words onto a notepad, click a button and my seed phrase is transformed into a string of 64 seemingly patternless characters:
This is what’s called a “private key” in the world of cryptography: a way of proving identity, in the same, limited way that real-world keys attest to your identity when you unlock your front door. My seed phrase will generate that exact sequence of characters every time, but there’s no known way to reverse-engineer the original phrase from the key, which is why it is so important to keep the seed phrase in a safe location.
That private key number is then run through two additional transformations, creating a new string:
That string is my address on the Ethereum blockchain.
Ethereum belongs to the same family as the cryptocurrency Bitcoin, whose value has increased more than 1,000 percent in just the past year. Ethereum has its own currencies, most notably Ether, but the platform has a wider scope than just money. You can think of my Ethereum address as having elements of a bank account, an email address and a Social Security number. For now, it exists only on my computer as an inert string of nonsense, but the second I try to perform any kind of transaction — say, contributing to a crowdfunding campaign or voting in an online referendum — that address is broadcast out to an improvised worldwide network of computers that tries to verify the transaction. The results of that verification are then broadcast to the wider network again, where more machines enter into a kind of competition to perform complex mathematical calculations, the winner of which gets to record that transaction in the single, canonical record of every transaction ever made in the history of Ethereum. Because those transactions are registered in a sequence of “blocks” of data, that record is called the blockchain.
The whole exchange takes no more than a few minutes to complete. From my perspective, the experience barely differs from the usual routines of online life. But on a technical level, something miraculous is happening — something that would have been unimaginable just a decade ago. I’ve managed to complete a secure transaction without any of the traditional institutions that we rely on to establish trust. No intermediary brokered the deal; no social-media network captured the data from my transaction to better target its advertising; no credit bureau tracked the activity to build a portrait of my financial trustworthiness.
And the platform that makes all this possible? No one owns it. There are no venture investors backing Ethereum Inc., because there is no Ethereum Inc. As an organizational form, Ethereum is far closer to a democracy than a private corporation. No imperial chief executive calls the shots. You earn the privilege of helping to steer Ethereum’s ship of state by joining the community and doing the work. Like Bitcoin and most other blockchain platforms, Ethereum is more a swarm than a formal entity. Its borders are porous; its hierarchy is deliberately flattened.
Oh, one other thing: Some members of that swarm have already accumulated a paper net worth in the billions from their labors, as the value of one “coin” of Ether rose from $8 on Jan. 1, 2017, to $843 exactly one year later.
You may be inclined to dismiss these transformations. After all, Bitcoin and Ether’s runaway valuation looks like a case study in irrational exuberance. And why should you care about an arcane technical breakthrough that right now doesn’t feel all that different from signing in to a website to make a credit card payment?
‘The Bitcoin bubble may ultimately turn out to be a distraction from the true significance of the blockchain.’
But that dismissal would be shortsighted. If there’s one thing we’ve learned from the recent history of the internet, it’s that seemingly esoteric decisions about software architecture can unleash profound global forces once the technology moves into wider circulation. If the email standards adopted in the 1970s had included public-private key cryptography as a default setting, we might have avoided the cataclysmic email hacks that have afflicted everyone from Sony to John Podesta, and millions of ordinary consumers might be spared routinized identity theft. If Tim Berners-Lee, the inventor of the World Wide Web, had included a protocol for mapping our social identity in his original specs, we might not have Facebook.
The true believers behind blockchain platforms like Ethereum argue that a network of distributed trust is one of those advances in software architecture that will prove, in the long run, to have historic significance. That promise has helped fuel the huge jump in cryptocurrency valuations. But in a way, the Bitcoin bubble may ultimately turn out to be a distraction from the true significance of the blockchain. The real promise of these new technologies, many of their evangelists believe, lies not in displacing our currencies but in replacing much of what we now think of as the internet, while at the same time returning the online world to a more decentralized and egalitarian system. If you believe the evangelists, the blockchain is the future. But it is also a way of getting back to the internet’s roots.
Once the inspiration for utopian dreams of infinite libraries and global connectivity, the internet has seemingly become, over the past year, a universal scapegoat: the cause of almost every social ill that confronts us. Russian trolls destroy the democratic system with fake news on Facebook; hate speech flourishes on Twitter and Reddit; the vast fortunes of the geek elite worsen income equality. For many of us who participated in the early days of the web, the last few years have felt almost postlapsarian. The web had promised a new kind of egalitarian media, populated by small magazines, bloggers and self-organizing encyclopedias; the information titans that dominated mass culture in the 20th century would give way to a more decentralized system, defined by collaborative networks, not hierarchies and broadcast channels. The wider culture would come to mirror the peer-to-peer architecture of the internet itself. The web in those days was hardly a utopia — there were financial bubbles and spammers and a thousand other problems — but beneath those flaws, we assumed, there was an underlying story of progress.
Last year marked the point at which that narrative finally collapsed. The existence of internet skeptics is nothing new, of course; the difference now is that the critical voices increasingly belong to former enthusiasts. “We have to fix the internet,” Walter Isaacson, Steve Jobs’s biographer, wrote in an essay published a few weeks after Donald Trump was elected president. “After 40 years, it has begun to corrode, both itself and us.” The former Google strategist James Williams told The Guardian: “The dynamics of the attention economy are structurally set up to undermine the human will.” In a blog post, Brad Burnham, a managing partner at Union Square Ventures, a top New York venture-capital firm, bemoaned the collateral damage from the quasi monopolies of the digital age: “Publishers find themselves becoming commodity content suppliers in a sea of undifferentiated content in the Facebook news feed. Websites see their fortunes upended by small changes in Google’s search algorithms. And manufacturers watch helplessly as sales dwindle when Amazon decides to source products directly in China and redirect demand to their own products.” (Full disclosure: Burnham’s firm invested in a company I started in 2006; we have had no financial relationship since it sold in 2011.) Even Berners-Lee, the inventor of the web itself, wrote a blog post voicing his concerns that the advertising-based model of social media and search engines creates a climate where “misinformation, or ‘fake news,’ which is surprising, shocking or designed to appeal to our biases, can spread like wildfire.”
For most critics, the solution to these immense structural issues has been to propose either a new mindfulness about the dangers of these tools — turning off our smartphones, keeping kids off social media — or the strong arm of regulation and antitrust: making the tech giants subject to the same scrutiny as other industries that are vital to the public interest, like the railroads or telephone networks of an earlier age. Both those ideas are commendable: We probably should develop a new set of habits governing how we interact with social media, and it seems entirely sensible that companies as powerful as Google and Facebook should face the same regulatory scrutiny as, say, television networks. But those interventions are unlikely to fix the core problems that the online world confronts. After all, it was not just the antitrust division of the Department of Justice that challenged Microsoft’s monopoly power in the 1990s; it was also the emergence of new software and hardware — the web, open-source software and Apple products — that helped undermine Microsoft’s dominant position.
The blockchain evangelists behind platforms like Ethereum believe that a comparable array of advances in software, cryptography and distributed systems has the ability to tackle today’s digital problems: the corrosive incentives of online advertising; the quasi monopolies of Facebook, Google and Amazon; Russian misinformation campaigns. If they succeed, their creations may challenge the hegemony of the tech giants far more effectively than any antitrust regulation. They even claim to offer an alternative to the winner-take-all model of capitalism than has driven wealth inequality to heights not seen since the age of the robber barons.
That remedy is not yet visible in any product that would be intelligible to an ordinary tech consumer. The only blockchain project that has crossed over into mainstream recognition so far is Bitcoin, which is in the middle of a speculative bubble that makes the 1990s internet I.P.O. frenzy look like a neighborhood garage sale. And herein lies the cognitive dissonance that confronts anyone trying to make sense of the blockchain: the potential power of this would-be revolution is being actively undercut by the crowd it is attracting, a veritable goon squad of charlatans, false prophets and mercenaries. Not for the first time, technologists pursuing a vision of an open and decentralized network have found themselves surrounded by a wave of opportunists looking to make an overnight fortune. The question is whether, after the bubble has burst, the very real promise of the blockchain can endure.
To some students of modern technological history, the internet’s fall from grace follows an inevitable historical script. As Tim Wu argued in his 2010 book, “The Master Switch,” all the major information technologies of the 20th century adhered to a similar developmental pattern, starting out as the playthings of hobbyists and researchers motivated by curiosity and community, and ending up in the hands of multinational corporations fixated on maximizing shareholder value. Wu calls this pattern the Cycle, and on the surface at least, the internet has followed the Cycle with convincing fidelity. The internet began as a hodgepodge of government-funded academic research projects and side-hustle hobbies. But 20 years after the web first crested into the popular imagination, it has produced in Google, Facebook and Amazon — and indirectly, Apple — what may well be the most powerful and valuable corporations in the history of capitalism.
Blockchain advocates don’t accept the inevitability of the Cycle. The roots of the internet were in fact more radically open and decentralized than previous information technologies, they argue, and had we managed to stay true to those roots, it could have remained that way. The online world would not be dominated by a handful of information-age titans; our news platforms would be less vulnerable to manipulation and fraud; identity theft would be far less common; advertising dollars would be distributed across a wider range of media properties.
To understand why, it helps to think of the internet as two fundamentally different kinds of systems stacked on top of each other, like layers in an archaeological dig. One layer is composed of the software protocols that were developed in the 1970s and 1980s and hit critical mass, at least in terms of audience, in the 1990s. (A protocol is the software version of a lingua franca, a way that multiple computers agree to communicate with one another. There are protocols that govern the flow of the internet’s raw data, and protocols for sending email messages, and protocols that define the addresses of web pages.) And then above them, a second layer of web-based services — Facebook, Google, Amazon, Twitter — that largely came to power in the following decade.
The first layer — call it InternetOne — was founded on open protocols, which in turn were defined and maintained by academic researchers and international-standards bodies, owned by no one. In fact, that original openness continues to be all around us, in ways we probably don’t appreciate enough. Email is still based on the open protocols POP, SMTP and IMAP; websites are still served up using the open protocol HTTP; bits are still circulated via the original open protocols of the internet, TCP/IP. You don’t need to understand anything about how these software conventions work on a technical level to enjoy their benefits. The key characteristic they all share is that anyone can use them, free of charge. You don’t need to pay a licensing fee to some corporation that owns HTTP if you want to put up a web page; you don’t have to sell a part of your identity to advertisers if you want to send an email using SMTP. Along with Wikipedia, the open protocols of the internet constitute the most impressive example of commons-based production in human history.
To see how enormous but also invisible the benefits of such protocols have been, imagine that one of those key standards had not been developed: for instance, the open standard we use for defining our geographic location, GPS. Originally developed by the United States military, the Global Positioning System was first made available for civilian use during the Reagan administration. For about a decade, it was largely used by the aviation industry, until individual consumers began to use it in car navigation systems. And now we have smartphones that can pick up a signal from GPS satellites orbiting above us, and we use that extraordinary power to do everything from locating nearby restaurants to playing Pokémon Go to coordinating disaster-relief efforts.
But what if the military had kept GPS out of the public domain? Presumably, sometime in the 1990s, a market signal would have gone out to the innovators of Silicon Valley and other tech hubs, suggesting that consumers were interested in establishing their exact geographic coordinates so that those locations could be projected onto digital maps. There would have been a few years of furious competition among rival companies, who would toss their own proprietary satellites into orbit and advance their own unique protocols, but eventually the market would have settled on one dominant model, given all the efficiencies that result from a single, common way of verifying location. Call that imaginary firm GeoBook. Initially, the embrace of GeoBook would have been a leap forward for consumers and other companies trying to build location awareness into their hardware and software. But slowly, a darker narrative would have emerged: a single private corporation, tracking the movements of billions of people around the planet, building an advertising behemoth based on our shifting locations. Any start-up trying to build a geo-aware application would have been vulnerable to the whims of mighty GeoBook. Appropriately angry polemics would have been written denouncing the public menace of this Big Brother in the sky.
But none of that happened, for a simple reason. Geolocation, like the location of web pages and email addresses and domain names, is a problem we solved with an open protocol. And because it’s a problem we don’t have, we rarely think about how beautifully GPS does work and how many different applications have been built on its foundation.
The open, decentralized web turns out to be alive and well on the InternetOne layer. But since we settled on the World Wide Web in the mid-’90s, we’ve adopted very few new open-standard protocols. The biggest problems that technologists tackled after 1995 — many of which revolved around identity, community and payment mechanisms — were left to the private sector to solve. This is what led, in the early 2000s, to a powerful new layer of internet services, which we might call InternetTwo.
For all their brilliance, the inventors of the open protocols that shaped the internet failed to include some key elements that would later prove critical to the future of online culture. Perhaps most important, they did not create a secure open standard that established human identity on the network. Units of information could be defined — pages, links, messages — but people did not have their own protocol: no way to define and share your real name, your location, your interests or (perhaps most crucial) your relationships to other people online.
This turns out to have been a major oversight, because identity is the sort of problem that benefits from one universally recognized solution. It’s what Vitalik Buterin, a founder of Ethereum, describes as “base-layer” infrastructure: things like language, roads and postal services, platforms where commerce and competition are actually assisted by having an underlying layer in the public domain. Offline, we don’t have an open market for physical passports or Social Security numbers; we have a few reputable authorities — most of them backed by the power of the state — that we use to confirm to others that we are who we say we are. But online, the private sector swooped in to fill that vacuum, and because identity had that characteristic of being a universal problem, the market was heavily incentivized to settle on one common standard for defining yourself and the people you know.
The self-reinforcing feedback loops that economists call “increasing returns” or “network effects” kicked in, and after a period of experimentation in which we dabbled in social-media start-ups like Myspace and Friendster, the market settled on what is essentially a proprietary standard for establishing who you are and whom you know. That standard is Facebook. With more than two billion users, Facebook is far larger than the entire internet at the peak of the dot-com bubble in the late 1990s. And that user growth has made it the world’s sixth-most-valuable corporation, just 14 years after it was founded. Facebook is the ultimate embodiment of the chasm that divides InternetOne and InternetTwo economies. No private company owned the protocols that defined email or GPS or the open web. But one single corporation owns the data that define social identity for two billion people today — and one single person, Mark Zuckerberg, holds the majority of the voting power in that corporation.
If you see the rise of the centralized web as an inevitable turn of the Cycle, and the open-protocol idealism of the early web as a kind of adolescent false consciousness, then there’s less reason to fret about all the ways we’ve abandoned the vision of InternetOne. Either we’re living in a fallen state today and there’s no way to get back to Eden, or Eden itself was a kind of fantasy that was always going to be corrupted by concentrated power. In either case, there’s no point in trying to restore the architecture of InternetOne; our only hope is to use the power of the state to rein in these corporate giants, through regulation and antitrust action. It’s a variation of the old Audre Lorde maxim: “The master’s tools will never dismantle the master’s house.” You can’t fix the problems technology has created for us by throwing more technological solutions at it. You need forces outside the domain of software and servers to break up cartels with this much power.
But the thing about the master’s house, in this analogy, is that it’s a duplex. The upper floor has indeed been built with tools that cannot be used to dismantle it. But the open protocols beneath them still have the potential to build something better.
One of the most persuasive advocates of an open-protocol revival is Juan Benet, a Mexican-born programmer now living on a suburban side street in Palo Alto, Calif., in a three-bedroom rental that he shares with his girlfriend and another programmer, plus a rotating cast of guests, some of whom belong to Benet’s organization, Protocol Labs. On a warm day in September, Benet greeted me at his door wearing a black Protocol Labs hoodie. The interior of the space brought to mind the incubator/frat house of HBO’s “Silicon Valley,” its living room commandeered by an array of black computer monitors. In the entrance hallway, the words “Welcome to Rivendell” were scrawled out on a whiteboard, a nod to the Elven city from “Lord of the Rings.” “We call this house Rivendell,” Benet said sheepishly. “It’s not a very good Rivendell. It doesn’t have enough books, or waterfalls, or elves.”
Benet, who is 29, considers himself a child of the first peer-to-peer revolution that briefly flourished in the late 1990s and early 2000s, driven in large part by networks like BitTorrent that distributed media files, often illegally. That initial flowering was in many ways a logical outgrowth of the internet’s decentralized, open-protocol roots. The web had shown that you could publish documents reliably in a commons-based network. Services like BitTorrent or Skype took that logic to the next level, allowing ordinary users to add new functionality to the internet: creating a distributed library of (largely pirated) media, as with BitTorrent, or helping people make phone calls over the internet, as with Skype.
‘We’re not trying to replace the U.S. government. It’s not meant to be a real currency; it’s meant to be a pseudo-currency inside this world.’
Sitting in the living room/office at Rivendell, Benet told me that he thinks of the early 2000s, with the ascent of Skype and BitTorrent, as “the ‘summer’ of peer-to-peer” — its salad days. “But then peer-to-peer hit a wall, because people started to prefer centralized architectures,” he said. “And partly because the peer-to-peer business models were piracy-driven.” A graduate of Stanford’s computer-science program, Benet talks in a manner reminiscent of Elon Musk: As he speaks, his eyes dart across an empty space above your head, almost as though he’s reading an invisible teleprompter to find the words. He is passionate about the technology Protocol Labs is developing, but also keen to put it in a wider context. For Benet, the shift from distributed systems to more centralized approaches set in motion changes that few could have predicted. “The rules of the game, the rules that govern all of this technology, matter a lot,” he said. “The structure of what we build now will paint a very different picture of the way things will be five or 10 years in the future.” He continued: “It was clear to me then that peer-to-peer was this extraordinary thing. What was not clear to me then was how at risk it is. It was not clear to me that you had to take up the baton, that it’s now your turn to protect it.”
Protocol Labs is Benet’s attempt to take up that baton, and its first project is a radical overhaul of the internet’s file system, including the basic scheme we use to address the location of pages on the web. Benet calls his system IPFS, short for InterPlanetary File System. The current protocol — HTTP — pulls down web pages from a single location at a time and has no built-in mechanism for archiving the online pages. IPFS allows users to download a page simultaneously from multiple locations and includes what programmers call “historic versioning,” so that past iterations do not vanish from the historical record. To support the protocol, Benet is also creating a system called Filecoin that will allow users to effectively rent out unused hard-drive space. (Think of it as a sort of Airbnb for data.) “Right now there are tons of hard drives around the planet that are doing nothing, or close to nothing, to the point where their owners are just losing money,” Benet said. “So you can bring online a massive amount of supply, which will bring down the costs of storage.” But as its name suggests, Protocol Labs has an ambition that extends beyond these projects; Benet’s larger mission is to support many new open-source protocols in the years to come.
Why did the internet follow the path from open to closed? One part of the explanation lies in sins of omission: By the time a new generation of coders began to tackle the problems that InternetOne left unsolved, there were near-limitless sources of capital to invest in those efforts, so long as the coders kept their systems closed. The secret to the success of the open protocols of InternetOne is that they were developed in an age when most people didn’t care about online networks, so they were able to stealthily reach critical mass without having to contend with wealthy conglomerates and venture capitalists. By the mid-2000s, though, a promising new start-up like Facebook could attract millions of dollars in financing even before it became a household brand. And that private-sector money ensured that the company’s key software would remain closed, in order to capture as much value as possible for shareholders.
And yet — as the venture capitalist Chris Dixon points out — there was another factor, too, one that was more technical than financial in nature. “Let’s say you’re trying to build an open Twitter,” Dixon explained while sitting in a conference room at the New York offices of Andreessen Horowitz, where he is a general partner. “I’m @cdixon at Twitter. Where do you store that? You need a database.” A closed architecture like Facebook’s or Twitter’s puts all the information about its users — their handles, their likes and photos, the map of connections they have to other individuals on the network — into a private database that is maintained by the company. Whenever you look at your Facebook newsfeed, you are granted access to some infinitesimally small section of that database, seeing only the information that is relevant to you.
Running Facebook’s database is an unimaginably complex operation, relying on hundreds of thousands of servers scattered around the world, overseen by some of the most brilliant engineers on the planet. From Facebook’s point of view, they’re providing a valuable service to humanity: creating a common social graph for almost everyone on earth. The fact that they have to sell ads to pay the bills for that service — and the fact that the scale of their network gives them staggering power over the minds of two billion people around the world — is an unfortunate, but inevitable, price to pay for a shared social graph. And that trade-off did in fact make sense in the mid-2000s; creating a single database capable of tracking the interactions of hundreds of millions of people — much less two billion — was the kind of problem that could be tackled only by a single organization. But as Benet and his fellow blockchain evangelists are eager to prove, that might not be true anymore.
So how can you get meaningful adoption of base-layer protocols in an age when the big tech companies have already attracted billions of users and collectively sit on hundreds of billions of dollars in cash? If you happen to believe that the internet, in its current incarnation, is causing significant and growing harm to society, then this seemingly esoteric problem — the difficulty of getting people to adopt new open-source technology standards — turns out to have momentous consequences. If we can’t figure out a way to introduce new, rival base-layer infrastructure, then we’re stuck with the internet we have today. The best we can hope for is government interventions to scale back the power of Facebook or Google, or some kind of consumer revolt that encourages that marketplace to shift to less hegemonic online services, the digital equivalent of forswearing big agriculture for local farmers’ markets. Neither approach would upend the underlying dynamics of Internet Two.
Chapter 3 Financial Instruments, Financial Markets, and Financial Institutions
Part I: Examples and characteristics of financial instruments
Discussion: You have some extra bucks. What will you do with the money?
With extra bucks č Find a proper financial instruments č find a financial institution č trade in the market
Part II: Order types (supplement materials)
1. Why did the other seller reduce the asking price after she posted her selling order?
2. Why did she hide her purchasing orders of 20,000 shares?
Understanding Stock Orders that you can try
1. Market order: A market order instructs your broker to buy or sell the stock immediately at the prevailing price, whatever that may be.
2. Limit order: Limit orders instruct your broker to buy or sell a stock at a particular price. The purchase or sale will not happen unless you get your price.
For example, our example portfolio purchased shares of Wal-Mart for $70.35 per share. Now we plan to sell our WMT
shares after they realize a $10, or roughly 20%, increase. However, rather
than constantly checking the market several times in a single day, with the
intent of entering a market sell order once WMT reaches at least $80.35 per
share, we can submit a simple limit sell order to do that for us.
As you can see, the use of limit sell orders is very useful if you wish to sell a stock at a specific target price, but are unwilling or unable to regularly check intraday or daily closing prices of the stock. Also, an added advantage of using limit sell orders is that they remove the emotional component of making trading decisions. Too often, investors will be tempted to hold on to a winning stock even once it becomes overpriced. Submitting a limit sell order immediately after you buy the stock is a good time to avoid any emotional complications, allowing you to better maintain your strategy and realize superior long-term returns.
Similarly, limit buy orders are equally useful. You can enter a limit buy order with a certain limit price, which allows you to buy a set number of shares only if the stock's market price equal to, or lower than, the maximum limit price you entered. In our example portfolio we purchased WMT for $70.35/share with a market buy order. But perhaps we thought WMT was a bit overpriced at the time, so we could have used a limit buy order to purchase 100 shares only if WMT fell to $65.00/share or less. That way, we only buy at a price we believe is fair. If WMT does not fall to $65, the order will not be processed.
3. Stop loss order: A stop loss order gives your broker a price trigger that protects you from a big drop in a stock.
Essentially, a stop order is "dormant" until a stock's price falls to the specified "stop price". In other words, a stop order is an instruction to your brokerage to buy (or sell) a specified number of shares of a company when the prevailing market price is equal or higher than (or, in the case of a sell stop order, equal or lower than) the specified price that you submitted. In our example portfolio, we purchased shares of Google Inc (Nasdaq: GOOG) for $463.18 per share. Many investors use a sell stop order to limit their losses, meaning that they'll automatically sell if a stock goes down a certain percentage.
Entering a stop order is an efficient and cost-effective means of limiting losses by avoiding the agony of regularly checking your stock and deciding whether to hold or sell it. For instance, if a so-called growth stock has headed south, an investor may choose to hold, hoping the share price might rebound, but if it doesn't, losses can quickly mount.
4. Short selling:
As you can see, short selling follows the conventional investing principle of “buying low” and “selling high” but with one critical difference – the sequence of the buy and sell transactions. While the buy transaction precedes the sell transaction in conventional “long only” investing, in short selling, the sell transaction precedes the buy transaction.
When you short sell, you create a short position or a shortfall. A short position represents a binding obligation that must be closed or covered at some point. This “short covering” obligation gives rise to one of the biggest risks of short selling, as discussed later in this tutorial.
Short selling is also known as "shorting," "selling short" or "going short." To be short a security or asset implies that one is bearish on it and expects the price to decline. Short selling has also spawned some of the most colorful terms in the investment lexicon.
Short selling can be used for speculation or hedging. Speculators use short selling to capitalize on a potential decline in a specific security or the broad market. Hedgers use the strategy to protect gains or mitigate losses in a security or portfolio. Note that institutional investors and savvy individuals frequently engage in short selling strategies simultaneously for both speculation and hedging. Hedge funds are among the most active short sellers, and often use short positions in select stocks or sectors to hedge their long positions in other stocks.
Short sellers are often portrayed as cynical, hardened individuals who are bent on making profits by driving the companies that are their “short” targets to failure and bankruptcy. The reality, however, is that short sellers facilitate smooth functioning of the markets by providing liquidity, and also act as a restraining influence on investors who may be prone to chase overhyped stocks, especially during periods of irrational exuberance.
Short selling is viewed by many investors as an inordinately dangerous strategy, since the long-term trend of the equity market is generally upward and there is theoretically no upper limit to how high a stock can rise. But under the right circumstances, short selling can be a viable and profitable investment strategy for experienced traders and investors who have an adequate degree of risk tolerance and are familiar with the risks involved in shorting.
Let's say XYZ's current ask price is 53. You place an order to buy at a limit price of 50. If the price of the security falls to 50, your order may be executed. If you had placed a limit order to buy at 53 or above, your order would have been "marketable" and executed right away.
In Class Exercise part I
1. A trading order that immediately purchases stock at the prevailing price is called a:
a. stop-loss order
b. limit order.
c. market order.
(DEFINITION of 'Stop-Loss Order': An order placed with a broker to sell a security when it reaches a certain price. A stop-loss order is designed to limit an investor’s loss on a position in a security. Although most investors associate a stop-loss order only with a long position, it can also be used for a short position, in which case the security would be bought if it trades above a defined price. A stop-loss order takes the emotion out of trading decisions and can be especially handy when one is on vacation or cannot watch his/her position. Also known as a “stop order” or “stop-market order.”) video: http://www.investopedia.com/terms/s/stop-lossorder.asp )
a. stop-loss order.
b. fill-or-kill limit order.
c. market order.
d. open order.
(DEFINITION of 'Fill Or Kill - FOK': A type of time-in-force designation used in securities trading that instructs a brokerage to execute a transaction immediately and completely or not at all. This type of order is most likely to be used by active traders and is usually for a large quantity of stock. The order must be filled in its entirety or canceled (killed). The purpose of a fill or kill order is to ensure that a position is entered at a desired price.)
(Definition of ‘Open Order’: A type of order to buy or sell a security that remains in effect until it is either canceled by the customer, until it is executed or until it expires. Open orders commonly occur when investors place restrictions on their buy and sell transactions. A lack of liquidity in the market or for a particular security can also cause an order to remain open. )
a. stop-loss order.
b. limit order.
c. market order.
d. fill or kill order.
4. Limit orders:
a. specify a certain price at which a market order takes effect.
b. specify a particular price to be met or bettered.
c. are executed at the best price available.
d. are orders entered for a particular day.
5. A market order is an instruction to:
a) immediately buy a security at the current bid price.
b) buy if the market price at least reaches the specified price target.
c) sell at or above a specified price target.
d) none of these.
Part III: IPO, SEO, Primary Market and Secondary Market
For class discussion:
1. What is IPO? SEO? Who are the major participants?
2. Why do firms hire investment banks for IPO and SEO? Can they do the IPO and SEO by themselves?
2. What is the primary market? What is the secondary market? Who are the major participants in these markets?
3. Shall a company go public? What is your opinion?
This Week (http://www.marketwatch.com/tools/ipo-calendar)
• 3 Total
• 3 Total
In Class Exercise part II
1. The market for equities is predominantly a:
a. primary market.
b. market dominated by individual investors.
c. secondary market.
d. market dominated by foreign investors.
2. Primary markets:
a. involve the organized trading of outstanding securities on exchanges.
b. involve the organized trading of outstanding securities in the over-the-counter market.
c. involve the organized trading of outstanding securities on exchanges and over-the-counter markets.
d. are where new issues (IPOs) are sold by corporations to raise new capital.
SEC develops fund-like plan to give retail investors access to pre-IPO shares
The Securities and Exchange Commission is looking to clear a path for small investors to access the burgeoning market for private company stocks. The effort could involve new rulemaking that would allow for the creation of a hedge fund-like instrument that invests in pre-IPO shares structured for the average retail investor, the Fox Business Network has learned.
The SEC initiative is still in the discussion stages and its timing of any implementation is unclear. But the talks follow recent remarks made by SEC Chairman Jay Clayton, who said small investors should have access to buying pre-IPO shares – a market that is open only to large institutional investors and accredited individual investors who either have a net worth of $1 million or make $200,000 annually.
The market for buying and selling pre-IPO shares is indeed booming, which is why Clayton and SEC commissioners have taken up the matter. They are trying to determine if a vehicle could be created to open such securities to small investors. Last year, companies in the private market raised roughly $3 trillion while public companies raised $1.8 trillion.
Market participants point out the gains are often greater in the trading of pre-IPOs shares than some recent prominent initial public offerings, such as ride-share provider Uber, which has floundered in its public debut after racking up huge gains when Uber private shares traded in the pre-IPO market.
"The SEC is seriously considering approving a new investment vehicle for private shares," John Coffee, a Columbia law school professor who specializes in financial issues, said.
“The mechanics are unclear but the SEC can either ask Congress for legislation or adopt a rule that exempts its new vehicle from the Investment Company Act of 1940,” Coffee added.
An SEC spokesman declined comment.
The SEC’s talks center on passing a rule that would create a new investment vehicle that mirrors a hedge fund. But unlike hedge funds, it would be open to non-accredited investors, according to people with knowledge of the discussions. Small investors would gain access to the private market by going through this fund-like vehicle, which would be comprised of a diversified portfolio of pre-IPO companies in order to reduce investment risk.
But not all market participants believe the effort is a good idea. The SEC would demand additional disclosures from the companies themselves, thus making the companies less likely to issue private shares, much less public shares. The reason many companies are opting to remain in the private market for years is the less stringent disclosure requirement mandated by the SEC because investors are considered more sophisticated than so-called mom-and-pop retail purchasers of stock.
“Part of why private companies can enjoy accelerated growth is that they are free from the regulatory burden public companies face. In addition, they are more efficient because their management teams are not beholden to quarterly earnings and compensated based on a public share price,” said Omeed Malik, the founder and CEO of Farvahar Partners, a broker-dealer specializing in the private stock market.
“Allowing Main Street to invest in privately traded companies sounds nice but the road to hell is paved with good intentions,” Malik said in an interview on FBN’s Cavuto Coast to Coast. “Allowing retailer investors to participate in private placement is a noble sentiment … but there are significant ramifications,” he said in a subsequent interview.
Because the private markets have fewer regulations than public markets, some analysts fear retail investors could be putting themselves at greater risk without fully understanding the volatility of pre-IPO companies. While there may be opportunities in private markets, investors are not insulated from losses just because they get in on a company’s stock earlier.
Clayton has made serving the needs of small investors a centerpiece of his agenda as SEC chairman, and people close to the commission say he’s intent on opening the private market to small investors as part of that effort.
In a Sept. 9 speech at the Economic Club of New York meeting, Clayton said, “Twenty-five years ago, the public markets dominated the private markets in virtually every measure. Today, in many measures, the private markets outpace the public markets, including in aggregate size.”
1. Do you support this idea that the pre-IPO shares should be available to all investors. Is that possible?
Homework ( DUE with first midterm exam)
Check three stocks listed above in the IPO table.
Follow these stocks and report their performances one month after the IPO.
Summarize your findings.
(……continuing from the above)
The first hint of a meaningful challenge to the closed-protocol era arrived in 2008, not long after Zuckerberg opened the first international headquarters for his growing company. A mysterious programmer (or group of programmers) going by the name Satoshi Nakamoto circulated a paper on a cryptography mailing list. The paper was called “Bitcoin: A Peer-to-Peer Electronic Cash System,” and in it, Nakamoto outlined an ingenious system for a digital currency that did not require a centralized trusted authority to verify transactions. At the time, Facebook and Bitcoin seemed to belong to entirely different spheres — one was a booming venture-backed social-media start-up that let you share birthday greetings and connect with old friends, while the other was a byzantine scheme for cryptographic currency from an obscure email list. But 10 years later, the ideas that Nakamoto unleashed with that paper now pose the most significant challenge to the hegemony of InternetTwo giants like Facebook.
The paradox about Bitcoin is that it may well turn out to be a genuinely revolutionary breakthrough and at the same time a colossal failure as a currency. As I write, Bitcoin has increased in value by nearly 100,000 percent over the past five years, making a fortune for its early investors but also branding it as a spectacularly unstable payment mechanism. The process for creating new Bitcoins has also turned out to be a staggering energy drain.
History is replete with stories of new technologies whose initial applications end up having little to do with their eventual use. All the focus on Bitcoin as a payment system may similarly prove to be a distraction, a technological red herring. Nakamoto pitched Bitcoin as a “peer-to-peer electronic-cash system” in the initial manifesto, but at its heart, the innovation he (or she or they) was proposing had a more general structure, with two key features.
First, Bitcoin offered a kind of proof that you could create a secure database — the blockchain — scattered across hundreds or thousands of computers, with no single authority controlling and verifying the authenticity of the data.
Second, Nakamoto designed Bitcoin so that the work of maintaining that distributed ledger was itself rewarded with small, increasingly scarce Bitcoin payments. If you dedicated half your computer’s processing cycles to helping the Bitcoin network get its math right — and thus fend off the hackers and scam artists — you received a small sliver of the currency. Nakamoto designed the system so that Bitcoins would grow increasingly difficult to earn over time, ensuring a certain amount of scarcity in the system. If you helped Bitcoin keep that database secure in the early days, you would earn more Bitcoin than later arrivals. This process has come to be called “mining.”
For our purposes, forget everything else about the Bitcoin frenzy, and just keep these two things in mind: What Nakamoto ushered into the world was a way of agreeing on the contents of a database without anyone being “in charge” of the database, and a way of compensating people for helping make that database more valuable, without those people being on an official payroll or owning shares in a corporate entity. Together, those two ideas solved the distributed-database problem and the funding problem. Suddenly there was a way of supporting open protocols that wasn’t available during the infancy of Facebook and Twitter.
These two features have now been replicated in dozens of new systems inspired by Bitcoin. One of those systems is Ethereum, proposed in a white paper by Vitalik Buterin when he was just 19. Ethereum does have its currencies, but at its heart Ethereum was designed less to facilitate electronic payments than to allow people to run applications on top of the Ethereum blockchain. There are currently hundreds of Ethereum apps in development, ranging from prediction markets to Facebook clones to crowdfunding services. Almost all of them are in pre-alpha stage, not ready for consumer adoption. Despite the embryonic state of the applications, the Ether currency has seen its own miniature version of the Bitcoin bubble, most likely making Buterin an immense fortune.
These currencies can be used in clever ways. Juan Benet’s Filecoin system will rely on Ethereum technology and reward users and developers who adopt its IPFS protocol or help maintain the shared database it requires. Protocol Labs is creating its own cryptocurrency, also called Filecoin, and has plans to sell some of those coins on the open market in the coming months. (In the summer of 2017, the company raised $135 million in the first 60 minutes of what Benet calls a “presale” of the tokens to accredited investors.) Many cryptocurrencies are first made available to the public through a process known as an initial coin offering, or I.C.O.
The I.C.O. abbreviation is a deliberate echo of the initial public offering that so defined the first internet bubble in the 1990s. But there is a crucial difference between the two. Speculators can buy in during an I.C.O., but they are not buying an ownership stake in a private company and its proprietary software, the way they might in a traditional I.P.O. Afterward, the coins will continue to be created in exchange for labor — in the case of Filecoin, by anyone who helps maintain the Filecoin network. Developers who help refine the software can earn the coins, as can ordinary users who lend out spare hard-drive space to expand the network’s storage capacity. The Filecoin is a way of signaling that someone, somewhere, has added value to the network.
Advocates like Chris Dixon have started referring to the compensation side of the equation in terms of “tokens,” not coins, to emphasize that the technology here isn’t necessarily aiming to disrupt existing currency systems. “I like the metaphor of a token because it makes it very clear that it’s like an arcade,” he says. “You go to the arcade, and in the arcade you can use these tokens. But we’re not trying to replace the U.S. government. It’s not meant to be a real currency; it’s meant to be a pseudo-currency inside this world.” Dan Finlay, a creator of MetaMask, echoes Dixon’s argument. “To me, what’s interesting about this is that we get to program new value systems,” he says. “They don’t have to resemble money.”
Pseudo or not, the idea of an I.C.O. has already inspired a host of shady offerings, some of them endorsed by celebrities who would seem to be unlikely blockchain enthusiasts, like DJ Khaled, Paris Hilton and Floyd Mayweather. In a blog post published in October 2017, Fred Wilson, a founder of Union Square Ventures and an early advocate of the blockchain revolution, thundered against the spread of I.C.O.s. “I hate it,” Wilson wrote, adding that most I.C.O.s “are scams. And the celebrities and others who promote them on their social-media channels in an effort to enrich themselves are behaving badly and possibly violating securities laws.” Arguably the most striking thing about the surge of interest in I.C.O.s — and in existing currencies like Bitcoin or Ether — is how much financial speculation has already gravitated to platforms that have effectively zero adoption among ordinary consumers. At least during the internet bubble of late 1990s, ordinary people were buying books on Amazon or reading newspapers online; there was clear evidence that the web was going to become a mainstream platform. Today, the hype cycles are so accelerated that billions of dollars are chasing a technology that almost no one outside the cryptocommunity understands, much less uses.
Let’s say, for the sake of argument, that the hype is warranted, and blockchain platforms like Ethereum become a fundamental part of our digital infrastructure. How would a distributed ledger and a token economy somehow challenge one of the tech giants? One of Fred Wilson’s partners at Union Square Ventures, Brad Burnham, suggests a scenario revolving around another tech giant that has run afoul of regulators and public opinion in the last year: Uber. “Uber is basically just a coordination platform between drivers and passengers,” Burnham says. “Yes, it was really innovative, and there were a bunch of things in the beginning about reducing the anxiety of whether the driver was coming or not, and the map — and a whole bunch of things that you should give them a lot of credit for.” But when a new service like Uber starts to take off, there’s a strong incentive for the marketplace to consolidate around a single leader. The fact that more passengers are starting to use the Uber app attracts more drivers to the service, which in turn attracts more passengers. People have their credit cards stored with Uber; they have the app installed already; there are far more Uber drivers on the road. And so the switching costs of trying out some other rival service eventually become prohibitive, even if the chief executive seems to be a jerk or if consumers would, in the abstract, prefer a competitive marketplace with a dozen Ubers. “At some point, the innovation around the coordination becomes less and less innovative,” Burnham says.
The blockchain world proposes something different. Imagine some group like Protocol Labs decides there’s a case to be made for adding another “basic layer” to the stack. Just as GPS gave us a way of discovering and sharing our location, this new protocol would define a simple request: I am here and would like to go there. A distributed ledger might record all its users’ past trips, credit cards, favorite locations — all the metadata that services like Uber or Amazon use to encourage lock-in. Call it, for the sake of argument, the Transit protocol. The standards for sending a Transit request out onto the internet would be entirely open; anyone who wanted to build an app to respond to that request would be free to do so. Cities could build Transit apps that allowed taxi drivers to field requests. But so could bike-share collectives, or rickshaw drivers. Developers could create shared marketplace apps where all the potential vehicles using Transit could vie for your business. When you walked out on the sidewalk and tried to get a ride, you wouldn’t have to place your allegiance with a single provider before hailing. You would simply announce that you were standing at 67th and Madison and needed to get to Union Square. And then you’d get a flurry of competing offers. You could even theoretically get an offer from the M.T.A., which could build a service to remind Transit users that it might be much cheaper and faster just to jump on the 6 train.
How would Transit reach critical mass when Uber and Lyft already dominate the ride-sharing market? This is where the tokens come in. Early adopters of Transit would be rewarded with Transit tokens, which could themselves be used to purchase Transit services or be traded on exchanges for traditional currency. As in the Bitcoin model, tokens would be doled out less generously as Transit grew more popular. In the early days, a developer who built an iPhone app that uses Transit might see a windfall of tokens; Uber drivers who started using Transit as a second option for finding passengers could collect tokens as a reward for embracing the system; adventurous consumers would be rewarded with tokens for using Transit in its early days, when there are fewer drivers available compared with the existing proprietary networks like Uber or Lyft.
As Transit began to take off, it would attract speculators, who would put a monetary price on the token and drive even more interest in the protocol by inflating its value, which in turn would attract more developers, drivers and customers. If the whole system ends up working as its advocates believe, the result is a more competitive but at the same time more equitable marketplace. Instead of all the economic value being captured by the shareholders of one or two large corporations that dominate the market, the economic value is distributed across a much wider group: the early developers of Transit, the app creators who make the protocol work in a consumer-friendly form, the early-adopter drivers and passengers, the first wave of speculators. Token economies introduce a strange new set of elements that do not fit the traditional models: instead of creating value by owning something, as in the shareholder equity model, people create value by improving the underlying protocol, either by helping to maintain the ledger (as in Bitcoin mining), or by writing apps atop it, or simply by using the service. The lines between founders, investors and customers are far blurrier than in traditional corporate models; all the incentives are explicitly designed to steer away from winner-take-all outcomes. And yet at the same time, the whole system depends on an initial speculative phase in which outsiders are betting on the token to rise in value.
“You think about the ’90s internet bubble and all the great infrastructure we got out of that,” Dixon says. “You’re basically taking that effect and shrinking it down to the size of an application.”
‘Bitcoin is now a nine-year-old multibillion-dollar bug bounty, and no one’s hacked it. It feels like pretty good proof.’
Even decentralized cryptomovements have their key nodes. For Ethereum, one of those nodes is the Brooklyn headquarters of an organization called ConsenSys, founded by Joseph Lubin, an early Ethereum pioneer. In November, Amanda Gutterman, the 26-year-old chief marketing officer for ConsenSys, gave me a tour of the space. In our first few minutes together, she offered the obligatory cup of coffee, only to discover that the drip-coffee machine in the kitchen was bone dry. “How can we fix the internet if we can’t even make coffee?” she said with a laugh.
Planted in industrial Bushwick, a stone’s throw from the pizza mecca Roberta’s, “headquarters” seemed an unlikely word. The front door was festooned with graffiti and stickers; inside, the stairwells of the space appeared to have been last renovated during the Coolidge administration. Just about three years old, the ConsenSys network now includes more than 550 employees in 28 countries, and the operation has never raised a d0ime of venture capital. As an organization, ConsenSys does not quite fit any of the usual categories: It is technically a corporation, but it has elements that also resemble nonprofits and workers’ collectives. The shared goal of ConsenSys members is strengthening and expanding the Ethereum blockchain. They support developers creating new apps and tools for the platform, one of which is MetaMask, the software that generated my Ethereum address. But they also offer consulting-style services for companies, nonprofits or governments looking for ways to integrate Ethereum’s smart contracts into their own systems.
The true test of the blockchain will revolve — like so many of the online crises of the past few years — around the problem of identity. Today your digital identity is scattered across dozens, or even hundreds, of different sites: Amazon has your credit-card information and your purchase history; Facebook knows your friends and family; Equifax maintains your credit history. When you use any of those services, you are effectively asking for permission to borrow some of that information about yourself in order perform a task: ordering a Christmas present for your uncle, checking Instagram to see pictures from the office party last night. But all these different fragments of your identity don’t belong to you; they belong to Facebook and Amazon and Google, who are free to sell bits of that information about you to advertisers without consulting you. You, of course, are free to delete those accounts if you choose, and if you stop checking Facebook, Zuckerberg and the Facebook shareholders will stop making money by renting out your attention to their true customers. But your Facebook or Google identity isn’t portable. If you want to join another promising social network that is maybe a little less infected with Russian bots, you can’t extract your social network from Twitter and deposit it in the new service. You have to build the network again from scratch (and persuade all your friends to do the same).
The blockchain evangelists think this entire approach is backward. You should own your digital identity — which could include everything from your date of birth to your friend networks to your purchasing history — and you should be free to lend parts of that identity out to services as you see fit. Given that identity was not baked into the original internet protocols, and given the difficulty of managing a distributed database in the days before Bitcoin, this form of “self-sovereign” identity — as the parlance has it — was a practical impossibility. Now it is an attainable goal. A number of blockchain-based services are trying to tackle this problem, including a new identity system called uPort that has been spun out of ConsenSys and another one called Blockstack that is currently based on the Bitcoin platform. (Tim Berners-Lee is leading the development of a comparable system, called Solid, that would also give users control over their own data.) These rival protocols all have slightly different frameworks, but they all share a general vision of how identity should work on a truly decentralized internet.
What would prevent a new blockchain-based identity standard from following Tim Wu’s Cycle, the same one that brought Facebook to such a dominant position? Perhaps nothing. But imagine how that sequence would play out in practice. Someone creates a new protocol to define your social network via Ethereum. It might be as simple as a list of other Ethereum addresses; in other words, Here are the public addresses of people I like and trust. That way of defining your social network might well take off and ultimately supplant the closed systems that define your network on Facebook. Perhaps someday, every single person on the planet might use that standard to map their social connections, just as every single person on the internet uses TCP/IP to share data. But even if this new form of identity became ubiquitous, it wouldn’t present the same opportunities for abuse and manipulation that you find in the closed systems that have become de facto standards. I might allow a Facebook-style service to use my social map to filter news or gossip or music for me, based on the activity of my friends, but if that service annoyed me, I’d be free to sample other alternatives without the switching costs. An open identity standard would give ordinary people the opportunity to sell their attention to the highest bidder, or choose to keep it out of the marketplace altogether.
Gutterman suggests that the same kind of system could be applied to even more critical forms of identity, like health care data. Instead of storing, say, your genome on servers belonging to a private corporation, the information would instead be stored inside a personal data archive. “There may be many corporate entities that I don’t want seeing that data, but maybe I’d like to donate that data to a medical study,” she says. “I could use my blockchain-based self-sovereign ID to [allow] one group to use it and not another. Or I could sell it over here and give it away over there.”
The token architecture would give a blockchain-based identity standard an additional edge over closed standards like Facebook’s. As many critics have observed, ordinary users on social-media platforms create almost all the content without compensation, while the companies capture all the economic value from that content through advertising sales. A token-based social network would at least give early adopters a piece of the action, rewarding them for their labors in making the new platform appealing. “If someone can really figure out a version of Facebook that lets users own a piece of the network and get paid,” Dixon says, “that could be pretty compelling.”
Would that information be more secure in a distributed blockchain than behind the elaborate firewalls of giant corporations like Google or Facebook? In this one respect, the Bitcoin story is actually instructive: It may never be stable enough to function as a currency, but it does offer convincing proof of just how secure a distributed ledger can be. “Look at the market cap of Bitcoin or Ethereum: $80 billion, $25 billion, whatever,” Dixon says. “That means if you successfully attack that system, you could walk away with more than a billion dollars. You know what a ‘bug bounty’ is? Someone says, ‘If you hack my system, I’ll give you a million dollars.’ So Bitcoin is now a nine-year-old multibillion-dollar bug bounty, and no one’s hacked it. It feels like pretty good proof.”
Additional security would come from the decentralized nature of these new identity protocols. In the identity system proposed by Blockstack, the actual information about your identity — your social connections, your purchasing history — could be stored anywhere online. The blockchain would simply provide cryptographically secure keys to unlock that information and share it with other trusted providers. A system with a centralized repository with data for hundreds of millions of users — what security experts call “honey pots” — is far more appealing to hackers. Which would you rather do: steal a hundred million credit histories by hacking into a hundred million separate personal computers and sniﬃng around until you found the right data on each machine? Or just hack into one honey pot at Equifax and walk away with the same amount of data in a matter of hours? As Gutterman puts it, “It’s the difference between robbing a house versus robbing the entire village.”
So much of the blockchain’s architecture is shaped by predictions about how that architecture might be abused once it finds a wider audience. That is part of its charm and its power. The blockchain channels the energy of speculative bubbles by allowing tokens to be shared widely among true supporters of the platform. It safeguards against any individual or small group gaining control of the entire database. Its cryptography is designed to protect against surveillance states or identity thieves. In this, the blockchain displays a familial resemblance to political constitutions: Its rules are designed with one eye on how those rules might be exploited down the line.
Much has been made of the anarcho-libertarian streak in Bitcoin and other nonfiat currencies; the community is rife with words and phrases (“self-sovereign”) that sound as if they could be slogans for some militia compound in Montana. And yet in its potential to break up large concentrations of power and explore less-proprietary models of ownership, the blockchain idea offers a tantalizing possibility for those who would like to distribute wealth more equitably and break up the cartels of the digital age.
The blockchain worldview can also sound libertarian in the sense that it proposes nonstate solutions to capitalist excesses like information monopolies. But to believe in the blockchain is not necessarily to oppose regulation, if that regulation is designed with complementary aims. Brad Burnham, for instance, suggests that regulators should insist that everyone have “a right to a private data store,” where all the various facets of their online identity would be maintained. But governments wouldn’t be required to design those identity protocols. They would be developed on the blockchain, open source. Ideologically speaking, that private data store would be a true team effort: built as an intellectual commons, funded by token speculators, supported by the regulatory state.
Like the original internet itself, the blockchain is an idea with radical — almost communitarian — possibilities that at the same time has attracted some of the most frivolous and regressive appetites of capitalism. We spent our first years online in a world defined by open protocols and intellectual commons; we spent the second phase in a world increasingly dominated by closed architectures and proprietary databases. We have learned enough from this history to support the hypothesis that open works better than closed, at least where base-layer issues are concerned. But we don’t have an easy route back to the open-protocol era. Some messianic next-generation internet protocol is not likely to emerge out of Department of Defense research, the way the first-generation internet did nearly 50 years ago.
Yes, the blockchain may seem like the very worst of speculative capitalism right now, and yes, it is demonically challenging to understand. But the beautiful thing about open protocols is that they can be steered in surprising new directions by the people who discover and champion them in their infancy. Right now, the only real hope for a revival of the open-protocol ethos lies in the blockchain. Whether it eventually lives up to its egalitarian promise will in large part depend on the people who embrace the platform, who take up the baton, as Juan Benet puts it, from those early online pioneers. If you think the internet is not working in its current incarnation, you can’t change the system through think-pieces and F.C.C. regulations alone. You need new code.
Chapter 4: Future value, Present Value, and Interest Rate
Example1: A 5 year, 5% coupon bond, currently provides an annual return of 3%. Calculate the price of the bond.
Example 2: Your cousin is entering medical school next fall and asks you for financial help. He needs $65,000 each year for the first two years. After that, he is in residency for two years and will be able to pay you back $10,000 each year. Then he graduates and becomes a fully qualified doctor, and will be able to pay you $40,000 each year. He promises to pay you $40,000 for 5 years after he graduates. Are you taking a financial loss or gain by helping him out? Assume that the interest rate is 5% and that there is no risk.
Example 3: You are awarded $500,000 in a lawsuit, payable immediately. The defendant makes a counteroffer of $50,000 per year for the first three years, starting at the end of the first year, followed by $60,000 per year for the next 10 years. Should you accept the offer if the discount rate is 12%? How about if the discount rate is 8%?
Example 4: John is 30 years old at the beginning of the new millennium and is thinking about getting an MBA. John is currently making $40,000 per year and expects the same for the remainder of his working years (until age 65). I f he goes to a business school, he gives up his income for two years and, in addition, pays $20,000 per year for tuition. In return, John expects an increase in his salary after his MBA is completed. Suppose that the post-graduation salary increases at a 5% per year and that the discount rate is 8%. What is miminum expected starting salary after graduation that makes going to a business school a positive-NPV investment for John? For simplicity, assume that all cash flows occur at the end of each year
Homework (just write down the PV equations – Due with the first mid term exam):
1. The Thailand Co. is considering the purchase of some new equipment. The quote consists of a quarterly payment of $4,740 for 10 years at 6.5 percent interest. What is the purchase price of the equipment? ($138,617.88)
2. The condominium at the beach that you want to buy costs $249,500. You plan to make a cash down payment of 20 percent and finance the balance over 10 years at 6.75 percent. What will be the amount of your monthly mortgage payment? ($2,291.89)
3. Today, you are purchasing a 15-year, 8 percent annuity at a cost of $70,000. The annuity will pay annual payments. What is the amount of each payment? ($8,178.07)
4. Shannon wants to have $10,000 in an investment account three years from now. The account will pay 0.4 percent interest per month. If Shannon saves money every month, starting one month from now, how much will she have to save each month? ($258.81)
5. Trevor's Tires is offering a set of 4 premium tires on sale for $450. The credit terms are 24 months at $20 per month. What is the interest rate on this offer? (6.27 percent)
6. Top Quality Investments will pay you $2,000 a year for 25 years in exchange for $19,000 today. What interest rate are you earning on this annuity? (9.42 percent)
7. You have just won the lottery! You can receive $10,000 a year for 8 years or $57,000 as a lump sum payment today. What is the interest rate on the annuity? (8.22 percent)
Summary of math and excel equations
FV = PV *(1+r)^n
PV = FV / ((1+r)^n)
N = ln(FV/PV) / ln(1+r)
Rate = (FV/PV)1/n -1
Annuity: N = ln(FV/C*r+1)/(ln(1+r))
Or N = ln(1/(1-(PV/C)*r)))/ (ln(1+r))
EAR = (1+APR/m)^m-1
APR = (1+EAR)^(1/m)*m
NPV NFV calculator:
First mid-term study guide (10/3 First Mid Term, Close book close notes)
1. What are the six parts of the financial markets
2. What are the five core principals of finance
3. Do you think that student loans will become a trigger for the next financial crisis? Please provide your explanation.
4. What is high frequency trading? pros and cons? What can SEC do to make high frequency trading less a threat to the financial market stability?
5. What is flash crash? Why do investors so worried about the occurrence of flash crash? How can high frequency trading trigger flash crash?
6. Why does flash crash occur more frequently in FX market than in the stock market?
7. What is M0? M1? M2? M3?
8. What could happen if we increase money supply? What about decrease money supply?
9. Why are M1 much greater than M0 and M2 much greater than M1?
10. “In a fractional reserve banking system, banks create money when they make loans. Bank reserves have a multiplier effect on the money supply.” Are the above sentences right or wrong? Please explain.
11. Imagine that you deposited $10,000 in Bank A. Imagine that the fractional banking system is fully functioning. After five cycles, what is the amount that has been deposited by the five customers? How much money has been lent out by the five banks? Please fill up the blanks in the following table.
12. What is bitcoin? In your view, could bitcoin become a major global currency? Could governments ban or destroy bitcoin?
13. What are bitcoin futures? How can you use bitcoin futures to improve your portfolio’s performance?
14. Bitcoin is used more often by speculators to make quick and easy money, rather than an investment for a long horizon. What is your opinion to bitcoin in terms of the purposes of investing in bitcoin?
15. As an investor, besides market order, what other types of orders can use choose from? Show definitions and examples.
For example, Wal-Mart stock is currently traded at 118$/share. You think it is overpriced and want to buy it at a lower price, such as $110/share.
Which order type shall you choose? Please explain with details.
Assume that you could buy Wal-Mart stock at $110/share and want to hedge against falling stock prices in the future. Which order type shall you choose? Please explain with details.
16. What is short selling? Do you think that short Apple stock is a good idea? Why or why not?
17. What is IPO? SEO?
18. Please compare a firm going public vs. a firm going private. https://www.forbes.com/sites/connieguglielmo/2013/10/30/you-wont-have-michael-dell-to-kick-around-anymore/#5c98b47b2a9b. Why is Dell going back and forth between a public firm and a private one? https://www.cnet.com/news/dell-goes-public-after-five-years-as-private-company-report/
19. Compare primary market vs. secondary market.
20. Time value of money question, similar to homework questions. Just show math equations. No need of excel or a calculator.
Chapter 6 Bond Market
1. Cash flow of bonds
For example: a 3 year bond 10% coupon rate, draw its cash flow.
How Bonds Work (video)
2. Risk of Bonds
Class discussion: Is bond market risky?
Bond risk (video)
Bond risk – credit risk (video)
Bond risk – interest rate risk (video)
3. Choices of investment in bonds
FINRA – Bond market information
Treasury Bond Auction and Market information
Bond Mutual Fund
Class discussion Topic I: As a college student, which type of bonds shall you buy? Why?
Class discussion Topics II
You can invest in junk bonds. Shall you? Or shall you not?
Definition: A high yield bond – also known as a junk bond – is a debt security issued by companies or private equity concerns, where the debt has lower than investment grade ratings. It is a major component – along with leveraged loans – of the leveraged finance market.(www.highyieldbond.com)
Everything You Need to Know About Junk Bonds (video)
Updated Aug 17, 2019
Junk bonds differ because of their issuers' credit quality. All bonds are characterized according to this credit quality and therefore fall into one of two bond categories:
Investment Grade – These bonds are issued by low- to medium-risk lenders. A bond rating on investment-grade debt usually ranges from AAA to BBB. Investment-grade bonds might not offer huge returns, but the risk of the borrower defaulting on interest payments is much smaller.
Although junk bonds pay high yields, they also carry a higher-than-average risk that the company will default on the bond. Historically, average yields on junk bonds have been 4% to 6% above those for comparable U.S. Treasuries.
Who Buys Junk Bonds?
The Bottom Line
Home Work chapter 6 (due with the second mid term exam):
1. Draw cash flow graph of a bond with 5 years left to maturity 5% coupon rate.
2. Find Wal-Mart bond in FINRA website. Pick one of the three bonds and answer the following questions. ( http://finra-markets.morningstar.com/BondCenter/Default.jsp, and search for Wal-Mart bond)
a. How to calculate the price?
b. Why Wal-Mart bond yield is lower than Microsoft’s?
c. What does “callable” mean?
d. Who are the three major rating agencies?
e. What is the rating of War-Mart bond? Is it better than MSFT’s or are they the same?
3. Explain why Wal-Mart bond is more risky than the Treasury bond with the same condition.
4. As a bond investor, do you plan to invest in junk bond? Why or why not?
5. Fed reduced interest rate. Do you think that it is safer to invest in junk bond when interest rates are low? Or just the opposite? Why or why not?
6. What is the take away of the following article? Why does it happen?
Rising defaults in high-yield bonds puts this year on track for postcrisis record, warns Goldman Sachs 8/18/2019
Defaults reach above 5%, from 1.3% bottom in November 2018
Defaults on bonds issued by debt-laden U.S. companies with speculative-grade ratings are on pace to reach a new high this year for the post 2008 crisis era, according to Goldman Sachs analysts.
The bank has tracked more than $36 billion of defaulted so-called “junk bonds” already in 2019, and there are likely to be more, particularly in the energy sector, to eclipse the prior post crisis default record of $43 billion in 2016, wrote Goldman analysts led by Lotfi Karoui in a Thursday note to clients.
“Thus far, defaults have been highly concentrated among energy issuers, a trend that reflects structural as opposed to cyclical challenges,” the Goldman analysts wrote. “The lingering weakness in oil prices coupled with weak growth sentiment may push issuers in other structurally-challenged sectors toward defaults.”
Oil field servicing company Weatherford International Ltd , which filed for bankruptcy with $7.4 billion of high-yield debt, is the year’s second-largest default, after the massive default of California’s Pacific Gas and Electric Company on $18.3 billion of debt in January, according to Moody’s Investors Service.
In the case of Weatherford, Moody’s said it expects to see bond recoveries of 35%-65% on roughly $5.85 billion of debt that the company hopes to slash through its restructuring.
PG&E was considered an investment-grade credit, until it filed for bankruptcy following devastating California wildfires in 2017 and 20180 left it facing billions in potential liabilities.
This chart shows the dollar amount of defaulted U.S. high-yield bonds thus far in 2019, which is approaching levels not seen since 2016, after Brent crude oil prices plunged below $35 per barrel and put significant pressure on the financial conditions of oil companies and exporters.
Moody’s said this week in a separate report that junk-bonds issued by companies in July came with the worst protections yet for investors.
At present, the three-month trailing high-yield bond default rate is above 5% on an annualized basis, a sharp jump from its 1.3% bottom in November 2018, according to Goldman analysts.
By comparison, the default rate traveled north of 14% for U.S. high-yield bonds in the aftermath of the 2007-2008 global financial crisis, according to Moody’s, which said in July that its baseline forecast was for defaults to stay below 4% through July 2020.
Goldman analysts also don’t see defaults moving meaningfully higher from current levels, absent a “full-blown recession,” which the bank’s U.S. economics team doesn’t anticipate occurring in the near term.
Recession and trade war jitters rattled U.S. stocks this week, although the major benchmarks managed to close higher on Friday, with the Dow Jones Industrial Average adding 300 points, and the S&P 500 index gaining 41 points and the Nasdaq Composite Index increasing by 308 points.
Investors have plenty of high-risk and so-called grey swan events to watch for, as the third quarter draws closer.
In high-yield, a big focus will be corporate earnings through year-end. Companies can end up in default when earnings slump, making it harder for borrowers to keep up on debt payments.
And with energy making up 14% of the closely-tracked Bloomberg Barclays U.S. high-yield bond Index, Oxford Economics is keeping a close eye on the fortunes of energy companies.
“Our main source of worry is the fact that the improvement in U.S. fundamentals since 2017 can be entirely attributed to the energy sector,” wrote Michiel Tukker, Oxford Economics’ global strategist in a note Friday.