FIN310 Class Web Page, Fall ' 21
Instructor: Maggie Foley
Jacksonville University
Term
project (due with final) –
Please refer to the following for the weblinks of the databases needed for the
term project
·
https://www-mergentonline-com.ju.idm.oclc.org/basicsearch.php -- mergent
·
https://research-valueline-com.ju.idm.oclc.org/Secure/Research/Home#sec=library - value line
Weekly SCHEDULE, LINKS, FILES and Questions
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Chapter |
Coverage,
HW, Supplements -
Required |
References
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Chapter 1, 2 |
Discussion: How to pick stocks (finviz.com) How To Win The MarketWatch Stock Market Game
Daily earning announcement: http://www.zacks.com/earnings/earnings-calendar IPO schedule: http://www.marketwatch.com/tools/ipo-calendar Chapter 1 Introduction |
8/17 Class video:
syllabus and market watch game 8/19 class video:
chapters 1, discussion on factors for
next financial crisis 8/24 Class video:
8/26 class video
8/31 Class video · M0, MB, M1, M2 · Fed balance sheet 9/2 class video · Fractional reserve banking system 9/7 Class video · Bitcoin’s impact
on economy, on banks, on central banks · Cryptocurrency 9/9 class video (Thanks
Jack, Madeline, Thomas) · Ethereum · Bitcoin · Dogecoin 9/14 Class video:
Order types, money market, financial instruments 9/16 class video: IPO,
SEO, NYSE vs. NASDAQ 9/21
Class video (Sorry I forgot to record the class today) · Chapter 4 (Time value of money) (hw
solution posted) · Prepare
HFT and flash crash for the midterm · Prepare
IPO under pricing question for the midterm 9/23
class video: First mid
term exam (Study guide posted) and homework due 9/28 Class video · What is bond? · The risks of investing in a bond. · Types of bonds 9/30 class video · What is muni bond? · What is TIPS? ·
High
yield bonds 10/5
Class video (cancelled) 10/7 class video · International bond · Bond rating · Z-score · Airline companies’ z-scores 10/12 Class video · Discussion of airline bond and airline
stock · Yield curve 10/14 class video · Inverted yield curve · Steepening yield curve · S&P500 vs. Apple stock 10/19 Class video · S&P500 index · Pro and Con 10/21 class video · Mutual fund vs. ETF 10/26 Class video: · QQQ vs. SPY · Bond mutual fund · Stock chapter Q&A 10/28 class video – · Behavior finance 11/2 Class
video - Second mid term exam (in class, close book, close notes) ·
Study guide (see blow) 11/4 Class video: · Call and put option · Futures contract for bitcoin 11/9 Class video:
Commercial banks 11/11 Class video: Veterans’ day, no class 11/16 Class video:
Introduction of the Fed (Thanks, Madeline, Jack, Thomas) 11/18 Class video:
Monetary Policy 11/20, 4-6 pm: Final Exam; Term
project due Will choose 15 questions out of the following 25 questions 1. Anything wrong of the above balance sheet of
Wells Fargo? Where do the loans and deposits go? 3. What is bank run? It is rare. Why? 4. Why are banks reluctant to lend out to small
business, but offer loans to homebuyers? 5. Too big too fail. What is your opinion on this
statement? Should we worry about banks getting bigger and bigger? Why or why not? 6. Similar to the homework question. Bank has one million dollars that can be lent out.
Shall the bank lend it out to a small business owners or to a house buyer?
Why? 7. How to
explain the uniqueness of banks’ balance sheet. For example, banks are highly
leveraged. 8. What are
the differences between commercial bank and investment bank? 9. What are the pro and con for big banks? 10. As compared with small banks, do big banks are
relatively more burdened by regulations? Or vice versa? 11. What is
the purpose of the Fed? The structures
of the Fed? 12. The
duties of the Fed? 13. What are the changes in monetary policy? 14. The three approaches to conduct Monetary
policy. 15. Compare fed fund rate with discount rate.
Which rate is targeted by Fed to implement monetary policy? 16. What is interest rate on bank reserve balance?
17. What is open market operation? When Fed plans to increase interest rate,
how can Fed do so via open market operation? Draw the supply and demand curve
to show the results. 18. What is your opinion regarding the interest
rate that Fed will determine in the upcoming FOMC meeting 19. If Fed does increase interest rate in mid Dec,
what is your prediction of its impact in the stock market? If Fed does not
increases interest rate, what will happen to the stock market? 20. What
is easing monetary policy? What is contractary monetary policy? 21. Why is
there a futures market for bitcoin? 22. Why shall you consider investing in Bitcoin
futures market? Or otherwise, why should not you? 23. What is call option? What is put option?
Between a call option holder and a put option holder, who is going to benefit
from the stock price falling? Who is going to benefit from stock price rising? 24.
Name three professions in the banking industry 25.
Name three types of banks The World
of High-Frequency Algorithmic Trading In the
last decade, algorithmic trading (AT) and high-frequency trading (HFT) have
come to dominate the trading world, particularly HFT. During 2009-2010, more
than 60% of U.S. trading was attributed to HFT, though that percentage has
declined in the last few years.1 Here’s a look into the world of algorithmic and high-frequency
trading: how they're related, their benefits and challenges, their main users
and their current and future state. High-Frequency Trading – HFT
Structure First,
note that HFT is a subset of algorithmic trading and, in turn, HFT includes
Ultra HFT trading. Algorithms essentially work as middlemen between buyers
and sellers, with HFT and Ultra HFT being a way for traders to capitalize on infinitesimal price discrepancies that
might exist only for a minuscule period. Computer-assisted
rule-based algorithmic trading uses dedicated programs that make automated
trading decisions to place orders. AT
splits large-sized orders and places these split orders at different times
and even manages trade orders after their submission. Large
sized-orders, usually made by pension funds or insurance companies, can have
a severe impact on stock price levels. AT aims to reduce that price impact by
splitting large orders into many small-sized orders, thereby offering traders
some price advantage. The
algorithms also dynamically control the schedule of sending orders to the
market. These algorithms read
real-time high-speed data feeds, detect trading signals, identify appropriate
price levels and then place trade orders once they identify a suitable
opportunity. They can also detect arbitrage opportunities and can place
trades based on trend following, news events, and even speculation. High-frequency
trading is an extension of algorithmic trading. It manages small-sized trade
orders to be sent to the market at high
speeds, often in milliseconds or microseconds—a
millisecond is a thousandth of a second and a microsecond is a thousandth of
a millisecond. These
orders are managed by high-speed
algorithms which replicate the role of a market maker. HFT algorithms typically
involve two-sided order placements
(buy-low and sell-high) in an attempt to benefit from bid-ask spreads.
HFT algorithms also try to “sense”
any pending large-size orders by sending multiple small-sized orders and
analyzing the patterns and time taken in trade execution. If they sense an
opportunity, HFT algorithms then try to capitalize on large pending orders by
adjusting prices to fill them and make profits. Also,
Ultra HFT is a further specialized stream of HFT. By paying an additional
exchange fee, trading firms get access to see pending orders a split-second before the rest of the market does. Profit Potential from HFT Exploiting
market conditions that can't be detected by the human eye, HFT algorithms
bank on finding profit potential in
the ultra-short time duration. One example is arbitrage between futures
and ETFs on the same underlying index. Automated Trading In the
U.S. markets, the SEC authorized automated
electronic exchanges in 1998. Roughly a year later, HFT began, with trade
execution time, at that time, being a few seconds.
By 2010, this had been reduced to milliseconds—see the speech by the Bank of England's Andrew Haldane's
"Patience and finance"—and today,
one-hundredth of a microsecond is enough time for most HFT trade decisions
and executions. Given ever-increasing computing power, working at nanosecond
and picosecond frequencies may be achievable via HFT in the relatively near
future. Bloomberg
reports that while in 2010, HFT "accounted for more than 60% of all U.S.
equity volume,” that proved to be a high-water mark.
By 2013, that percentage had fallen to roughly 50%. Bloomberg further noted
that where, in 2009, "high-frequency traders moved about 3.25 billion
shares a day. In 2012, it was 1.6 billion a day” and “average profits
have fallen from about a tenth of a penny per share to a twentieth of a
penny.” HFT Participants HFT
trading ideally needs to have the
lowest possible data latency (time-delays) and the maximum possible automation level. So participants prefer to
trade in markets with high levels of automation and integration capabilities
in their trading platforms. These include NASDAQ, NYSE, Direct Edge, and BATS. HFT is
dominated by proprietary trading firms and spans across multiple securities,
including equities, derivatives, index
funds, and ETFs, currencies and fixed income instruments. A 2011 Deutsche
Bank report found that of then-current HFT participants, proprietary trading
firms made up 48%, proprietary trading desks of multi-service broker-dealers
were 46% and hedge funds about 6%. Major
names in the space include proprietary trading firms like KWG Holdings
(formed of the merger between Getco and Knight Capital) and the trading desks
of large institutional firms like Citigroup (C), JP Morgan (JPM) and Goldman
Sachs (GS). HFT Infrastructure Needs For
high-frequency trading, participants need the following infrastructure in place:
Benefits of HFT HFT is
beneficial to traders, but does it help the overall market? Some overall market benefits that HFT supporters
cite include:
Challenges Of HFT Opponents
of HFT argue that algorithms can be programmed to send hundreds of fake orders and cancel them in the
next second. Such “spoofing” momentarily creates a false
spike in demand/supply leading to price anomalies, which can be exploited by
HFT traders to their advantage. In 2013, the SEC introduced the Market
Information Data Analytics System (MIDAS), which screens multiple markets
for data at millisecond frequencies to try and catch fraudulent activities
like “spoofing." Other obstacles to HFT's growth are its high costs of entry, which
include:
The HFT
marketplace also has gotten crowded, with participants trying to get an edge
over their competitors by constantly improving algorithms and adding to
infrastructure. Due to this "arms race," it's getting more
difficult for traders to capitalize on price anomalies, even if they have the
best computers and top-end networks. And the
prospect of costly glitches is also scaring away potential participants. Some
examples include the “Flash Crash" of May 6, 2010, where HFT-triggered sell orders
led to an impulsive drop of 600 points in the DJIA index.9
Then there's the case of Knight Capital, the then-king of HFT on NYSE. It
installed new software on Aug 1, 2012, and accidentally bought and sold $7
billion worth of NYSE stocks at unfavorable prices.10
Knight was forced to settle its positions, costing it $440 million in one day
and eroding 40% of the firm’s value.
Acquired by another HFT firm, Getco, to form KCG Holdings, the merged entity
still continues to struggle. So, some major bottlenecks for HFT's
future growth are its declining profit potential, high operational costs, the
prospect of stricter regulations and the fact that there is no room for
error, as losses can quickly run in the millions. The Bottom Line The
growth of computer speed and algorithm development has created seemingly
limitless possibilities in trading. But, AT and HFT are classic examples of
rapid developments that, for years, outpaced regulatory regimes and allowed
massive advantages to a relative handful of trading firms. While HFT may
offer reduced opportunities in the future for traders in established markets
like the U.S., some emerging markets could still be quite favorable for
high-stakes HFT ventures. Goldman Sachs says
computerized trading may make next 'flash crash' worse
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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: Draw Me The
Economy: Money Supply (video)
For discussion:
·
Fed balance sheet over $5 trillion for first time (video) Whiteboard Economics: The Fed’s Balance Sheet Unwind
(youtube) – 2017
Federal Reserve Balance Sheet (Khan academy)- 2009
(optional)
https://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab9
For discussion:
Summary:
Money 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.
From https://tradingeconomics.com/united-states/money-supply-m2
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Beyond
Bitcoin bubble – New York Times (FYI only) https://www.nytimes.com/2018/01/16/magazine/beyond-the-bitcoin-bubble.html 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: 1b0be2162cedb2744d016943bb14e71de6af95a63af3790d6b41b1e719dc5c66 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: 0x6c2ecd6388c550e8d99ada34a1cd55bedd052ad9 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. 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. . You need new code. |
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Part II What is Fractional Reserve Banking System? The Money
Multiplier (video)
Money creation in a fractional reserve system |
Financial sector | AP Macroeconomics | Khan Academy
In a fractional
reserve banking system, banks create money when they make loans. Bank reserves have a multiplier effect
on the money supply. What Is Fractional Reserve Banking?
Understanding Fractional Reserve Banking Banks
are required to keep on hand and available for withdrawal a certain amount of
the cash that depositors give them. If someone deposits $100, the bank can't
lend out the entire amount. Nor are
banks required to keep the entire amount on hand. Many central banks have
historically required banks under
their purview to keep 10% of the deposit, referred to as reserves. This
requirement is set in the U.S. by the Federal Reserve and is one of the central bank's tools to implement
monetary policy. Increasing the reserve requirement takes money out of the
economy while decreasing the reserve requirement puts money into the economy. Historically, the required reserve ratio
on non-transaction accounts (such as CDs) is zero, while the requirement on
transaction deposits (e.g., checking accounts) is 10 percent. Following
recent efforts to stimulate economic growth, however, the Fed has reduced the
reserve requirements to zero for transaction accounts as well. Fractional Reserve Requirements Depository
institutions must report their transaction accounts, time and savings
deposits, vault cash, and other reservable obligations to the Fed either
weekly or quarterly. Some banks are exempt from holding reserves, but all banks are paid a rate of interest on
reserves called the "interest rate on reserves" (IOR) or the
"interest rate on excess reserves" (IOER). This rate acts as an
incentive for banks to keep excess reserves. Banks
with less than $16.3 million in assets are not required to hold reserves.
Banks with assets of less than $124.2 million but more than $16.3 million
have a 3% reserve requirement, and those banks with more than $124.2 million
in assets have a 10% reserve requirement. Fractional banking aims to expand the
economy by freeing capital for lending. Fractional Reserve Multiplier Effect "Fractional reserve" refers to the
fraction of deposits held in reserves. For example, if a bank has $500
million in assets, it must hold $50 million, or 10%, in reserve. Analysts
reference an equation referred to as the multiplier equation when estimating
the impact of the reserve requirement on the economy as a whole. The equation
provides an estimate for the amount of money created with the fractional
reserve system and is calculated by multiplying the initial deposit by one
divided by the reserve requirement. Using the example above, the calculation
is $500 million multiplied by one divided by 10%, or $5 billion. This is
not how money is actually created but only a way to represent the possible
impact of the fractional reserve system on the money supply. As such, while
is useful for economics professors, it is generally regarded as an
oversimplification by policymakers. The
Bottom Line Fractional reserve banking has pros and
cons. It permits banks to use funds (the bulk of deposits) that would be
otherwise unused to generate returns in the form of interest rates on loans—and to make more money available to grow the economy. It
also, however, could catch a bank short in the self-perpetuating panic of a
bank run. Many
U.S. banks were forced to shut down during the Great Depression because too
many customers attempted to withdraw assets at the same time. Nevertheless,
fractional reserve banking is an accepted business practice that is in use at
banks worldwide. https://www.investopedia.com/terms/f/fractionalreservebanking.asp Example:
You deposited $1,000 in a local bank
Summary:
Weaknesses of
fractional reserve lending (khan academy)
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(continuing from above) 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. |
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Part III: Could
Cryptocurrency Put Banks out of Business? What is
Cryptocurrency? What is blockchain? How the blockchain is changing money and business | Don
Tapscott (TED, video)
Impact
of Cryptocurrency on economy For discussion:
· The first crypto currency discussed in this paper as an example is Bitcoin which is technically, “an algorithm that records an ongoing chain of transactions between members of a decentralized peer-to-peer network and broadcasts these records to all members of the network”. ·
Secondly, Ethereum
is used as an example which is a blockchain-based, public, open-source,
computing platform and operating system for smart contracts. · The first advantage is that crypto currencies combine important properties to foster trust, such as accountability and transparency, which allows trust free interactions between counterparties. · Another benefit of the decentralization of crypto currencies is that governments cannot manage them. Hence, crypto currencies are not restricted to a specific geographic area and can be traded around the world. Therefore, Bitcoin can be used to provide low-cost money transfers, particularly for those seeking to transfer small amounts of money internationally, such as remittance payments · One characteristic is that it makes it easy to transfer money from illegal activities or to finance terror activities without the possibility of government intervention · the decentralization and “the lack of flexibility in the Bitcoin supply schedule results in high price volatility” · Furthermore, no government or central bank can influence the supply of crypto currencies. · Cryptocurrency has not changed existing job markets, however it created jobs in a new category of its own. Cryptocurrency job availability has increased demand for software engineers, and provided many new jobs for US workers. https://www.arcgis.com/apps/Cascade/index.html?appid=b9bafd50ab5f4eec9a77925cec0db09d
Could digital currencies put banks out of business? |
The Economist (video)
The short answer is yes.
Cryptocurrencies are an existential threat to central banks, and the response
from national financial authorities thus far seems to be, “If you can't beat
them, join them.” Ages 25-34 (https://coinmarketcap.com/alexandria/article/will-cryptocurrencies-and-blockchain-replace-banking-and-finance) The youngest age demographic is most likely to participate in crypto, with 58% of digital currency owners worldwide being under 34, according to a 2021 survey. A whopping 27% of people ages 18-34 prefer Bitcoin (the largest crypto by market cap) over stocks (April 2019 study). The youngest age demographic of investors is the most likely to adopt Bitcoin and other cryptocurrencies as a large or maybe the largest portion of their portfolios. Additionally, 54.9% of retail investors are between the ages of 26 and 40. This class of investors has shown increasing interest in crypto in 2021 after it provided unprecedented short-term opportunities. From Dogecoin to Ethereum, speculation and value investing have been off the charts in a crypto bull run. This young investor demographic has grown impatient and used to sky-high returns and volatility. Ages 35-44 This age category is the next most likely to enter the crypto scene. 36% of crypto investors worldwide have an income of over 100,000 USD. The next wave of crypto buyers is older, with an average age of 44 in the USA. With more education and more disposable income, this investor class is looking to cash in on early crypto adoption and coin trading. These two youngest groups of investors on the chart are also most likely to use DeFi’s other tools like staking and borrowing currency. Ages 45-54 Even ages 45-54 show signs of adopting crypto as the average age of the crypto-curious settles around 44. Many in this age group are looking for extra portfolio allocations that may help them reach a comfier retirement. However, many Gen Xers prefer a relationship with mutual funds and safe stocks like Apple or Amazon. Ages 55-64 The Baby Boomer generation shows a less than 1% likelihood of investing in Bitcoin as a long-term investment (July 2018 study). They have little trust for digital currency and prefer mainstream investments as safer vehicles for their wealth as they look to transition out of the workforce. Age 65+ Those ages 65 and over aren’t likely to contribute to cryptocurrency’s rise, as they are mostly concerned with safe investments to hold them through retirement. This age demographic is not as familiar with tech and has very low trust for digital assets. They are more likely to stay the path of 90-year-old investor Warren Buffet with a background in safer blue-chip stocks and mutual funds. We shouldn’t forget that Asia and China make up a huge portion of these demographics, with over 59 million crypto users.
Google.com
https://www.coingecko.com/en/coins/cardano https://www.coinbase.com/price Top 5
cryptocurrency
For discussion:
What is bitcoin? By Khan Academy (video) (optional) Bitcoin vs. Ethereum - Everything you need to know!
(Similarities & differences)
Is
Ethereum More Important Than Bitcoin? https://www.investopedia.com/articles/investing/032216/ethereum-more-important-bitcoin.asp By ADAM HAYES Reviewed by ERIKA RASURE Updated Aug 26, 2021 Blockchain
technology, the distributed ledger system that underpins the digital currency
Bitcoin, is getting a lot of attention from Wall Street
lately. With uses ranging from cross-border payments to settlements and
clearing of over-the-counter derivatives to streamlining back-office
processes, the potential for disruption in the financial industry and
elsewhere is growing more real each day. While bitcoin is the most widely
used and well-known use case of blockchain, Ethereum may be the killer app that allows for this disruption to
finally take place. The token native to the Ethereum
blockchain, Ether (ETH), currently trades around $230, and the market capitalization
of all ether around $25 billion, making it the second most valuable
blockchain behind Bitcoin (which represents approximately $185 billion of
value). What is Ethereum and why is it
interesting? KEY
TAKEAWAYS
A Brief Overview of Ethereum Ethereum
was developed to augment and improve on bitcoin, expanding its capabilities.
Importantly, it was developed to feature
prominently “smart contracts:” decentralized,
self-executing agreements coded into the blockchain itself. Ethereum was first proposed by Vitalik
Buterin in 2013 and went live with its first beta version in 2015. Its blockchain is built with a
turing-complete scripting language that can simultaneously run such smart
contracts across all nodes and achieve verifiable consensus without the need
for a trusted third party such as a court, judge or legal system.
According to its website, Ethereum can
be used to “codify, decentralize, secure and trade just about anything.”
In late 2014, Ethereum raised almost $18 million in bitcoin by way of a crowd
sale to fund its development.6 The ‘Ethereum Virtual Machine’
(EVM) is capable of running smart
contracts that can represent financial agreements such as options
contracts, swaps or coupon-paying bonds. It
can also be used to execute bets and wagers, to fulfill employment contracts,
to act as a trusted escrow for the purchase of high-value items, and to
maintain a legitimate decentralized gambling facility. These are just a
few examples of what is possible with smart contracts, and the potential to
replace all sorts of legal, financial and social agreements is exciting. Currently, the EVM is in its
infancy, and running smart contracts is both “expensive” in terms of ether
consumed, as well as limited in its processing power. According to its
developers, the system is currently about as powerful as a late 1990s-era
mobile phone. This, however, is likely to change as the protocol is developed
further. To put this into perspective, the computer on the Apollo 11 lander
had less power than an iPhone; it is certainly plausible that in a few short
years, the EVM (or something like it) will be able to handle sophisticated
smart contracts in real time.8 Within the Ethereum ecosystem, ether exists as the internal cryptocurrency which is used to settle the outcomes
of smart contracts executed within the protocol. Ether can be mined for
and traded on cryptocurrency exchanges with bitcoin or fiat currencies such
as US Dollars, and is also used to pay for computational effort employed by
nodes on its blockchain. Ethereum and Decentralized
Autonomous Organizations Smart
contracts could be the building blocks for entire decentralized autonomous
organizations (DAO's) that function like
corporations, engaging in economic transactions—buying and selling things,
hiring labor, negotiating deals, balancing budgets and maximizing
profits—without any human or institutional intervention. If one takes the
view that corporations are just a complex web of contracts and obligations of
varying size and scope, then such DAO's could be coded into Ethereum. This
opens the door for all sorts of new and interesting possibilities such as
emancipated machines that literally own themselves and people being employed
directly by pieces of software. Ethereum and Decentralized
Applications While DAO's may be a concept to
be realized in the future, decentralized applications (Dapps) are currently
being developed for Ethereum today. These standalone applications utilize
smart contracts and run on the EVM.9 Some examples include micro-payments
platforms, reputation functions, online gambling apps, schedulers and P2P
marketplaces. The key feature to Dapps is that
they run across a decentralized network and are enforced without the need for
a central authority or overseer. Any sort of multi-party application that
today relies on a central server can be disintermediated via the Ethereum
blockchain.9
This can eventually include chat, gaming, shopping and banking. The Bottom Line What Bitcoin did for money and
payments by harnessing blockchain technology, Ethereum may do for
applications of all shapes and sizes. With a built-in scripting language and
distributed virtual machine, smart contracts can be built to carry out all
sorts of functions without the need for a trusted third party or central
authority. Using its internal cryptocurrency, ether, nodes can be paid for
their processing power in running these decentralized apps, and eventually,
entire decentralized autonomous organizations may exist in an ether economy. Cardano
joins crypto’s creative destruction loop https://www.reuters.com/breakingviews/cardano-joins-cryptos-creative-destruction-loop-2021-09-02/ By John Foley September 3, 2021 Representations of
cryptocurrencies Bitcoin, Ethereum, DogeCoin, Ripple, Litecoin are placed on
PC motherboard in this illustration taken, June 29, 2021. NEW YORK, Sept 3 (Reuters
Breakingviews) - Watch out, bitcoin and ether. Cryptocurrency platform
Cardano had its ADA token pass the $3
mark for the first time on Sept. 1, just weeks after becoming the world’s
third-biggest virtual tender. While its total value at that price of $96
billion is roughly a fifth of that of Ethereum’s currency and a 10th of that
of leader bitcoin, according to Coinbase, the No. 3 has doubled in a month. Cardano differs from its bigger
cousins because transactions are verified using “proof of stake,” which rewards ownership, rather than “proof of
work,” which rewards effort. The
former uses much less energy. Ethereum is switching to proof of stake,
but maybe not for a year or two. On the other hand, Cardano is less suited to so-called smart contracts, which
automatically execute certain agreed actions, until a revamp later in
September. Another difference is that the supply of Cardano’s ADA is limited, like bitcoins but unlike ether’s. Crypto-believers
may just hedge their bets by investing in all of them. But Cardano’s rise
shows how the space is evolving – collectively.
New entrants from Polkadot to Iota each bring some perk that the others
don’t. Variations run into the thousands.
Cardano’s success could be fleeting as copycats take its charms and build on
them to create more appealing alternatives. Those with long memories might
remember Altavista, the 1990s search engine that introduced firsts like
web-page translation. It stormed ahead until Google wiped it off the map, in
part by piggybacking off the advances of its predecessors. A dollar invested
in Google’s forebears might have been wasted, but without that, search
wouldn’t be what it is today. That’s the paradox of crypto too: only through
today’s investors losing fortunes will the sector deliver sustainable riches. How Does Cardano Work? (video, optional)
Dogecoin
(DOGE) https://www.investopedia.com/terms/d/dogecoin.asp By JAKE FRANKENFIELD Updated
December 21, 2020 What Is Dogecoin? Dogecoin (DOGE) is a peer-to-peer, open-source
cryptocurrency. It is considered an altcoin
and an almost sarcastic meme coin. Launched in Dec. 2013, Dogecoin has
the image of a Shiba Inu dog as its logo. While it was created seemingly as
a joke, Dogecoin's blockchain still has merit. Its underlying technology is derived from Litecoin. Notable features
of Dogecoin, which uses a scrypt algorithm, are its low price and unlimited
supply. KEY TAKEAWAYS
Understanding Dogecoin Dogecoin started as something of
a joke, but after it was created, it gained a following. By late 2017, it was
participating in the cryptocurrency bubble that sent the values of many coins
up significantly.1
After the bubble burst in 2018, Dogecoin lost much of its value, but it still
has a core of supporters who trade it
and use it to tip content on Twitter and Reddit. Users
can buy and sell Dogecoin on digital currency exchanges. They can opt to
store their Dogecoin on an exchange or in a Dogecoin wallet. The History of Dogecoin In the Beginning Jackson Palmer, a product manager
at the Sydney, Australia office of Adobe Inc., created Dogecoin in 2013 as a
way to satirize the hype surrounding cryptocurrencies. Palmer has been
described as a "skeptic-analytic" observer of the emerging
technology, and his initial tweets about his new cryptocurrency venture were
done tongue-in-cheek. But after getting positive feedback on social media, he
bought the domain dogecoin.com. Meanwhile in Portland, Oregon,
Billy Markus, a software developer at IBM who wanted to create a digital
currency but had trouble promoting his efforts, discovered the Dogecoin buzz.
Markus reached out to Palmer to get permission to build the software behind
an actual Dogecoin. Markus based Dogecoin's code on
Luckycoin, which is itself derived from Litecoin, and initially used a
randomized reward for block mining, although that was changed to a static
reward in March 2014. Dogecoin uses Litecoin's scrypt technology and is a
proof-of-work coin. Palmer
and Markus launched the coin on Dec. 6, 2013.
Two weeks later on Dec. 19, the value of Dogecoin jumped 300%, perhaps due to
China forbidding its banks from investing in cryptocurrency. The Rise of Dogecoin Dogecoin marketed itself as a
"fun" version of Bitcoin with a Shibu Inu (Japanese dog) as its
logo. Dogecoin's casual presentation suited the mood of the burgeoning crypto
community. Its scrypt technology and
unlimited supply was an argument for a faster, more adaptable, and
consumer-friendly version of Bitcoin. Dogecoin
is an "inflationary coin," while cryptocurrencies like Bitcoin are
deflationary because there’s a ceiling on the number of coins that will be
created. Every four years the amount of Bitcoin released
into circulation via mining rewards is halved and its inflation rate is
halved along with it until all coins are released. In Jan. 2014, the Dogecoin
community donated 27 million Dogecoins worth approximately $30,000 to fund
the Jamaican bobsled team's trip to the Sochi Winter Olympic games.
In March of that year, the Dogecoin community donated $11,000 worth of Dogecoin
to build a well in Kenya and $55,000 of Dogecoin to sponsor NASCAR driver
Josh Wise. By its first birthday, Dogecoin
had a market capitalization of $20 million and a loyal fanbase. Controversy Takes Some Fun From
Dogecoin The freewheeling fun of Dogecoin
lost some of its mirth in 2015 as the crypto community, in general, started
to grow more serious. The first sign that not all was well with the Dogecoin
community was the departure of Jackson Palmer who has said that a “toxic
community” had grown up around the coin and the money it was producing. One member of that toxic
community was Alex Green, a.k.a. Ryan Kennedy, a British citizen who created
a Dogecoin exchange called Moolah. Alex Green (his pseudonym) was known in
the community as a lavish tipper who reportedly mistakenly gave $15,000
instead of $1,500 to the NASCAR fundraiser. Green's exchange convinced
members of the community to donate large sums to help fund the creation of
his exchange, but it later surfaced that he had used the donations to buy
more than $1.5 million of Bitcoin that in turn bought him a lavish lifestyle.
Separately, Kennedy was convicted in 2016 of multiple counts of rape and
sentenced to 11 years in prison. Dogecoin During and After the
Crypto Bubble of 2017-2018 Dogecoin's value skyrocketed with
the rest of the cryptoverse during the bubble that peaked at the end of 2017,
and it fell with the rest of the cryptoverse over 2018. At its height, Dogecoin was trading for $0.018 and had a market cap
of over $2 billion. In the summer of 2019, Dogecoin
saw another bump in value along with the rest of the crypto market. Dogecoin
enthusiasts were happy when the crypto exchange Binance listed the coin, and
many thought Tesla CEO Elon Musk had endorsed the coin in a cryptic tweet. Dogecoin in the 2020s Dogecoin's infrastructure has not
been a central source of concern for the coin's developers, however, who are
still volunteers. One reason it still continues to operate and trade,
however, is its active community of miners. As Zachary Mashiach of CryptoIQ
puts it: Numerous Scrypt miners still
prefer Dogecoin (DOGE) over other Scrypt PoW cryptocurrencies. Indeed, the
Dogecoin (DOGE) hash rate is roughly 150 TH/s. This is just below the Litecoin
(LTC) hash rate of 170 TH/s, likely because Dogecoin (DOGE) can be merge
mined with Litecoin (LTC), meaning miners can mine both cryptos
simultaneously using the same work. Essentially, practically everyone who
mines Litecoin (LTC) chooses to mine Dogecoin (DOGE) as well, because merge
mining Dogecoin (DOGE) increases profits. As of Dec. 21, 2020, Dogecoin's
market cap ranking was 43, with a market capitalization of $611 million. Ethereum, Bitcoin, and Dogecoin
Lecture (Thanks, Jack, Madeline, and Thomas) Homework of
chapter 2 (due with first mid term)
What happens when Fed balance sheet is too
big? Answer: Here's why investors
worry about the Fed's balance sheet: If it unwinds too quickly and overly
constrains the money supply, higher borrowing costs could grind the economy
into a recession. However, if there's too much money sloshing around it could
lead to higher inflation. (https://www.northwesternmutual.com/life-and-money/why-investors-care-about-the-feds-balance-sheet/) 2. Write down the
definition of M0, M1, M2 and M3; Which one is used as a measure of money
supply in this country? How much is it by the end of July 2020? 3. From Fed St. Louis website, find the most recent
charts of M1 money stock and M2 money stock. http://research.stlouisfed.org/fred2/categories/24 Compare the two charts and
discuss the differences between the two charts. 4.What
is fractional banking system? Imagine that you
deposited $5,000 in Bank A. Reserve ratio is 0.1. 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? 5.
What is bitcoin? In your view, could bitcoin become a major global
currency? Could governments ban or destroy bitcoin? 6. What is Ethereum? What is
Dogecoin? 7. Among the three crypto currencies
(Bitcoin, Ethereum, and Dogecoin), which one do you recommend? For shrot
term? For long term? 8. Could crypto currency put banks out of business? What is your opinion? |
(continuing from above) 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 Supplemental reading material Can Bitcoin Kill Central Banks? (optional) https://www.investopedia.com/articles/investing/050715/can-bitcoin-kill-central-banks.asp By JAMES MCWHINNEY
Updated Mar 11, 2021 What Is Bitcoin? Bitcoin is a digital
currency that, in the words of its sponsors, “uses peer-to-peer technology to operate with no central
authority or banks.”By its very definition Bitcoin seems well-positioned to kill
off central banks. Could it? Would it? Should it? Like just about everything
else involving finance, the topic of central banks and their potential
replacements is complex with valid arguments for and against. KEY TAKEAWAYS
The History of Central Banks The English refined the
concept of central banking in 1844 with the Bank Charter Act, a legislative
effort that laid the groundwork for an institution that had monopoly power to
issue currency. The idea was that a bank with that level of power could help
stabilize the financial system in times of crisis. It’s a concept that many
experts agree helped stave off disaster during the 2007-2008 financial crisis
and the Great Recession that followed. Central banks have evolved
over time. The U.S. Federal Reserve,
for example, is tasked with using monetary policy as a tool to do the
following:
What Central Banks Do To achieve these objectives,
the Federal Reserve and other central banks can increase or decrease interest
rates and create or destroy money. For example, if the economy seems to be
growing too quickly and causing prices for goods and services to rise so
rapidly that they become unaffordable, a central bank can increase interest
rates to make it more expensive for borrowers to access money. A central bank can also
remove money from the economy by reducing the amount of money the central
bank makes available to other banks for borrowing purposes. Since money
largely exists on electronic balance sheets, simply hitting delete can make
it disappear. Doing so reduces the amount of money available to purchase
goods, theoretically causing prices to fall. Of course, every action has
a reaction. While reducing the amount of money in circulation may cause
prices to fall, it also makes it more difficult for businesses to borrow
money. In turn, these businesses may become cautious, unwilling to invest,
and unwilling to hire new workers. If an economy is not growing
quickly enough, central banks can reduce interest rates or create money.
Reducing interest rates make it less expensive, and therefore easier and more
appealing, for business and consumers to borrow money. Similarly, central
banks can increase the amount of money that banks have available to lend. Central banks can also
engage in additional efforts to manipulate economies. These efforts can include
the purchase of securities (bonds) on the open market in an effort to
generate demand for them. Increased demand leads to lower interest rates, as
borrowers do not need to offer a higher rate because the central bank offers
a ready and willing buyer. Central Bank Policy Risks Central bank-led efforts to
steer economies on to the path to prosperity are fraught with peril. If
interest rates are too low, inflation can become a problem. As prices rise
and consumers can no longer afford to buy the items they wish to purchase,
the economy can slow. If rates are too high, borrowing is stifled and the
economy is hobbled. Low-interest rates (relative
to other nations) cause investors to pull money out of one country and send
it to another country that offers a greater return in the form of higher
interest rates. Consider the plight of retirees who rely on high-interest
rates to generate income. If rates are low, these people suffer a direct hit
to their purchasing power and ability to pay their bills. Sending cash to a
country that offers better returns is a logical decision. Manipulation of interest
rates and/or the money supply also has a direct effect on the value of a
nation’s currency. A strong dollar makes it more expensive for
domestic firms to sell goods abroad. This can lead to domestic unemployment.
A weak dollar increases the price of imported goods, including oil and other
commodities. This can make it more
expensive for consumers to purchase imports and for domestic companies to
produce goods that rely on imported parts or materials. Arguably, a weak
dollar is beneficial for a slow economy that needs to pick up steam while a
strong dollar is good for consumers. Because there is a lag between the time a central bank begins
to implement a policy change and that change actually having an impact on a
nation’s economy, central banks are always looking to the future.
They want to make policy changes today that will enable them to achieve
future goals. Arguments Against Central
Banks The very complexities
associated with national and global economies set the stage for an argument
that these economies are too unpredictable to be successfully managed by the
type of manipulation central banks engage in. This argument, made by
proponents of the Austrian School of Economics, can be used to support the
implementation of Bitcoin-style peer-to-peer currency that eliminates central
banks and their complex schemes. Negative Impact on Citizens
and the Economy Modern central banks have
been the subject of controversy since their inception. And the reasons for
discontent are wide and varied. On one hand, the concept of monopoly power is
profoundly disturbing to many people. On another, the existence of an
independent, opaque entity that has the power to manipulate an economy is
even more disturbing. Many people (including
economists and politicians) believe that central banks make mistakes that
have enormous ramifications in the lives of citizens. These mistakes include: Increases in the monetary supply
(creating inflation and hurting consumers by raising prices for the goods and
services they purchase) The implementation of
interest rate increases (hurting consumers who wish to borrow money) The formulation of policies
that keep inflation too low (resulting in unemployment) The implementation of
unnaturally low-interest rates (creating asset bubbles in real estate,
stocks, or bonds) Along these lines, no less
an authority than former Chair of the Federal Reserve Ben Bernanke blames
manipulation by the central bank (which raised interest rates) for the Great
Depression of 1929. The Impact of Technology In an era when technology
has enabled consumers to engage in commerce without the need for a central
authority, an argument can be made that central banks are no longer
necessary. A broader examination of the banking system extends this argument. Corruption associated with
the banking system resulted in the Great Recession and a host of scandals.
Bankers have caused great angst in Greece and other nations. Organizations
such as the International Monetary Fund have been cited for fostering profits
over people. And at the more local level, bankers make billions of dollars by
serving as the middlemen in transactions between individuals. In this
environment, the elimination of the entire banking system is an appealing
concept to many people. The Bottom Line Central banks are currently the dominant structure nations use
to manage their economies. They have monopoly power and are not going to give
up that power without a fight. While Bitcoin and other digital currencies
have generated significant interest, their adoption rates are minuscule and
government support for them is virtually nonexistent. Until and unless governments recognize Bitcoin as a legitimate
currency, it has little hope of killing off central banks any time soon. That noted, central banks across the globe are
watching and studying Bitcoin. Based on the fact that metal coins are
expensive to manufacture (often costing more than their face value), it is
more likely than not that central banks will one day issue digital currencies
of their win. Bank
of America, JPMorgan Call Cryptocurrencies a Threat (optional) https://www.investopedia.com/news/bank-america-calls-cryptocurrencies-risk-its-business/ By DAVID FLOYD Updated Jun 25, 2019 In its annual 10-K filing with
the Securities and Exchange Commission (SEC), released Feb. 22, Bank of
America Corp. (BAC) listed cryptocurrencies among the risk factors that could
impact the bank's competitiveness and reduce its revenues and profits. The disclosure
was followed on Feb. 27 by a similar message from JPMorgan Chase & Co. (JPM), whose CEO, Jamie Dimon, has
previously called bitcoin a "fraud." The idea that bitcoin and other
cryptocurrencies pose a threat to incumbent financial institutions is as old
as Satoshi Nakamoto's whitepaper, the abstract of which begins, "A purely peer-to-peer version of
electronic cash would allow online payments to be sent directly from one
party to another without going through a financial institution." But
the idea that this threat was real – much less imminent or existential – was
long limited to enthusiasts’ forums, dedicated subreddits and certain corners
of Twitter. To be sure, Bank of America's
brief mentions of cryptocurrencies as risk factors – first spotted by the
Financial Times – hardly signal panic. The bank describes three ways in which
cryptocurrencies could pose a threat. The first two implicitly denigrate the
new assets. "Emerging technologies, such as cryptocurrencies, could
limit our ability to track the movement of funds," the filing says,
making it harder for Bank of America to comply with know-your-customer and
anti-money-laundering regulations. "Further," the bank
writes, "clients may choose to conduct business with other market
participants who engage in business or offer products in areas we deem
speculative or risky, such as cryptocurrencies." The
third risk factor, however, does not derive from cryptocurrencies’ legal
complications or flighty customers' susceptibility to bubbles. It derives
from bitcoin's ability to bypass intermediaries: "Additionally, the
competitive landscape may be impacted by the growth of non-depository
institutions that offer products that were traditionally banking products as
well as new innovative products. This can reduce our net interest margin and
revenues from our fee-based products and services. In addition, the
widespread adoption of new technologies, including internet services,
cryptocurrencies and payment systems, could require substantial expenditures
to modify or adapt our existing products and services as we grow and develop
our internet banking and mobile banking channel strategies in addition to
remote connectivity solutions." If that disclosure is a bit
mealy-mouthed, JPMorgan's is to-the-point, almost echoing Nakamoto's
language: "both financial institutions and their non-banking competitors face
the risk that payment processing and other services could be disrupted by
technologies, such as cryptocurrencies, that require no intermediation. New
technologies have required and could require JPMorgan Chase to spend more to
modify or adapt its products to attract and retain clients and customers or
to match products and services offered by its competitors, including
technology companies." A Real Threat? While
decentralized financial networks could threaten banks' long-term viability,
the immediate threat posed by bitcoin and its peers is negligible. Bitcoin
in particular has several widely acknowledged flaws, which its detractors see
as crippling. It can process only a handful of transactions per second,
compared to the tens of thousands major credit card networks can handle.
As Bank of America mentioned, its quasi-anonymity makes its use dicey if not
illegal for certain applications, particularly by heavily regulated
institutions. Its price in fiat terms
is so volatile that accepting a salary or taking out a mortgage in bitcoin
would be extremely risky. Finally, its occasionally high and generally
unpredictable fees make it all but worthless for small transactions.
Other cryptocurrencies have made attempts to solve one or more of these
problems, with limited success. At the same time, bitcoin and its
peers enable something that has never before been possible in human history:
transacting at a distance without placing trust in an intermediary. Banks' business models depend on their
role as trusted nodes in a centralized financial system. Replacing them with
a decentralized network remains firmly in the realm of theory. But it is,
as Bank of America and JPMorgan appear to acknowledge, theoretically
possible. (See also, Blockchain Could Make You—Not Equifax—the Owner of Your
Data.) Blockchain Not Bitcoin While this is the first time big
banks' 10-Ks have hinted at the fundamental threat posed by peer-to-peer
money, the sector has engaged in a multi-year dialogue with proponents of
cryptocurrencies. Mostly it has been acrimonious. Charlie Munger, vice-chair of
Berkshire Hathaway Inc. (BRK-A, BRK-B) called bitcoin "noxious
poison" earlier in February. Berkshire's biggest stock holding is Wells
Fargo & Co. (WFC), which opened perhaps 3.5 million fake accounts in
customers' names without their permission from 2009 to 2016. Munger said
regulators should "let up" on the lender following this scandal,
which bitcoin's proponents might argue illustrates the "inherent
weakness of the trust based model" – Nakamoto's words. (See also, Wells
Fargo CEO John Stumpf to Retire Immediately.) Dimon, JPMorgan's CEO, has called
bitcoin a fraud, but has expressed enthusiasm for the underlying blockchain
technology. This blockchain-not-bitcoin line has been echoed by a number of
other financial incumbents, and it's hinted at in the 10-K's suggestion that JPMorgan could have to "modify or
adapt its products." The bank is already building a blockchain platform
called Quorum. In fact almost every major lender
has joined one blockchain consortium or another, and central bankers – most
recently the Bank of England's Mark Carney – have expressed enthusiasm for
blockchain that does not extend to bitcoin. When Is a Blockchain Not a
Blockchain? Critics of this
blockchain-not-bitcoin posture see it as a way of deflecting attention from
bitcoin's core innovation. Bitcoin and other blockchain-based assets offer
distributed networks in which value can be transferred without trusting any
single party, such as a bank. According to this logic, banks cannot innovate their way out of trouble by building their
own decentralized networks: banks are necessarily absent from any such
network. Another critique is that blockchain technology – at least the most
reliably secure form, known as proof of work – is highly inefficient (and
carries potentially severe environmental consequences). Centralized parties
such as banks have little obvious reason to employ blockchains, which offer
no advantage over traditional databases – unless the goal is decentralization
– and promise to consume vastly more electricity in order to process
transactions at slower speeds. Banks have countered that blockchain
technology can speed up settlement times, particularly for complicated
derivatives trades. (See also, How Does Bitcoin Mining Work?) On the other hand, many proposed
enterprise blockchains use alternative consensus models, which are more
similar to proof of stake than proof of work. These models are potentially
more energy efficient but, critics argue, have not demonstrated the same
security as proof of work. It may make some sense for large
consortia of banks to employ blockchains, since they could allow all parties
to transact among themselves without trusting each other. The issue is that,
in order to be trustless, a blockchain-based network must be at least half
honest. If even the slimmest majority of banks collude, the network can
suffer a so-called 51% attack. Past manipulation of rates and markets for
currencies and precious metals by groups of financial institutions indicate
that is not an unreasonable concern. In any case, though, it is not
necessary for banks to explicitly conspire to compromise a network. Blockchains are intended to enable
commerce among networks of nodes who do not know or trust each other at all.
Even if a majority of participants shares an interest in common – which is
not unlikely in a group of a couple dozen financial incumbents – the network
is insecure enough. That is, the added inefficiencies of using blockchain
technology may outweigh the benefits of decentralization. "Some of these platforms are
developed to be kind of replicas of the old system," MIT assistant
professor of technological innovation, entrepreneurship and strategic
management Christian Catalini told Investopedia in September, "where the
trusted intermediary has almost the same control, or exactly the same control,
it would have had in the old system. And then you're wondering, why are we switching to a less efficient
IT infrastructure? Because it's trendy?" That, or to mitigate a growing
threat. |
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Chapter 3 Financial
Instruments, Financial Markets, and Financial Institutions Part I: Examples and characteristics of financial
instruments What
Is a Financial Instrument? Video
https://www.investopedia.com/terms/f/financialinstrument.asp Financial
instruments are assets that can be traded, or they can also be seen as
packages of capital that may be traded. Most types of
financial instruments provide efficient flow and transfer of capital all
throughout the world's investors. These assets can be cash, a contractual
right to deliver or receive cash or another type of financial instrument, or
evidence of one's ownership of an entity. KEY TAKEAWAYS
Understanding Financial Instruments Financial
instruments can be real or virtual documents representing a legal agreement
involving any kind of monetary value. Equity-based financial instruments
represent ownership of an asset. Debt-based financial instruments represent a
loan made by an investor to the owner of the asset. Foreign exchange instruments
comprise a third, unique type of financial instrument. Different
subcategories of each instrument type exist, such as preferred share equity
and common share equity. International Accounting
Standards (IAS) defines financial
instruments as "any contract that gives rise to a financial asset of one
entity and a financial liability or equity instrument of another
entity." Types
of Financial Instruments Financial
instruments may be divided into two types: cash instruments and derivative
instruments. Cash Instruments The
values of cash instruments are directly influenced and determined by the
markets. These can be securities that are easily
transferable. Cash instruments may also be deposits
and loans agreed upon by borrowers and lenders. Derivative Instruments The value and characteristics of
derivative instruments are based on the vehicle’s underlying components, such
as assets, interest rates, or indices. An equity options contract, for
example, is a derivative because it derives its value from the underlying
stock. The option gives the right, but not the obligation, to buy or sell the
stock at a specified price and by a certain date. As the price of the stock
rises and falls, so too does the value of the option although not necessarily
by the same percentage. There can be over-the-counter
(OTC) derivatives or exchange-traded derivatives. OTC is a market or process
whereby securities–that are not listed on formal exchanges–are priced and
traded. Types of Asset Classes of
Financial Instruments Financial instruments may also be
divided according to an asset class, which depends on whether they are
debt-based or equity-based. Debt-Based Financial Instruments Short-term debt-based financial
instruments last for one year or less. Securities of this kind come in the
form of T-bills and commercial paper. Cash of this kind can be deposits and
certificates of deposit (CDs). Exchange-traded derivatives under
short-term, debt-based financial instruments can be short-term interest rate
futures. OTC derivatives are forward rate agreements. Long-term debt-based financial
instruments last for more than a year. Under securities, these are bonds.
Cash equivalents are loans. Exchange-traded derivatives are bond futures and
options on bond futures. OTC derivatives are interest rate swaps, interest
rate caps and floors, interest rate options, and exotic derivatives. Equity-Based Financial
Instruments Securities under equity-based
financial instruments are stocks. Exchange-traded derivatives in this
category include stock options and equity futures. The OTC derivatives are
stock options and exotic derivatives. Getting
to Know the Money Market By BARCLAY PALMER Updated June 08,
2021 https://www.investopedia.com/articles/04/071304.asp The major attributes that draw an
investor to short-term money market instruments are superior safety and
liquidity. Money market instruments
have maturities that range from one day to one year, although they are most
often three months or less.
Because these investments are associated with massive and actively traded
secondary markets, you can almost always sell them prior to maturity, albeit
at the price of forgoing the interest you would have gained by holding them
until maturity. Types of Money Market Instruments A large number of financial
instruments have been created for the purposes of short-term lending and
borrowing. Many of these money market instruments are quite specialized, and
they are typically traded only by those with intimate knowledge of the money
market, such as banks and large financial institutions. Some
examples of these specialized instruments are federal funds, the discount
window, negotiable certificates of deposit (NCDs), eurodollar time deposits,
repurchase agreements, government-sponsored enterprise securities, shares in
money market instruments, futures contracts, futures options, and swaps. Aside from these specialized
instruments on the money market are the investment vehicles with which
individual investors will be more familiar, such as short-term investment pools (STIPs) and money market mutual funds,
Treasury bills, short-term municipal securities, commercial paper, and
bankers' acceptances. Here we take a closer look at STIPs, money market
mutual funds, and Treasury bills. Short-Term Investment Pools and
Money Market Mutual Funds Short-term
investment pools (STIPs) include money market mutual funds, local government
investment pools, and short-term investment funds of bank trust departments.
All STIPs are sold as shares in very
large pools of money market instruments, which may include any or all of the
money market instruments mentioned above. In other words, STIPs are a convenient means of
cumulating various money market products into one product, just as an
equity or fixed income mutual fund brings together a variety of stocks,
bonds, and so forth. STIPs
make specialized money market instruments accessible to individual investors
without requiring intimate knowledge of the various instruments contained
within the pool. STIPs also alleviate the large minimum investment amounts
required to purchase most money market instruments, which generally equal or
exceed $100,000. Money
market accounts are safe, low-risk investments. They're generally a good
place to put your money, especially if you need immediate access to it while
you collect interest. Institutions offer higher
interest rates because they use the funds in money market accounts to invest
in short-term assets with short-term maturities, as noted above. How does the Money Market work? (video)
Part II:
Order types
|
Robinhood will give retail investors
access to IPO shares (optional) PUBLISHED
THU, MAY 20 2021 11:44 AM EDTUPDATED THU, MAY 20 20211:34 PM EDT Maggie
Fitzgerald Robinhood said it is
giving retail investors access to IPO shares. Retail traders typically don’t
have a vehicle to buy into newly listed companies until those shares begin
trading on an exchange. Robinhood will
not be an underwriter for companies
hitting the public markets but the stock trading company will get an allocation
of shares by partnering with investment banks. It is unclear if
Robinhood clients will be able to invest in Robinhood’s pending market debut. IPO
shares have historically been set aside for Wall Street’s institutional
investors or high-net worth individuals. Retail traders typically don’t have
a vehicle to buy into newly listed companies until those shares begin trading
on an exchange, which is often after the share price has surged.
“We’re starting to roll out IPO Access, a new product that will give you the
opportunity to buy shares of companies at their IPO price, before trading on
public exchanges. With IPO Access, you can now participate in upcoming IPOs
with no account minimums,” Robinhood said in a blog post Thursday. Robinhood will not be
an underwriter for companies hitting the public markets but will get an
allocation of shares by partnering with investment banks. This move is
Robinhood’s latest to antagonize Wall Street. IPO stock pops on the first day averaged 36% in 2020, according
to Dealogic, demonstrating individual investor thirst for some of these
popular names that is not priced into IPO pricing. These are gains the little
guy is missing out on. The traditional IPO
process has been criticized in recent years as being broken, with investment
banks allotting the shares to big clients who reap the instant first-day
gains. Going public by way of direct listing has combated some of these
criticisms. Using
IPO Access, Robinhood clients will be able to request to buy shares at their initial
listing price range. When the final price is set, clients will be able to go through with
the purchase, change or cancel. “We currently anticipate that up to 1.0% of
the shares of Class A common stock offered hereby will, at our request, be
offered to retail investors through Robinhood Financial, LLC, as a selling
group member, via its online brokerage platform,” Figs said in its S1 filing
document. “This is the first
initial public offering to be included on the Robinhood platform and there
may be risks associated with the use of the Robinhood platform that we cannot
foresee, including risks related to the technology and operation of the
platform, and the publicity and the use of social media by users of the
platform that we cannot control,” the company added. The IPO date isn’t
set, but companies typically go public one to months after their S1
prospectus is filed with the SEC. It is unclear if
Robinhood clients will be able to invest in Robinhood’s pending IPO. The stock
trading app is expected to go public in the first half of 2021 and has filed
confidentially with the SEC. IPO Access will be
rolled out to all clients over the next few weeks. Robinhood’s
IPO product comes on the heels of record levels of new, younger traders
entering the stock market during the pandemic.
That surge has continued into 2021, marked by frenzied trading around
so-called meme stocks like GameStop. Online finance
start-up SoFi made a move similar to Robinhood’s in March; however, Sofi will
be an underwriter for its offered IPOs. https://robinhood.com/us/en/support/articles/ipo-access/
For discussion:
·
What advantage to
buy pre-IPO shares?
·
What risks are
associated with it?
Ex-NYSE
President Tom Farley’s SPAC to merge with Bullish to bring planned crypto
exchange public (optional) PUBLISHED FRI, JUL 9 20218:31 AM
EDTUPDATED FRI, JUL 9 202111:27 AM EDT Kevin Stankiewicz KEY POINTS Tom Farley’s Far Peak Acquisition
Corp. announced a deal Friday to bring
crypto start-up Bullish public. Farley’s Far Peak Acquisition
Corp. SPAC was up more than 2% in late-morning trading on the news. Backed by venture capitalist
Peter Thiel, Bullish plans to launch a
cryptocurrency exchange later this year. Farley, formerly the New York
Stock Exchange president, will serve as CEO of Bullish when the deal closes.
Crypto start-up Bullish plans to go public in a reverse merger with a special
purpose acquisition company backed by Tom Farley, former president of the New
York Stock Exchange. Farley’s Far Peak Acquisition
Corp. SPAC was up more than 2% in late-morning trading on the news. The deal, announced Friday, is
expected to close by the end of 2021 — and Farley, who oversaw the NYSE from
2014 to 2018, will become CEO of Bullish when that happens. “This is a big idea whose time
has come,” Farley said in an interview on CNBC’s “Squawk Box,” shortly after
the deal was announced. “Digital assets are here to stay. The smartest engineering talent is
going into digital assets; digital assets are solving very important
problems. Anybody who tells you they know exactly how it’s going to turn out
is lying or delusional, but in general, you’re going to see more and more
interesting use cases, more and more dollars go into the space,” he
added. Farley’s
plan to lead the cryptocurrency exchange is noteworthy given his experience
with financial regulators from his time at the NYSE.
The prospect of additional regulation in the U.S. is being watched closely by
the crypto industry. Bullish expects to receive around
$600 million in proceeds from Far Peak, plus another $300 million through a
PIPE, or private investment in public equity. A host of big-name investors
are participating in the PIPE, including BlackRock, the world’s largest asset
manager, and Mike Novogratz’s crypto-focused financial services firm Galaxy
Digital. The merger between Far Peak and
Bullish implies a pro forma equity value of roughly $9 billion, according to
a press release. Bullish intends to launch “a
revolutionary, regulated cryptocurrency exchange” later this year, with a
private pilot program beginning in the coming weeks, the press release said.
The exchange will offer “deep, predictable liquidity with technology that
enables retail and institutional investors to generate yield from their
digital assets,” the release said. Bullish started in May as a
subsidiary of Block.one, a blockchain company with backing from well-known
investors including Peter Thiel, a PayPal co-founder and prominent venture
capitalist. Thiel’s firms, Thiel Capital and
Founders Fund, participated in Bullish’s capital raise in May. Additional
investors in Bullish include British hedge fund manager Alan Howard, Galaxy
Digital and Richard Li, a billionaire businessman from Hong Kong. The
institutional adoption of bitcoin and other cryptocurrencies has been a big
topic in the past year. Companies such as Tesla and Square have invested in bitcoin
to hold on their balance sheet, and major Wall Street
banks have taken steps to provide wealth management clients exposure to
digital assets. In
April, the most popular U.S. crypto exchange, Coinbase, went public through a
direct listing on the Nasdaq, a development that
was heralded as a watershed for the nascent yet ascendant industry. Coinbase’s public market debut
coincided with bitcoin’s current all-time high near $65,000 per unit. However, the world’s largest
cryptocurrency by market value has struggled since then due to a number of
factors, including the Chinese government intensifying its crypto crackdown.
Bitcoin traded below $33,000 on Friday morning. Last month, it plunged
briefly below $29,000 where it started the year. Bitcoin and other
cryptocurrencies such as ether run on decentralized digital ledgers known as
blockchains. While the digital asset
industry has its fierce critics, its supporters see potential to disrupt
traditional finance with the use of so-called smart contracts and other
blockchain-related innovations. In a CNBC interview in April,
Farley said he believes the crypto space is “the best kept secret in the
world and maybe the history of the financial markets.” In 2015, while Farley was still
president, the NYSE made a minority investment in Coinbase. |
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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. Homework
(just write down the PV equations – Due with the first mid term exam): Solution
FYI 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) |
Summary of math and excel equations Math 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: |
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First Mid Term Exam
– taken in classroom, close book,
close notes, 9/23, in class Study Guide 1. What are the six parts of the financial
markets 2. What are the five core
principals of finance 3. Why do we need stock
exchanges? 4. What is high frequency
trading? pros and cons? What is spoofing? 5. What is flash crash?
How does it make investors so worried? How can HFT trigger flash crash? 6. What is M0? MB? M1?
M2? M3? 7. What could happen if
we increase money supply? What about decrease
money supply? What is QE? 8. Why M2 is >> M0?
Why M2>>M1? 9. “In a fractional reserve banking system, banks create
money when they make loans. Bank reserves have a multiplier effect on the money supply.”
This sentence is right or wrong? Please provide your rational 10. Imagine
that you deposited $1,000 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? 11. What is bitcoin? What is Etherum? What is
Dogecoin? In your view, could bitcoin become a major global currency? 12. Could cryptocurrency
put banks out of business? 13. As an investor,
besides market order, what other types of orders can use choose from? Show
definitions and examples. 14. What is short sell? Do
you think that short Apple stock is a good idea? Why or why not? What about
short GameStop? Short Tesla? 15. What is IPO? Why shall
you buy stocks pre-IPO shares? 17. Compare primary market
vs. secondary market. 18. Time value of money
questions – show math equations only. No need of excel or calculator. 19. In your view, what
might trigger the next financial crisis? Why? 20. Compare NYSE with
NASDAQ. |
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Chapter 6 Bond Market 1. Cash flow of bonds
The above graph shows the cash flow of
a five year 5% coupon bond. http://finra-markets.morningstar.com/BondCenter/Default.jsp
For example: a 3 year bond 10% coupon rate, draw its cash flow. Introduction to bond investing (video) 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) Bond risk – how to reduce your risk (video) 3. Choices of investment in bonds FINRA – Bond market information http://finra-markets.morningstar.com/BondCenter/Default.jsp Treasury Bond Auction and Market information http://www.treasurydirect.gov/ Treasury Bond Corporate Bond Municipal Bond International Bond Bond Mutual Fund TIPs Class
discussion Topic I:
·
As a college student, which type of bonds shall
you buy? Why? ·
Looking forward, inflation might be a threat to
the economy. How can you hedge the inflation risk with bonds? Class discussion
Topics II ·
You can invest in junk bonds. Shall you? Or shall
you not? ·
In a low interest rate economy, is it wise to
invest in high yield bond? What is a high yield bond (Video) 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) How to trade high-yield bond ETFs in this market
environment (optional, video)
Everything
You Need to Know About Junk Bonds (video) Updated Aug 17, 2019 For many investors, the term "junk bond" evokes thoughts of investment scams and high-flying financiers of the 1980s, such as Ivan Boesky and Michael Milken, who were known as "junk-bond kings." But don't let the term fool you—if you own a bond fund, these worthless-sounding investments may have already found their way into your portfolio. Here's what you need to know about junk bonds. Junk Bonds From a technical viewpoint, a junk bond is exactly the same as a regular bond. Junk bonds are an IOU from a corporation or organization that states the amount it will pay you back (principal), the date it will pay you back (maturity date), and the interest (coupon) it will pay you on the borrowed money. 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. Junk Bonds – These are the bonds that pay high yield
to bondholders because the borrowers don't have any other option. Their
credit ratings are less than pristine, making it difficult for them to
acquire capital at an inexpensive cost. Junk bonds are typically rated 'BB'
or lower by Standard & Poor's and 'Ba' or lower by Moody’s. Think of a bond rating as the report card for a company's credit rating. Blue-chip firms that provide a safer investment have a high rating, while risky companies have a low rating. 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. Junk bonds can be broken down
into two other categories:
Who Buys Junk Bonds?
You need to know a few things before you run out and tell
your broker to buy all the junk bonds he can find. The obvious
caveat is that junk bonds are high risk. With this bond type, you risk the
chance that you will never get your money back. Secondly, investing in junk
bonds requires a high degree of analytical skills, particularly knowledge of
specialized credit. Short and sweet, investing
directly in junk is mainly for rich and motivated individuals. This market is overwhelmingly dominated
by institutional investors. This isn't to say that junk-bond investing is strictly for the
wealthy. For many individual investors, using a high-yield bond
fund makes a lot of sense. Not only do these funds allow you to take
advantage of professionals who spend their entire day researching junk bonds,
but these funds also lower your risk by diversifying your investments across
different asset types. One important note: know how long you can commit your
cash before you decide to buy a junk fund. Many junk bond funds do not allow
investors to cash out for one to two years. Also, there comes a point in time when the rewards of junk
bonds don't justify the risks. Any individual investor can determine this by
looking at the yield spread between junk bonds and U.S. Treasuries. As
we already mentioned, the yield on junk is historically 4% to 6% above
Treasuries. If you notice the yield
spread shrinking below 4%, then it probably isn't the best time to invest in
junk bonds. Another thing to look for is the default rate on junk bonds. An
easy way to track this is by checking the Moody's website. The final warning is that junk bonds are not much different
than equities in that they follow boom and bust cycles. In the early 1990s,
many bond funds earned upwards of 30% annual returns, but a flood of defaults
can cause these funds to produce stunning negative returns. The
Bottom Line
Despite their name, junk
bonds can be valuable investments for informed investors, but their potential
high returns come with the potential for high risk.
International Bond For discussion: Should you invest in foreign bonds? China is
snapping up Japanese government bonds, and it’s not just for the returns PUBLISHED TUE,
OCT 13 2020 8:58 PM EDT Weizhen Tan https://www.cnbc.com/2020/10/14/why-china-is-buying-up-more-japanese-government-bonds.html KEY POINTS · China bought 1.46 trillion yen ($13.8 billion) in medium to long-term Japanese government bonds on a net basis between April and July. That was 3.6 times more than the same period last year. · In the same period, the U.S. increased its purchases by only 30%, in comparison. Europe, meanwhile, sold off 3 trillion yen worth of JGBs. · Yields on such bonds are near zero, making them an unlikely option as an investment. But analysts told CNBC there are other reasons why China would want to buy those bonds. SINGAPORE — China’s recent purchase of Japanese government bonds surged to the
highest level in more than three years – as the country more than tripled
its holdings between April and July this year, compared to the previous year. During those
three months in 2020, China bought
1.46 trillion yen ($13.8 billion) of medium- to long-term JGBs on a net basis,
according to Japanese media Nikkei, which cited data from Japan’s finance
ministry and its central bank. That
was 3.6 times more than the same period last year. In comparison, the U.S. increased its purchases by
only 30% in the same period, that data reportedly showed. Europe, meanwhile, sold off 3 trillion yen worth of JGBs, according to
Nikkei. Yields on JGBs are around zero, making them an
unlikely option as an investment since the returns are comparatively low. But analysts
told CNBC there could be other reasons why China would want to buy those
bonds. “One of the
odd things about the current environment is that JGBs are no longer an obviously unattractive fixed income security,
depending on the currency you are funding the purchase in,” said Ross
Hutchison, investment director of global fixed income at Aberdeen Standard
Investments. For instance, China
can actually earn more on the investment by buying 30-year JGBs in the
Japanese yen and swapping their currency exposure back into U.S. dollars, said
Hutchison. It can pick up an additional 0.56% by doing so, according to him. Longer term bonds typically have higher
yields as investors need to take on higher risks for holding on to them for a
longer period of time. The practice of a currency swap is when two
parties exchange an equivalent amount of money with each other in different
currencies, in order to protect themselves from further exposure to exchange
rate risk,
for instance. “Many reserve managers buy JGBs and then swap or
hedge the currency back into dollars, earning an additional ‘basis’ premium,” said David
Nowakowski, a senior strategist of multi-asset and macro at Aviva Investors. It’s also
possible that China may be trying to
manage the appreciation of the yuan, as the Chinese currency spiked
against the Japanese yen in June, Hutchison pointed out. Selling off the yuan to buy JGBs, which are denominated in yen, could
help to curb some of that appreciation. The yuan has also broadly spiked against the U.S.
dollar this year, as the Chinese economy gathers momentum again after what
may have been the worst of the coronavirus pandemic. What is
currency manipulation? Another factor
is that in comparison to its global counterparts, Japanese government bonds
do not have the lowest yields, Nowakowski said. “Even with a zero yield — in fact JGB
yields are slightly below 0% — Japan’s bond market is more attractive than
many other countries’ bonds, with Sweden,
Switzerland, and core Eurozone countries all having deeply negative yields,”
he said. Treasury yields globally this year have gone down
as investors flocked to the safety of government bonds amid the worsening
pandemic. As prices go up, yields fall as they move inversely to each other. 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 (hint: cash flows include
coupon per year plus principal at maturity) 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) 3. Compare municipal bond, TIPS, corporate
bond and Treasury bond in terms of issuers, pro and cons (risk). 4. As a bond investor, do you plan to invest
in junk bond? Why or why not? 5. In “The junk bond market is on fire
this year as yields hit a record low”, it states that “what kills a credit rally is
the Fed tightening. More hawkish than expected rhetoric from the Fed can kill
a credit rally as well”. Why is that? 6. Do you think that Japanese government bond is
a good option for diversification? Why or why not? |
The junk bond market is on fire this year as
yields hit a record low PUBLISHED WED,
JUL 14 2021 10:38 AM EDTUPDATED THU,
JUL 15 20214:58 PM EDT Jeff Cox KEY POINTS ·
Junk
bonds have seen a record low in yields as strong balance sheets and a
changing economy have boosted the market. ·
Fixed
income traders see the move in the market backed by strong fundamentals and a
quest for yield of any type. ·
Issuance
in the low-grade category is on pace to smash previous records. Junk bonds aren’t so junky anymore, with a strong
fundamental backdrop helping to underpin what traditionally has been one of
the riskiest sections of the financial markets. Yields in the
$10.6 trillion space for the lowest-grade bonds in terms of quality are
around historic lows after a tumultuous year that saw corporate America face
down the Covid-19 pandemic and come out on the other side with balance sheets
looking extraordinarily strong. Bond yields decline as prices rise; the two have
an inverse relationship to each other. Most recently,
the junk bond sector collectively was yielding 3.97%, according to the ICE
Bank of America High-Yield index. That’s up from a record low of 3.89% on
Monday. In March 2020,
during the worst of the pandemic volatility, the yield was at 9.2%. This is the first time in history that
the collective yield for junk has been below the rate of inflation as
measured by the consumer price index, which rose 5.4% in June year over year.
At the same time, spreads, or the difference
between high-yield and Treasurys of similar duration, have fallen to 3.05%,
just off the lowest since June 2007. Falling junk
bond yields aren’t a concern – yet While the prospect of the poorest-rated companies
being able to pay less than 4% to issue debt might raise the specter of a
bubble in the making, most bond pros don’t see any major problems brewing, at least not
yet. “Corporations
weathered the storm last year and have positioned themselves really well,”
said Collin Martin, fixed income strategist at Charles Schwab. “Couple that with yield-starved investors going
into anything and everything that offer better than a 0% yield, and it’s
really the perfect storm to see spreads drop to those pre-financial crisis
levels.” Companies have built huge cash positions over the
past several years, with total liquid assets at nonfinancial companies
totaling $6.4 trillion through the first quarter of 2021, according to
the Federal Reserve. That’s up nearly 50% just since 2018. They’ve built cash as they’ve taken advantage of
interest rates that the Fed has kept around record lows, a situation that’s
proven particularly advantageous for lower-quality companies. High-yield debt issuance has totaled $298.7
billion in 2021, up 51.1% from the same point in 2020, a year
itself that saw a record-smashing $421.4 billion in junk issuance, according
to SIFMA data. At the same time, investment-grade issuance has plunged 32.7%
this year.
While
investors have been avoiding ETFs that trade in the high-yield market – the
above-mentioned JNK ETF actually has seen outflows of $3.34 billion in 2021 –
mutual fund and institutional investors have been willing to take on the risk
to capture some yield.
“It’s a tough world as an investor, because
valuations are awful but fundamentals are pretty good. Usually, fundamentals
win out,”
said Tom Graff, head of fixed income at Brown Advisory. “We’re pretty
cautious on high yield. We own some. That risk-reward is so skewed right now,
but you need to be realistic. It’s probably not going to go the other way
anytime real soon.” Like others
who spoke about junk, Graff said investors
can protect themselves by moving up the quality ladder – single- or double-B
companies rather than the riskier C-rated. Fallen angels
vs. rising stars Part of that
story is an interesting reversal in dynamics for the broader bond market. One of the big
worries for the past two years has been the increase in what bond pros call “fallen angels,” or companies that were
investment grade but have slid down the ladder. However, that narrative
has changed, with investors now
looking for “rising stars,” or companies that are climbing in credit quality. Companies that
once were investment grade and descended into speculative have raised the
overall profile of the lower-graded parts of the market, and themselves could
keep moving higher as their balance sheets improve. Some examples of firms moving up the ladder
through this year are First Energy, Murphy Oil and Booz Allen Hamilton, according to
Moody’s Investor Service. Those
heading in the fallen angel direction include Darden Restaurants, Delta Air
Lines and General Motors. “Because of all the downgrades that we saw
last year, the credit quality in the market is higher than it’s ever been
historically,” said Bill Ahmuty, head of the SPDR Fixed Income Group at State
Street Global Advisors. “That’s helping to drive overall yields lower and
spreads a little lower.” Wall Street is
expecting the level of companies moving up the quality scale to increase
considerably through 2022 after little change in a 2020 market that saw a
near-record amount of fallen angels. Citing
Barclays data, Ahmuty said rising
stars will account for four or five times as much debt as fallen angels
through 2022. At the same time, default levels are projected to be well
below historical averages. “High-yield
indices are higher in credit quality. You have lower projected default rates
and you have this component where you’re going to see rising stars over the
next couple of years,” he said. “There’s a good fundamental backdrop there.” The ill
effects of inflation One element that could spoil the high-yield party
is inflation. The CPI’s nearly 13-year high in June is another
signal that inflationary pressures remain and are a longer-term threat to
push up interest rates. Since yields and prices move in opposite direction,
higher bond yields would eat into capital price appreciation for bondholders,
and especially hurt those in funds. The Federal
Reserve has vowed to stay on the sidelines until its employment objectives
are met, but the threat of a tighter central bank always looms over the bond
market. “What kills a credit rally is the Fed
tightening. More hawkish than expected rhetoric from the Fed can kill a
credit rally as well,” Martin, the Schwab strategist, said. “We’ve seen
very high inflation spikes and indications from the Fed for more hikes than
anticipated. But the markets are just shrugging it off.” For Bonds, Add Safety by Venturing Abroad Investors often neglect to add international bond
funds to their investments. That failure can increase overall risk and raise
the chance of missing savings goals. A broad range of
international holdings can add stability to a domestic portfolio. By Tim Gray
April 8, 2021 https://www.nytimes.com/2021/04/08/business/bonds-safety-international-risk.html Making your
bond-fund portfolio less risky requires doing something that can feel like
living dangerously: investing abroad. If you’re like
most people, you may have put too much of your money in bond funds invested
in your home market and so failed to spread your bets around. “People are
used to thinking about diversification in their stock portfolio, and they
understand how that works to control the risk,” said Rob Waldner, chief
strategist for fixed income at Invesco. “You need to do that with your fixed
income, too.” Bond diversification matters all the more when
traditional income producers like U.S. Treasuries are paying measly rates, he said. With the
pandemic beginning to wane, bond yields are ticking up — the 10-year U.S.
Treasury, a benchmark bond, was paying 1.7 percent in early April, compared
with less than 1 percent in January. But rates are likely to remain
relatively low by long-term standards. A well-diversified portfolio might include mutual
funds or exchange-traded funds that buy bonds issued by the United States and
foreign governments, and large U.S. and foreign companies, as well as ones
backed by mortgages, auto loans or credit-card receivables in the United
States.
(Pools of these financial assets are
securitized, and rights to payments from the pools become mortgage-backed and
asset-backed bonds.) “Home bias” is
the financial term for people’s tendency to over-invest in their home market
and shy from other places. Investment experts say it’s pervasive. “It’s something
we observe in every country,” said Roger Aliaga-Diaz, global head of
portfolio construction at Vanguard. Do-it-yourself
investors typically keep about 85 percent of their bond investments in their
home market, Mr. Aliaga-Diaz said. Daily business
updates The latest coverage of
business, markets and the economy, sent by email each weekday. Get it sent to
your inbox. In contrast,
people who buy into Vanguard’s U.S.
target-date retirement funds (which handle investment allocation for their
shareholders) have about 70 percent of the bond portion of their money
invested at home and 30 percent abroad, he said. Vanguard’s research has found that international
bonds reduce portfolios’ ups and downs without hurting the total return.
Internationally diversifying can provide access to securities from more than
40 countries. “This broad exposure is important, as the factors
that drive international bond prices are relatively uncorrelated to those
that drive prices in the U.S.,” the report said. Lately, for example,
South Korea’s 10-year government bond is yielding 2 percent, while Mexico’s
is yielding nearly 7 percent. The
international bond slice of Vanguard’s target-date funds is invested in the
Vanguard Total International Bond Index Fund, which owns mainly
developed-world bonds. Like many international bond funds, it uses hedging to
protect its shareholders against the return volatility that currency
fluctuations can cause. Jean Boivin,
head of the BlackRock Investment Institute, said his outfit’s research
suggests that investors may want to be bold in their foreign bond forays and
look beyond developed markets. Amazon settles
with activist workers who say they were illegally fired. Macy’s sues to
block Amazon from taking over the billboard at its Herald Square flagship. AT&T
extends its vaccination mandate to most unionized workers. “You need to
think about emerging-market bonds and, in particular, Asia ex-Japan,” he
said. In the past,
investors could view the U.S. bond market as a proxy for the world, partly
because U.S. companies often had sprawling international operations, Mr.
Boivin said. But there is enormous global diversity today. Foreign markets,
especially China, have risen so much that this approach doesn’t work as well. Someone’s
precise stake in emerging-market bonds, or any specific bond subclass, will
be determined by that person’s risk tolerance and other assets. BlackRock’s
broadly diversified Total Return Fund might provide a starting point for
considering reasonable ranges. It recently allocated about 8.6 percent of its
assets to emerging markets. The Fidelity
Total Bond Fund, another broad offering, lately had a 16 percent stake in
higher-yielding, riskier kinds of domestic and foreign debt. “Historically,
we’ve owned from 8 to 18 percent in the higher-yielding sectors,” said Celso
Munoz, one of the fund’s managers. “It’s appropriate for most people to have
exposure to the broader fixed-income world, which would include high yield,
emerging markets and bank loans.” People may
tend to shun international bonds partly because stocks overshadow bonds in
the popular media, said Kathy Jones, chief fixed-income strategist at the
Schwab Center for Financial Research. “Every day
somebody is talking about the S&P 500 or the Dow,” she said. “People
don’t talk like that about Bloomberg Barclays U.S. Aggregate Bond Index,” a
leading bond index, and relatively few people plunge even deeper into the
fixed-income universe. To decide how
you might better diversify your bond funds, it helps to reflect on why you
own them, said Tad Rivelle, chief investment officer for fixed income at TCW. “The
existential question is do you think of fixed income as a safe asset that
enables you to take risk elsewhere,” he said, “or do you expect your bonds to
pull their own weight, and so you’re OK with them going down in a market
panic?” People in the former group might favor more
traditional fixed-income categories, like Treasuries and investment-grade
corporate and mortgage bonds, while those in the latter might also opt for
high-yield bonds or a greater variety of securitized fare, he said.
TCW’s MetWest Total Return Bond Fund might work for the first group, and its
MetWest Flexible Income Fund for the second. A puzzle for all bond-fund investors is how the
end of the Covid-19 pandemic might affect interest rates. Rates usually rise when the economy grows, as it’s
expected to do as the world emerges from the pandemic. As that happens,
inflation may rise, which could stifle a long bull market in bonds. Bond
prices rise as interest rates fall. Yet renewed
inflation has been erroneously predicted before, and Jerome Powell, the chair
of the Federal Reserve, has made clear that the bank isn’t rushing to raise the short-term rates it controls. For investors
who are counting on their bond funds for income, continued low rates could
create a temptation to court risk. A more patient
approach is prudent, said Mary Ellen Stanek, chief investment officer for
Baird Advisors, which oversees the Baird Funds. “You don’t own
bonds for excitement and drama,” she said. “You own them for predictability
and lower volatility.” Ms. Jones of
Schwab warned, too, against seeking excessive risk. She suggested investors
instead rethink how they take cash from their portfolios. “In a year
when your stocks are up 20 percent and your bonds are up 2, you may want to
pull out some of those capital gains and put them in your cash bucket,” she
said. “Say you’re looking to generate 6 percent overall, and you’ve made 20
percent in stocks. If you have excess above your plan, you can look at that
as potential income.” No matter what path investors choose, they should
always pay close attention to the costs of funds and E.T.F.s, said Jennifer
Ellison, a financial adviser at Bingham, Osborn & Scarborough in San
Francisco. “Costs are
really important, especially with yields where they are,” since those costs
will eat up much of that scant yield, she said. “If you’re a retail investor and
you’re buying a loaded bond fund, you’re giving all your yield away up
front.” |
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Chapter
7 Rating, Term structure Part I: Credit
Rating Agency Chapter
7 Rating Agency, Interest rate risk, yield curve (PPT) The Big Short - Standard and Poors
scene --- This is how they worked 1. Conflict of
interest? 2. Who is doing
the right thing, the lady representing the rating agency, or the Investment
Banker? Three Major Rating Agencies University:
Bond rating (video) 1. Who are they? 2. Are they private firms or government agencies? 3. How do they rank? 4. Do we need rating agencies and critiques.
Sovereign Credit Rating By JAMES CHEN,
Reviewed by GORDON SCOTT on August 26, 2020
https://www.investopedia.com/terms/s/sovereign-credit-rating.asp What Is a Sovereign Credit Rating? A sovereign credit rating is an independent
assessment of the creditworthiness of a country or sovereign entity.
Sovereign credit ratings can give investors insights into the level of risk
associated with investing in the debt of a particular country, including any
political risk. At the request
of the country, a credit rating agency will evaluate its economic and
political environment to assign it a rating. Obtaining a good sovereign
credit rating is usually essential for developing countries that want access
to funding in international bond markets. KEY TAKEAWAYS · A sovereign credit rating is an independent assessment of the creditworthiness of a country or sovereign entity. · Investors use sovereign credit ratings as a way to assess the riskiness of a particular country's bonds. · Standard & Poor's gives a BBB- or higher rating to countries it considers investment grade, and grades of BB+ or lower are deemed to be speculative or "junk" grade. · Moody’s considers a Baa3 or higher rating to be of investment grade, and a rating of Ba1 and below is speculative. Understanding Sovereign Credit Ratings In addition to
issuing bonds in external debt markets, another common motivation for
countries to obtain a sovereign credit rating is to attract foreign direct
investment (FDI). Many countries seek ratings from the largest and most
prominent credit rating agencies to encourage investor confidence. Standard & Poor's, Moody's, and Fitch
Ratings are the three most influential agencies. Other well-known credit
rating agencies include China Chengxin International Credit Rating Company,
Dagong Global Credit Rating, DBRS, and Japan Credit Rating Agency (JCR).
Subdivisions of countries sometimes issue their own sovereign bonds, which
also require ratings. However, many agencies exclude smaller areas, such as a
country's regions, provinces, or municipalities. Investors use sovereign credit ratings as a way to
assess the riskiness of a particular country's bonds. Sovereign credit risk, which is reflected in
sovereign credit ratings, represents the likelihood that a government might
be unable—or unwilling—to meet its debt obligations in the future. Several key factors come into play in
deciding how risky it might be to invest in a particular country or region. They include its debt service ratio,
growth in its domestic money supply, its import ratio, and the variance of
its export revenue. Many countries
faced growing sovereign credit risk after the 2008 financial crisis, stirring
global discussions about having to bail out entire nations. At the same time,
some countries accused the credit rating agencies of being too quick to
downgrade their debt. The agencies were also criticized for following an
"issuer pays" model, in which nations pay the agencies to rate
them. These potential conflicts of interest would not occur if investors paid
for the ratings. Examples of
Sovereign Credit Ratings Standard &
Poor's gives a BBB- or higher rating to countries it considers investment
grade, and grades of BB+ or lower are deemed to be speculative or
"junk" grade. S&P gave Argentina a CCC- grade in 2019, while
Chile maintained an A+ rating. Fitch has a similar system. Moody’s
considers a Baa3 or higher rating to be of investment grade, and a rating of
Ba1 and below is speculative. Greece received a B1 rating from Moody's in
2019, while Italy had a rating of Baa3. In addition to their letter-grade ratings,
all three of these agencies also provide a one-word assessment of each
country's current economic outlook: positive, negative, or stable. Sovereign Credit Ratings in the Eurozone The European
debt crisis reduced the credit ratings of many European nations and led to
the Greek debt default. Many sovereign nations in Europe gave up their
national currencies in favor of the single European currency, the euro. Their sovereign debts are no longer
denominated in national currencies. The
eurozone countries cannot have their national central banks "print
money" to avoid defaults. While the euro produced increased trade
between member states, it also raised the probability that members will
default and reduced many sovereign credit ratings. Sovereigns Rating (http://countryeconomy.com/ratings/)
Class discussion Topics · How
much do you trust those rating agencies? · Are
those rating agencies private or public firms? · What
factors should be considered when a rating agency is evaluating a debt? How credit agencies work(video) Rating Conflicts (video) https://www.youtube.com/watch?v=-C5JW4I3nfU Part II: Z Scores calculating Z
scores is as follows: Z = α + where a is a
constant, Ri the ratios, βi the relative weighting applied to ratio Ri
and n the number of ratios used. The Altman Z-Score Formula (https://www.investopedia.com/terms/z/zscore.asp)
The Altman Z-score is the
output of a credit-strength test that helps gauge the likelihood of
bankruptcy for a publicly traded manufacturing company. The Z-score is based
on five key financial ratios that
can be found and calculated from a company's annual 10-K report.
The calculation used to determine the Altman Z-score is as follows:
where: Zeta(ζ)=The Altman Z-score A=Working capital/total assets B=Retained earnings/total assets C=Earnings before interest and taxes (EBIT)/totalassets D=Market value of equity/book value of total liabilities E=Sales/total assets Typically, a score
below 1.8 indicates that a company is likely heading for or is under the
weight of bankruptcy. Conversely, companies that score above 3 are less
likely to experience bankruptcy. The zones of discrimination were as such: When Altman Z-Score <= 1.8, it is in Distress Zones.
https://www.gurufocus.com/term/zscore/NAS:AAL/Altman-Z-Score/American-Airlines-Group For class discussion: Which of
the above airlines are in danger based on its z score? But do you think so? ********* Let’s try to get AAL’s z score
(FYI)****************** https://www.gurufocus.com/term/zscore/NAS:AAL/Altman-Z-Score/American-Airlines-Group American Airlines Group Altman Z-Score Calculation. Altman Z-Score model is an accurate forecaster of failure up
to two years prior to distress. It can be considered the assessment of the
distress of industrial corporations. American Airlines Group's Altman Z-Score
for today is calculated with this formula: Z=1.2* X1+1.4*X2+3.3*X3+ 0.6*X4+1.0*X5 =1.2*0.0155+1.4*-0.1087+3.3*-0.0814+0.6*0.1728+1.0*0.2579 = -0.04 * For Operating Data section: All numbers are indicated by the
unit behind each term and all currency related amount are in USD. * For other sections: All numbers are in millions except for
per share data, ratio, and percentage. All currency related amount are
indicated in the company's associated stock exchange currency. GuruFocus does
not calculate Altman Z-Score when X4 or X5 value is 0. Trailing Twelve Months (TTM) ended in Jun. 2021: Total Assets was $72,464 Mil. Total Current Assets was $22,647 Mil. Total Current Liabilities was $21,521 Mil. Retained Earnings was $-7,876 Mil. Pre-Tax Income was 9 + -1573 + -2809 + -3095 = $-7,468 Mil. Interest Expense was -486 + -371 + -376 + -340 = $-1,573 Mil. Revenue was 7478 + 4008 + 4028 + 3173 = $18,687 Mil. Market Cap (Today) was $13,849 Mil. Total Liabilities was
$80,131 Mil. X1= Working Capital / Total
Assets = (Total Current
Assets - Total Current Liabilities) / Total Assets = (22647 -
21521) / 72464 = 0.0155 X2= Retained Earnings / Total
Assets = -7876 / 72464 = -0.1087 X3= Earnings Before
Interest and Taxes / Total Assets = (Pre-Tax
Income - Interest Expense) / Total Assets = (-7468 -
-1573) / 72464 = -0.0814 X4= Market Value
Equity / Book Value of Total Liabilities = Market Cap / Total
Liabilities = 13849.123 / 80131 = 0.1728 X5= Revenue / Total
Assets = 18687 / 72464 = 0.2579 The zones of discrimination were as such: Distress Zones - 1.81 < Grey Zones < 2.99 - Safe Zones American Airlines Group has a Altman Z-Score of -0.04
indicating it is in Distress Zones. Study by Altman found that companies that are in Distress Zone
have more than 80% of chances of bankruptcy in two years. American Airlines Group
(NAS:AAL) Altman Z-Score Explanation X1: The Working
Capital/Total Assets (WC/TA) ratio is a
measure of the net liquid assets of the firm relative to the total
capitalization. Working capital is defined as the difference between current
assets and current liabilities. Ordinarily, a firm experiencing consistent
operating losses will have shrinking current assets in relation to total
assets. Altman found this one proved to be the most valuable liquidity ratio
comparing with the current ratio and the quick ratio. This is however the
least significant of the five factors. X2: Retained Earnings/Total
Assets: the RE/TA ratio measures
the leverage of a firm. Retained earnings is the account which reports the
total amount of reinvested earnings and/or losses of a firm over its entire
life. Those firms with high RE, relative to TA, have financed their assets
through retention of profits and have not utilized as much debt. X3, Earnings Before Interest
and Taxes/Total Assets (EBIT/TA): This
ratio is a measure of the true productivity of the firm's assets, independent
of any tax or leverage factors. Since a firm's ultimate existence is based on
the earning power of its assets, this ratio appears to be particularly
appropriate for studies dealing with corporate failure. This ratio
continually outperforms other profitability measures, including cash flow. X4, Market Value of
Equity/Book Value of Total Liabilities (MVE/TL): The measure shows how much the firm's assets can decline in
value (measured by market value of equity plus debt) before the liabilities
exceed the assets and the firm becomes insolvent. X5, Revenue/Total Assets (S/TA): The capital-turnover ratio is a standard financial ratio
illustrating the sales generating ability of the firm's assets. Homework of
chapter 7 part I: (Due with the second mid term exam) 1.
Why does Moody downgrade Ford’s bond to Junk bond? Do you support the
decisions of the other two rating agencies giving an investment grade bond
rating to Ford’s bond? 2.
What is Z score? Refer to the Z scores of American airlines, Jet Blue
Airlines, and Delta Airlines. For example, you can find Delta’s z score at https://www.gurufocus.com/term/zscore/DAL/Altman-Z-Score/Delta-Air-Lines-Inc Delta Air Lines has a Altman Z-Score of 0.07, indicating it is in Distress Zones. This implies bankruptcy possibility in the next two years. The historical rank and industry rank for Delta Air Lines's Altman Z-Score or its related term are showing as below: NYSE:DAL' s Altman Z-Score Range Over the Past 10 Years Min: -1.33 Med: 0.89 Max: 1.85 Current: 0.08 -1.33 1.85 During
the past 13 years, Delta Air Lines's highest Altman Z-Score was 1.85. The
lowest was -1.33. And the median was 0.89. Do you think that Delta
airline is more likely to default than the other two airlines based on z score?
Why or why not? 3.
Why are airline companies’ stocks better investments than airline
companies’ bonds, according to https://www.forbes.com/sites/michaelgoldstein/2021/03/18/are-airline-bonds-and-airline-stocks-telling-different-stories/?sh=240e532bcffa? |
America could be hit with a debt downgrade for the
first time since 2011 By Matt Egan,
Updated 12:43 PM ET, Fri October 1, 2021 https://www.cnn.com/2021/10/01/economy/credit-rating-debt-ceiling/index.html New York, NY
(CNN) Fitch Ratings warned Friday that the
fight in Washington over raising the debt ceiling could force the firm to
downgrade America's AAA credit rating. "The
failure of the latest efforts to suspend the U.S. federal government's debt
limit indicates that the current stand-off could be among the most protracted
since 2013," Fitch said. Echoing what
S&P Global Ratings said Thursday, Fitch said it believes the debt limit
will be raised or suspended "in time to avert a default event." However, Fitch
added that "if this were not done
in a timely manner, political brinksmanship and reduced financing flexibility
could increase the risk of a US sovereign default." The Treasury Department has warned it will run out
of cash and exhaust extraordinary measures by October 18. At that point,
Treasury would no longer have 100% confidence it could pay America's bills. Fitch suggested that getting near that date could
trigger a downgrade. "We view
reaching the Treasury's X-date without the debt limit having been raised as
the principal tail risk to the US sovereign's willingness and capacity to
pay," Fitch said. "If this appeared likely we would review the US
sovereign rating, with probably negative implications." Fitch reiterated that the United States would
likely get downgraded even if it kept paying bondholders, but delayed other
payments like Social Security and paychecks to federal workers. "Prioritization
of debt payments, assuming this is an option, would lead to non-payment or
delayed payment of other obligations, which would likely undermine the U.S.'s
'AAA' status," Fitch said. During the 2011 debt ceiling fight, S&P
downgraded the US credit rating for the first time ever, while Fitch and
Moody's kept a perfect AAA rating on the world's largest economy. Fitch has
had a negative outlook on the United States since July 2020. "The debt
limit impasse reflects a lack of political consensus that has hampered the
U.S.'s ability to meet fiscal challenges for some time," Fitch said on
Friday. Fitch said
amending the reconciliation bill to address the debt ceiling "appears
the most viable option for raising the debt ceiling, but the process would
take some time in the Senate." Are Airline Bonds Scarier Than Airline Stocks
Because Of Sub-Par Credit Ratings? Michael
Goldstein, Mar 18, 2021,05:27pm Airline stocks
have been on a tear. But do airline bonds—and their underlying credit
ratings—tell a different story? American hit a
year high of 25.94 on March 15, rising from a 52-week low of 8.25 on May 14,
2020. Southwest hit a 52-week high of 62.76 on March 15 as well, up from a
52-week low of 22.46 in May. Good news is
propelling airline stocks. The TSA reported five straight days of screening a
million passengers, including 1,357,111 on March 12, the most in a year. Brad
Tilden, CEO of Alaska Airlines, said upcoming bookings are up to 70% of
normal. Jet Blue is calling back flight attendants due to increased demand. In the U.S.,
100 million vaccines have been distributed, promising a “roaring ‘20’s” of
pent-up travel demand. Even international travel, snarled by quarantines, may
explode, speeded by controversial vaccine passports. But while airline stocks zoom ahead, their bonds
reflect a more sobering reality: weak credit ratings. Currently, rating
agencies like Fitch and Standard and Poor’s (S&P) put most airline credit
ratings and bonds in the sub-investment grade (aka “junk”) category. An exception is Southwest, which S&P rated
BBB/Negative as of March 16, 2021. “Going
into this Southwest benefited from their strong balance sheet. They had a lot
of liquidity, aircraft unencumbered by debt, more domestic travel, and were
not reliant on business,” says Betsy Snyder, Director, S&P Global
Ratings. On February 1, 2020, S&P rated Southwest
BBB+/Stable, while Delta Airlines was BBB-/Stable. But by March 16, 2021,
Southwest was rated BBB/Negative, and Delta BB/Negative. United went from
BB/Positive to B+/Negative, while American went from BB-/Stable to
B-/Negative. Hardest hit was Hawaiian Air[MG1] , which went from BB-/Stable
to CCC+/Negative. Why are airline stocks taking off while their
bonds seem earthbound? Philip Baggaley, Managing Director, S&P
Global Ratings, says “Share prices are just that—prices. The ratings are our
estimate of credit risk and the likelihood of default. And the bond prices have in fact rallied over
the last few months.” Sub-investment
grade airline bonds have relatively attractive yields. A quick search of
corporate bonds going out to December 2025 found just five investment grade
bonds rated A or better that yielded at least 1.2%. However, a search of
sub-investment grade bonds of the same duration found three from United and
two from Delta with a yield to maximum of 2.4% or better. Although
riskier, fund managers add high-yielding airline bonds to their mix, as
investment grade bonds offer little. Janet Rilling of Wells Fargo told Marketwatch
that her fund bought unsecured airline bonds. “U.S. high yield is our favored spot in credit, particularly BB bonds
that have more room to recover than BBB.” Will airline bonds remain fallen angels, or become
rising stars? Baggaley noted
that after significant downgrades in the first months of COVID, “ratings have
stabilized.” He added, “The airlines are remarkably good at raising
liquidity. We’re a little more cautiously optimistic. Our ratings anticipated
that all of these airlines [Southwest, Delta, Alaska, Air Canada, JetBlue,
United, Allegiant, Spirit, American, WestJet, Hawaiian] would survive.” On March 8 American announced a $5 billion
bond sale and $2.5 billion loan. The purpose was to pay back other debt like
loans from the U.S. Treasury. The airline said it would use its frequent
flyer program as backing. In 2017, Stifel analyst Joe DeNardi postulated
airline loyalty programs were worth more than their actual operations, a
theory which has seemingly become gospel. Nonetheless, Fitch rates the new
issue BB (speculative) with a negative outlook. Based on its
balance sheet as of October 2020, American had a net debt of $32.79 billion,
while total assets were about $64 billion. Meanwhile, the company was burning
cash at a rate of $30 million a day. Other airlines
have similar issues. Although bookings are picking up, US airlines currently
average about 20% capacity for international flights, about 40% domestically. Effects from
COVID are distributed unevenly, a disparity reflected in airline ratings. For
example, domestically focused Southwest maintains (barely) an investment
grade rating. United, on the other hand, dependent on business travel with an
extensive international flight schedule, has a sub-investment grade rating. Business
travel will “take years to come back. There is some portion that won’t come
back due to videoconferencing. International is hostage to virus conditions
in other countries,” says Baggaley. “The Big Three will see a slower recovery
but have strengths like route structures and loyalty programs.” Delta tapped
its SkyMiles loyalty program to back $9 billion in debt it raised in
September. “Delta said they’d like to get back to investment grade, but it’s
not going to happen overnight,” noted Baggaley. Baggaley says
the first quarter is looking worse than anticipated. But the arrival of
vaccines in mass quantities are “the light at the end of the runway.” For airline credit ratings to return to a
“Stable” rating would require “better industry conditions and confidence that
vaccines are returning passengers to the planes.” Joe Rohlena, a
senior director at Fitch said, “Our view is that there is still a lot of
risk. There are real green shoots, like vaccine rollouts, and bookings are
starting to come back. But we still have the whole sector on a negative
outlook—we don’t know when cases will drop, when borders will open.” For
airline to be upgraded, they need “a real and sustainable level of
traffic—better than what we’ve seen,” plus “a concrete effort to pay back
some of the debt raised during the pandemic.” As for airline
bonds issued against frequent flyer programs, “Our view is that the loyalty program really is a core asset of
the airline, and a lot of their profitability comes from those programs.”
Rohlena added that the coupons on American’s
bonds were also “pretty attractive” with five and 8-year bonds offering 5.5%.
With the offering giving American another $2.5 billion in liquidity. “You
ride through this portion of the pandemic and you chip away at the debt.” Pandemic or
no, Baggaley says two airline IPOs,
Frontier and Sun Country, are potentially upcoming, while Bjřrn Kjos,
founder of Norwegian, s involved in a new airline, Norse Atlantic. “Hope springs
eternal,” Baggaley says. |
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Part III: Yield curve (or
Term structure) ·
What is yield curve?
( http://www.yieldcurve.com/MktYCgraph.htm) Daily Treasury Yield Curve Rates http://www.yieldcurve.com/MktYCgraph.htm
For discussion: Why do the rates change daily? Can the 30y yield < 3m T-Bill rate? So the yield curve is not that flatten
anymore. So we do not need to worry for recession anymore? Right? ·
Why do we need yield
curve? ·
What can yield curve
tell us?
Yield Curve http://finra-markets.morningstar.com/BondCenter/Default.jsp Introduction to the
yield curve (Khan academy)
Summary of Yield Curve Shapes and Explanations Normal Yield Curve
Steep Curve – Economy is improving
Inverted Curve – Recession is coming
To become inverted, the yield curve must pass through
a period where long-term yields are the same as short-term rates. When that
happens the shape will appear to be flat or, more commonly, a little raised
in the middle. Unfortunately, not all flat or humped curves turn into fully
inverted curves. Otherwise we'd all get rich plunking our savings down on
30-year bonds the second we saw their yields start falling toward short-term
levels. On the other hand, you shouldn't discount a flat or humped curve
just because it doesn't guarantee a coming recession. The odds are still
pretty good that economic slowdown and lower interest rates will follow a
period of flattening yields.
*****Special
topic I: Inverted Yield Curve could be
used to predict recession***** How The Yield Curve Predicted Every Recession For The
Past 50 Years (video)
For discussion: · What
is the shape the most recent yield curve? · What
does it indicate or imply? · Do
you believe it? · What
can we do to prevent any possible losses in the future? · ……
What Is An Inverted Yield Curve And How Does It Affect
The Stock Market? | NBC News Now (video)
Inverted Yield Curve By WALDEN SIEW https://www.investopedia.com/terms/i/invertedyieldcurve.asp Fact checked by YARILET PEREZ on August 29,
2021, Reviewed by MICHAEL J BOYLE What Is an Inverted Yield Curve? An inverted yield curve represents a situation
in which long-term debt instruments
have lower yields than short-term debt instruments of the same credit
quality. An inverted yield curve is sometimes referred to as a negative yield curve. KEY TAKEAWAYS · An
inverted yield curve reflects a scenario in which short-term debt instruments
have higher yields than long-term instruments of the same credit risk
profile. · Investor
preferences of liquidity and expectations of future interest rates shape the
yield curve. · Typically,
long-term bonds have higher yields than short-term bonds, and the yield curve
slopes upward to the right. · An inverted yield curve is a strong indicator
of an impending recession. · Because
of the reliability of yield curve inversions as a leading indicator, they
tend to receive significant attention in the financial press. Understanding Inverted Yield Curve The yield curve graphically represents yields
on similar bonds across a variety of maturities. It is also known as the term structure of interest rates. A normal yield curve slopes upward,
reflecting the fact that short-term interest rates are usually lower than
long-term rates. That is a result of increased risk and liquidity premiums
for long-term investments. When the yield curve inverts, short-term interest rates become
higher than long-term rates. This type of yield curve is the rarest of the
three main curve types and is considered to be a predictor of economic
recession. Because of the rarity of
yield curve inversions, they typically draw attention from all parts of the
financial world. Historically, inversions of the yield curve have preceded recessions in the U.S.
Due to this historical correlation, the yield curve is often seen as a way to
predict the turning points of the business cycle. What an inverted yield curve really means is that most investors
believe that short-term interest rates are going to fall sharply at some
point in the future. As a practical matter, recessions usually cause interest
rates to fall. Inverted yield curves are almost always followed by
recessions. An inverted Treasury yield curve is one of the
most reliable leading indicators of an impending recession. Measuring Yield Curves One of the most popular methods of measuring
the yield curve is to use the spread
between the yields of ten-year Treasuries and two-year Treasuries to
determine if the yield curve is inverted. The Federal Reserve maintains a
chart of this spread, and it is updated on most business days and is one of
their most popularly downloaded data series. The 10-year to two-year Treasury spread is one of the most
reliable leading indicators of a recession within the following year. For as long as the Fed has published this
data back to 1976, it has accurately predicted every declared recession in
the U.S., and not given a single false positive signal. On Feb. 25, 2020, the spread dipped below zero, indicating an
inverted yield curve and signaling a possible economic recession in the U.S.
in 2020. Maturity Considerations Yields are typically
higher on fixed-income securities with longer maturity dates. Higher yields
on longer-term securities are a result of the maturity risk premium. All
other things being equal, the prices of bonds with longer maturities change
more for any given interest rate change. That makes long-term bonds riskier,
so investors usually have to be compensated for that risk with higher yields. If an investor thinks
that yields are headed down, it is logical to buy bonds with longer
maturities. That way, the investor gets to keep today's higher interest
rates. The price goes up as more investors buy long-term bonds, which drives
yields down. When the yields for long-term bonds fall far enough, it produces
an inverted yield curve. Economic Considerations The shape of the yield curve changes with the
state of the economy. The normal or
upward sloping yield curve occurs when the economy is growing. Two
primary economic theories explain the shape of the yield curve; the pure
expectations theory and the liquidity preference theory. In pure expectations theory, forward long-term
rates are thought to be an average of expected short-term rates over the same
total term of maturity. Liquidity preference theory points out that investors
will demand a premium on the yield they receive in return for tying up
liquidity in a longer-term bond. Together these theories explain the shape of
the yield curve as a function of investors’ current preferences and future
expectations and why, in normal times, the yield curve slopes upward to the
right. During normal periods of economic growth, and
especially when the economy is being stimulated by low interest rates driven
by Fed monetary policy, the yield curve slopes upward both because investors
demand a premium yield for longer-term bonds and because they expect that at
some point in the future the Fed will have to raise short-term rates to avoid
an overheated economy and/or runaway inflation. In these circumstances, both
expectations and liquidity preference reinforce each other and both
contribute to an upward sloping yield curve. When signals of an overheated economy start to appear or when
investors otherwise have reason to believe that a short-term rate hike by the
Fed is imminent, then these theories begin to work in the opposite directions
and the slope of the yield curve flattens and can even turn negative (and
inverted) if this effect is strong enough. Investors begin to expect that the Fed’s
efforts to cool down the overheated economy by raising short-term rates will
lead to a slowdown in economic activity, followed by a return to a low
interest rate policy in order to fight the tendency for a slowdown to become
a recession. Investors' expectation of falling short-term interest rates in
the future leads to a decrease in long-term yields and an increase in
short-term yields in the present, causing the yield curve to flatten or even
invert. It is perfectly rational to expect interest
rates to fall during recessions. If there is a recession, then stocks become
less attractive and might enter a bear market. That increases the demand for
bonds, which raises their prices and reduces yields. The Federal Reserve also
generally lowers short-term interest rates to stimulate the economy during
recessions. That expectation makes long-term bonds more appealing, which
further increases their prices and decreases yields in the months preceding a
recession. Historical Examples of Inverted Yield Curves In 2006, the yield curve was inverted during
much of the year. Long-term Treasury bonds went on to outperform stocks
during 2007. In 2008, long-term Treasuries soared as the stock market
crashed. In this case, the Great Recession arrived and turned out to be worse
than expected. In 1998, the yield curve briefly inverted. For
a few weeks, Treasury bond prices surged after the Russian debt default.
Quick interest rate cuts by the Federal Reserve helped to prevent a recession
in the United States. However, the Fed's actions may have contributed to the
subsequent dotcom bubble. Fed’s
Bullard says ignoring the Treasury yield curve has burned him in the past Published: Oct 15, 2019 8:35 a.m. ET, by STEVEGOLDSTEIN There are a lot of valid reasons why the inversion of the U.S. Treasury yield
curve — that is, the yield of short-term bonds being higher than that of
longer-term securities — isn’t a sign of economic worries. But count James Bullard, president of the
St. Louis Federal Reserve, as not one to ignore the yield curve’s predictive
powers. Elga Bartsch, head of macro research at
BlackRock, asked Bullard whether in an era of rapidly falling natural
interest rate estimates and a global savings glut, the yield curve still
carries the same significance. Bullard, at a conference on monetary and
financial policy in London, replied that he was burned twice as a Fed staffer
in the 2000s on trying to dismiss the predictive powers of the yield curve.
He recalled a speech in 2006 from then Fed Chairman Ben Bernanke who also
minimized the curve’s predictive powers. “The idea has always been to downplay this
issue,” Bullard said. “If you want to ignore the signal, you should say, okay,
but I’m ignoring it with open eyes.” The yield on the 10-year TMUBMUSD10Y, -1.05%
is currently a bit higher than the 2-year TMUBMUSD02Y, +0.01% ,
at 1.73% versus 1.59%. Earlier in the year, the 2-year yield was higher than
the 10-year. Bullard, who wanted a half percentage point
rate cut in September, continued to press the case for easier policy. “Insurance rate cuts may help re-center
inflation and inflation expectations at the 2% target sooner than otherwise,”
he said. The Fed is meeting at the end of October to
determine whether it will make its third quarter-point rate cut in succession
this year. Asked by MarketWatch, he declined to
quantify a probability of recession and acknowledged that most estimates of
them are based off the yield curve. He also said uncertainty about international trade policies is
likely to linger for longer than markets anticipate. “We’ve opened a Pandora’s box,” he said. “If you study the
history of trade negotiations, they’re very long and very involved over a
very long period of time.” 5 things investors need to
know about an inverted yield curve Published: Aug 28, 2019 9:43 a.m. ET , By WILLIAMWATTS, DEPUTY MARKETS EDITOR, SUNNYOH The 10-year yield fell below the 2-year
yield for the first time since June 2007
The main measure of the yield curve briefly
deepened its inversion on Tuesday — with the yield on the 10-year Treasury
note extending its drop below the yield on the 2-year note — underlining
investor worries over a potential recession. But while
inversions are seen as a reliable indicator of an economic downturn,
investors may be pushing the panic button prematurely. Here’s a look at what
happened and what it might mean for financial markets. What’s the
yield curve? The yield curve is a line plotting out yields
across maturities. Typically, it slopes upward, with investors demanding more
compensation to hold a note or bond for a longer period given the risk of
inflation and other uncertainties. An inverted curve can be a source of concern for
a variety of reasons: short-term rates could be running high because overly
tight monetary policy is slowing the economy, or it could be that investor worries
about future economic growth are stoking demand for safe, long-term
Treasurys, pushing down long-term rates, note economists at the San
Francisco Fed, who have led research into the relationship between the curve
and the economy. They noted in an August 2018
research paper that, historically, the causation “may have
well gone both ways” and that “great caution is therefore warranted in
interpreting the predictive evidence.” What just
happened? The yield curve has been flattening for some
time. A global bond rally in the wake of rising trade tensions pulled down yields
for long-term bonds. The 10-year Treasury note yield TMUBMUSD10Y, -1.05% fell
as low as 1.453% on Wednesday, trading around 4 basis points below the yield
on the 2-year note peerTMUBMUSD02Y, -0.25%. The inversion on this widely-watched measure of
the yield curve’s slope had already taken place two weeks ago, when signs of economic weakness across the globe drew
investors into haven Why does it
matter? The 2-year/10-year version of the yield curve
has preceded each of the past seven recessions, including the most recent
slowdown between 2007 and 2009. Other yield curve measures
have already inverted, including the widely-watched 3-month/10-year spread
used by the Federal Reserve to gauge recession probabilities. Is recession
imminent? A recession isn’t a certainty. Some economists
have argued that the aftermath of quantitative easing measures that saw
global central banks snap up government bonds and drive down longer term
yields may have robbed inversions of their reliability as a
predictor. According to this school of thought, negative bond yields in Europe and Japan have forced yield-starved
investors to the U.S., artificially depressing long-term Treasury yields. Some Fed
policy makers, including New York Fed
President John Williams, have also periodically questioned
the overwhelming importance placed by market participants on the yield curve,
seeing it as only one measure among many that could point to economic distress.
Others say an inversion of the yield curve reflects when the bond-market is
expecting the U.S. central bank to set off on an extended easing cycle. This
pent-up anticipation drives long-term bond yields below their short-term
peers. But if the Fed cuts rates in a speedy fashion and successfully
prevents an economic downturn, the yield curve’s inversion this time around
may turn out to be a false positive. And even if
the yield curve does point to a future recession, investors might not want to
panic immediately. From 1956, past
recessions have started on average around 15 months after an inversion of the
2-year/10-year spread occurred, according to Bank of America Merrill
Lynch. Are market
worries overdone? Some investors
argued that until other recession indicators, such as the unemployment rate,
start blinking red, it’s probably premature to press the panic button. “It’s a recession indicator among many
others, though the yield curve may be flashing red, others are not,” said
Adrian Helfert, director of multi-asset portfolios at Westwood Holdings
Group, in an interview with MarketWatch. ********* Special Topic 2: Steepening
Yield Curve *************** What Is
a Steep Yield Curve? (https://www.thebalance.com/steepening-and-flattening-yield-curve-416920) The gap between the yields
on short-term bonds and long-term bonds increases when the yield curve
steepens. The increase in this gap usually indicates that yields on long-term
bonds are rising faster than yields on short-term bonds, but sometimes it can
mean that short-term bond yields are falling even as longer-term yields are
rising. For
example, assume that a two-year note was at 2% on Jan. 2, and the 10-year was
at 3%. On Feb. 1, the two-year note yields 2.1% while the 10-year yields
3.2%. The difference went from 1 percentage point to 1.10 percentage points,
leading to a steeper yield curve. A steepening yield curve
typically indicates that investors expect rising inflation and stronger
economic growth. Fed to Broadly
Accept a Steepening Yield Curve: Peterson’s Posen (youtube)
How the Fed’s
Mission Impacts the Yield Curve (youtube)
Steepening
Yield Curve (youtube)
For discussion: Do you agree
with the Fed’s current QE monetary policy? Treasury yield curve steepens to 4-year high as
investors bet on growth rebound · ·
AuthorBrian
ScheidPolo Rocha Jan 13, 2021 ·
·
The short-term outlook for
the U.S. economy may be dark, but bond investors see a bright future. The U.S. Treasury yield
curve has steepened to levels not seen since 2016, signaling that investors
expect economic expansion and higher inflation in the coming years as coronavirus vaccines are distributed and incoming President Joe
Biden and a Democrat-controlled Congress are expected to pass another
substantial stimulus package. The steepening curve is
likely a sign of economic recovery, said
Michael Crook, deputy chief investment officer at Mill Creek Capital. "It's very possible we're
on track for a period of above-trend economic growth unlike anything we've
seen in the last two decades, but it won't happen all at once." The fly in the ointment could be the Federal Reserve, where regional
presidents have begun weighing the possibility of reducing the bank's $120
billion in monthly bond purchases if the economy sees a boom later this year.
Should the Fed stay on course, the yield curve would likely steepen further
as short-term rates remain pegged as growth and inflation accelerate. Nominal Treasury yields have moved in "near lockstep" with
rates on Treasury Inflation-Protected Securities over the past week, an
indication that the climb's main driver was growth expectations, Crook said. Inflation expectations A steep yield curve — when
there is a large spread in interest rates between shorter-term Treasury bonds
to longer-term bonds — often precedes a period of economic expansion, as
investors bet that a central bank will be forced to raise rates in the future
to tamp down higher inflation. The opposite is true of
inverted yield curves, which suggest investors see the need for lower
interest rates to prop up slowing inflation. The U.S. Treasury 10-year yield settled at 1.15% on Jan. 12, up 19
basis points from Jan. 5, when Democrats won the races for Georgia's two
Senate seats and tilted the balance of Congress. The 10-year yield has risen
34 basis points in the roughly two months since the U.S. presidential
election and is now at its highest level since March 18, 2020, when the early
days of the coronavirus pandemic caused wild swings in bond markets. Yields on 10-year Treasurys should reach 1.5% by the end of 2021 as
the rollout of the coronavirus vaccine, additional government stimulus and
overall economic recovery expectations push long bonds' yields up in the
first half of this year, Bruno Braizinha, a rates strategist with Bank of
America Securities, said in a Jan. 12 note. The 30-year yield has surged 32 basis points since November's
Election Day, settling at 1.88% on Jan. 12, its highest close since Feb. 21. Meanwhile, the gap between the five- and 30-year yields climbed to
138 basis points on Jan. 12, its highest point since November 2016. The gap
between the two- and 10-year yields closed at 101 points on Jan. 12, its
highest point since May 2017. Those gaps remained the same Jan. 12. "The steepening signals
that inflation expectations are rising," agreed Mike O’Rourke, chief
market strategist at JonesTrading. The 10-year breakeven rate, a measure of market inflation
expectations, settled at 2.06% on Jan. 11, its highest level since November
2018.
The rise in inflation
expectations, strategists said, will likely only reinforce the Fed's plan to
keep interest rates lower for longer and try to run inflation above 2% to
average out the years below that target threshold. "The Fed states it won't
do much until it is confident inflation will run above 2% for a period of
time," O'Rourke said. "So for now, I don't expect them to take
any action." The Fed's preferred inflation gauge, the core
personal consumption expenditures price index, rose by 1.4% in November 2020. Patrick Leary, chief market strategist and senior trader at
Incapital, said that in addition to more stimulus, which would be funded
through borrowing, Treasury yields are also rising on optimism of a
coronavirus vaccine and the release of pent-up demand later this year as
social distancing mandates are eased or dropped entirely. Fed far from a shift Despite the recent rise, the 10-year yield remains at a historically
low level. A 1.15% yield would be unlikely to impair growth nor impact Fed
policy, Leary said. "I don't think it is necessarily about a level that the Fed
would consider shifting its bond purchases but more about the reason yields
are rising, and what effect that rise is having on financial conditions and
more specifically the stock market," Leary said. "If the stock market hangs in there, I
don't expect the Fed to change from their current pace of bond
purchases."
Financial conditions appear to be roughly the same as they were in
mid-February, with the Chicago Fed's
National Financial Conditions Index clocking in at -0.62. The weekly index
measures risk, credit and leverage conditions in money markets, debt and
equity markets and shadow banking systems. A negative value indicates that
financial conditions are looser — borrowing and spending are easier
— than average, while a positive value indicates tighter-than-average
conditions. The index has fallen from a recent spike to 0.33 in early
April, largely due to the Fed's accommodative monetary policies. The Fed, in order to keep the economic recovery on track, needs to
keep financial conditions loose, said Gennadiy Goldberg, senior U.S. rates
strategist with TD Securities. An increase in real rates would signal
tightening conditions and could draw a reaction from the Fed. "There isn't an exact rubric on where the Fed would step into
the market, but we think they would step in to prevent rates from rising
excessively," he said. "If they rise too dramatically in a short
span of time and if that increase is driven by expectations that the Fed
would be less supportive to the US economy, we think the Fed would signal
their displeasure and push back."
The 10-year real yield, which is adjusted for expected inflation,
settled at -0.93% on Jan. 12, up 15 basis points in a week. But Goldberg said it would like to take a 50-basis-point increase in real
10-year rates over several months to prompt a rethink of the Fed's policy
stance. "The Fed is keen to avoid repeating the Taper Tantrum of 2013,
which set the recovery back significantly by prematurely tightening financial
conditions," he said. During a Jan. 8 presentation before the Council on Foreign Relations,
Richard Clarida, the Fed's vice chairman, said he was "not
concerned" about the 10-year yield's rise above 1%. "The way that I look at the bond market and yields is: You have
to try to understand why yields are moving up," Clarida said. "And
if yields are moving up because people are more optimistic about growth,
about a vaccine, are more confident, that we'll be able to achieve our two
percent inflation objective, then that is not something that that that
troubles me in the context of the overall picture." Optimism about 2021 growth
has also raised the prospects that the Fed could start to pull back the pace
of its bond purchase program earlier than expected. The Fed is buying $80
billion in Treasurys and $40 billion in mortgage-backed securities each
month. Atlanta Fed President Raphael Bostic told Reuters on Jan. 4 that he
hopes the central bank could "start to recalibrate" the program if
the economy rebounds strongly later this year, a sentiment shared by a few
other regional Fed presidents. For his part, Clarida said his outlook suggests the Fed should keep
the program as-is throughout the rest of the year. Fed Chairman Jerome Powell
will also have a chance to push back on talk of an early tapering during a
Jan. 14 appearance at Princeton University. Crook with Mill Creek Capital said in spite of the potential spike in
demand in the second half of this year and the likelihood of more fiscal
stimulus from a Democratic Congress, unemployment remains well above full
employment giving the Fed "plenty of breathing room" to keep rates
near zero and its accommodative policy in place. "I believe the mistakes of the last cycle loom large at the Fed,
and they will be very cautious about restricting policy before it is
absolutely necessary," Crook said. Homework chapter 7 part II (due with the second mid-term exam): 1.
Based on “Inverted yield curve” written by
walden Siew, please answer the following questions. · What does inverted yield curve usually indicate to the market? Why? · What are the causes of the current inverted yield curve this
time? · What does an upward yield
curve indicate? What can we learn from an steepening yield curve? · How to tell that the yield curve is inverted? (Hint: check the spread
between 10 year Treasury bond yield and 2 year Treasury note yield) Write a summary about the inverted yield curve learned
from the three articles. Based
on the rates on Treasury securities provided by the Fed, draw a yield curve
of any day in October 2021. And
discuss: the shape of the yield curve, its implication on future economy.
|
The Market Finally Has Its Inversion. Now What?
(optional) The latest move in the bond market is unlike
anything investors have seen, and not in a good way. By John Authers August 15, 2019, 12:01
AM EDT We have inversion. The most widely watched part of the U.S. Treasury market’s yield
curve has finally inverted. In early Wednesday trading, yields on 10-year
notes briefly fell below those on two-year notes for the first time
since 2007. Most of the human population will not care about this event. So
two questions need answering: Should we care? And, if so, why should we care? Historically, yield curve inversions have been reliable early indicators of a
recession. This is particularly true of the spread between the 3-month bill
rates and 10-year Treasury yields, in which all persistent inversions since 1960 have been
followed by a recession:
An examination by Duke University professor Cam
Harvey found that on average
stocks underperform Treasury bills from the moment of inversion. Stocks
often continue to rise after the yield curve first inverts, as stockbrokers
have been keenly pointing out in the last 24 hours, but on average the moment
of a yield curve inversion is a bad time to buy stocks. But we only have a sample of seven recessions to study, and
the circumstances in all those inversions were slightly different. What was
different about this one? What is most notable
this time is the drop in longer-dated bond yields, says Jim Bianco of Bianco Research. The
30-year Treasury yield hit an all-time low on Wednesday, and he
finds that its recent decline is shocking in historic terms. (And
note that a 10-day trading span takes us back exactly to the moment when
President Donald Trump tweeted about new tariffs on China,
escalating the trade war): This is the 7th time
in 35 years that 30-year yields have declined by such a large degree over a
10-day span. · Oct 1987 – The week
after stock market crash · Jun 1989 – The week
the Fed started easing (recession 13 months later) · Feb 2000 – Tech bubble
(Mar 2000) · Nov 2001 – In
recession · Dec 2008 – The depths
of the Great Recession · Aug 2011 – The week
after the U.S. lost its AAA rating and a 20% correction in the S&P 500 · Aug 2019 – ??? All these instances
occurred in the middle of great stress. The exception was Feb 2000, but the
stress started a month later when the tech bubble peaked. So this was a
major and extreme event. The
inversion only happened briefly amid thin volume before most American traders
were at their desks, which is another reason that is being given to
ignore the event, but it is plain in any sensible context that this
was a very major market event. If the market is any use in helping us
make predictions, it is certainly trying to tell us something. The sharp drop in the 30-year yield
brings us to another reason that is being cited to treat this inversion
differently from its predecessors. This was, in the obscene-sounding
vocabulary of the bond market, a “bull flattener.” Rest assured that no
bulls were flattened by the bond market Wednesday. Instead, this means that this inversion came as a result of
long-dated yields coming down (a bullish event if you own bonds when this
happens), rather than because short-dated yields went up, which would be a
“bear flattener.” As this chart shows, bear flatteners are more common.
The explanation for this is that recessions usually come as the Federal
Reserve raises short-term rates. This time, the Fed stopped tightening
eight months ago, and rates have been heading down all year.
So if anything, this
inversion does look different from its predecessors, but scarier. Next, rates on their own are less significant than real rates,
or those after inflation. Inflation expectations have tumbled in recent
weeks, but not as fast as yields. As a result, real yields on 10-year Treasuries have dropped to zero for
the first time since before election day in 2016:
Declines in real yields show specific anxiety about future
growth among investors. And the last few months have seen a remarkable and
coordinated drop in real yields around the world. This chart from
Bank of New York Mellon illustrates this well:
With the exception of Japan, marooned with low growth
expectations for a generation, the tumble in real rates over the last
three months has been severe. Then we move to another problem with the other precedents, which
is that they all, without exception, happened with rates at higher
levels. There is no precedent for yields this low, and therefore there is no
precedent for an inversion at such low rates. This is a caveat that has hung
over the financial world for a decade. Many things look alarming and
unsustainable, but we simply have no experience to say whether they can be
sustained with rates this low. The Federal Reserve
Bank of New York has long published an indicator of the probability of a
recession within the next 12 months, which is derived solely from the
Treasury curve. The latest reading,
from before the hectic trading of the last two weeks, showed a recession looking ever more likely.
Indeed, if a recession is avoided, this will be the highest probability the
indicator has signaled without a subsequent recession in more than 50 years:
So
the Fed itself has found that the yield curve works better than any other
single leading indicator from the real economy as a warning that a recession
is coming. The New York Fed
provides a good summary of the evidence for this here.
And yet Janet Yellen, who stood down as chair of the Fed last year,
said Wednesday that this yield curve inversion may not be as good a
recession indicator as others. She said this on Fox Business Network: “Historically, it has
been a pretty good signal of recession, and I think that’s when markets pay
attention to it, but I would really urge that on this occasion it may be a
less good signal. The reason for that is there are a number of factors other
than market expectations about the future path of interest rates that are
pushing down long-term yields.” It is true that much of the buying is for reasons other than expectations
about the future path of interest rates. Falling
yields make it harder for pension funds to guarantee an income. Many around
the world are now obligated by regulators to buy bonds to be sure that they
can meet their liabilities, which helps to create a vicious circle. Lower yields mean that the funds need to
buy more bonds, which pushes down yields further, meaning that they need
to buy still more bonds to generate the same interest income. Further, much of the current buying is
part of a straight “carry trade,” as investors desperately try to find a
positive yield somewhere. But there are limits to how far this argument
can go. The last inversion more than a decade ago took place against the
background of what the then Fed chairman Alan Greenspan called a “conundrum,”
which was that the Fed was raising short-term rates but long-term bonds
yields fell nonetheless. The most popular explanation was that this was due
to a “savings glut” outside the U.S. as countries led by China parked
resources in Treasuries and kept their yields down. That yield curve
inversion was followed by a big recession. The conundrum did not make it any
less valid as a recession indicator. Yellen’s arguments take us to the broader point that the
financial economy – which has featured rising asset prices for a
decade – seems thoroughly divorced from the real economy, which features
large numbers of disgruntled people who are not earning as much as they used
to do. This is true as far as it goes, but ignores the concept coined by
George Soros of reflexivity. By this, he meant that markets do not merely
attempt to reflect economic reality, but they also can affect that economic
reality. If bond yields fall sharply, then financial conditions are eased,
for example. Markets can force central banks’ hands. And, unfortunately, an inverted yield curve has real world
effects however it came to be inverted. Banks make their money by borrowing for the short-term from
depositors and lending at higher rates for the longer term. When those rates
invert (or merely flatten), it becomes far harder for them to make profits.
They have less incentive to lend, and
they have less capital with which to withstand any risks. The inverted yield curve has quite
rationally spurred a tumble for bank stocks in the U.S. and particularly in
the euro zone. Banks are arguably less important to the U.S. economy than
they were a generation ago; they are still central to the European economy,
and further problems for European banks will create problems for the U.S. That leads to yet
another argument to ignore this latest yield curve inversion: that the
pressure on the U.S. market at this point is largely from beyond American
shores. Europe is in the midst of a deflation scare, and investors there are
rushing to get yield wherever they can – which means buying Treasuries.
There are no good precedents for international economic conditions bringing
the U.S. into recession (give
or take the oil embargoes of the 1970s). Again, this makes sense but only to a point. Post-globalization,
it is far harder for the U.S. to ignore events elsewhere in the world. The
dollar is a critical point of pressure. If its economy remains strong, its
currency will be bid up and that will dent American companies’ profits
and render American exporters less competitive. And at present, the differential
between the yields available in the U.S. and Europe is so wide that it puts
huge upward pressure on the dollar, something that Trump wants to avoid.
This chart shows the spread of U.S. over German 10-year yields over the last
10 years. Even after the dramatic
drop in Treasury yields of the last few days, it shows that there is
still strong upward pressure on the dollar:
This pressure is not going to go away because German growth
is terrible. The latest numbers, which certainly contributed to the carnage
in the Treasury market on Wednesday, show that annual GDP growth had dropped
to zero. The gap between the growth of the two economies is widening. And Germany
is a big exporter, which stands to be hurt more than the U.S. by any fallout
from a U.S.-China trade war, so the prospects are for further upward pressure
on the dollar:
So it would be unwise to assume that the U.S. can ignore these
events just because they are generated outside the country. Unless it wishes
to withdraw from the global economy (which would be a bad idea), it is
exposed to the global economy. Further, there is the issue that the U.S.
has benefited in recent years from that exposure. China was critical in
allowing the rest of the world to escape from the recession that followed the
Global Financial Crisis. The huge stimulus it announced in late 2008, in the
form of extra loans, fired up the global economy. A the beginning of this
year, investors’ working assumption that another big stimulus was on the way
from China, to avert the risk of slowing. But the data that came out
just before the bond market swoon showed almost the opposite. If we look at a
12-month average (to avoid the distorting effects caused by China’s shutdown
for the lunar new year), we see that new loan growth is actually slowing.
This is nothing at all like the huge stimulus of 2009:
This leaves one final
objection, which is that bond markets can get it wrong. This is true. I myself argued in this space only a few
days ago that bonds were in a classic investment bubble. But, unfortunately,
the real and financial economies cannot ignore each other. Overshooting in
the bond market has real effects on the real economy, which are likely to be
negative. Does
all of this prove that a recession is inevitable? No, nothing can do that.
But it would be wise to take this yield curve inversion seriously, and act on
the assumption that the chances of a recession have greatly increased. We
should care about the inversion, and we should care because it will affect
the world we live in. Silver lining for real
estate developers. Few benefit from these events, but real estate stocks are an
exception. Oddly, real estate stocks have performed very poorly since a real
estate developer reached the White House. But real estate investment
trusts do pay out a regular dividend from rents, and this makes
them very popular when rates are falling. Meanwhile banks are hammered by the
flattening yield curve. And so, for
the first time in the Trump presidency, REITs are outperforming banks:
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Chapter 5 Diversification – Part
I Diversification Investing in
the S&P 500 (video)
“Members of a
Yale class entering their prime giving years had decided to set up a private
fund, manage the money themselves, and give it to the University 25 years
later. The worrisome part for Yale was that it would have no control over the
fund, which was going to be invested in high-risk securities. What if all the
money was blown by these “amateurs"? And what if the scheme siphoned off
other potential donations? Happily,
everything turned out for the best. Despite Yale’s initial efforts to
discourage the Class of 1954 from its plan, the class persisted. And last
October, its leaders announced that their original collective investment of
$380,000 had grown to $70 million, earning unalloyed gratitude from the
University and the right to name two new Science Hill buildings after their
class.” ----- What is your opinion? Apple is one of the stocks in their
portfolio. So shall you pick stocks individually or buy S&P500? Shall you
diversify or not? Let’s compare AAPL with S&P500. Stock returns from 1995-2015 - Apple and
S&P 500
Regress
Apple’s Return on S&P500’s
Apple and
S&P500’s Stand Deviation Comparison
Questions for class discussion: · Which one is better, the S&P500 or
Apple? In the past? About the future? · Which one is riskier and which one’s
return is higher? · Are you tempted to invest in APPLE or
SP500? · How to find the next Apple? · How much is the weight of Apple in
S&P500? For example, you have a total of $1,000 to invest in SP500, how
much you have invested in apple? · How are the weights in the following
table calculated?
=========================================================================
https://www.slickcharts.com/sp500 For class discussion: ·
Based on the above information, what is your
conclusion? ·
When you invest in S&P500, how is the fund
allocated?
http://siblisresearch.com/data/weights-sp-500-companies/ What Is
the Weighting of the S&P 500? --- Understanding the Sectors and Market Caps
in the Index BY TIM LEMKE REVIEWED
BY DORETHA CLEMON on June 18, 2021 https://www.thebalance.com/what-is-the-sector-weighting-of-the-s-and-p-500-4579847 If
you’ve ever dipped so much as a toe into investing, you’ve probably heard
about the Standard & Poor’s 500 Index. The S&P 500 is the most
common index used to track the performance of the U.S. stock market.
It is based on the stock prices of 500
of the largest companies that trade on the New York Stock Exchange or the
NASDAQ. The
S&P 500 is often hailed as a representation of the entire U.S. stock
market and American business as a whole, but that is not entirely accurate.
While it does give you exposure to a broad swath of the economy, it is heavily weighted toward specific
market capitalizations, sectors, and industries, which is important to know
if you are seeking to build a diversified equity portfolio. S&P 500 Market
Capitalizations By
design, the S&P 500 includes only
large companies. Only the biggest companies with massive market
capitalizations ($9.8 billion or more) are included-think of large firms
such as Apple, Microsoft, Amazon.com, Facebook, and Alphabet, the parent
company of Google. One could argue that the S&P 500 is 100% weighted
toward large-cap firms, though many of the biggest firms would technically be
considered mega-cap. It's
important for investors to know that while investing in the S&P 500 can
give great returns, they may be missing out on returns from
medium-sized and small companies. Those who are looking for exposure to
smaller firms should consider investments that track the S&P 400, consisting of the top mid-cap companies, or the Russell
2000, which features mostly smaller companies. Those
who are looking for exposure to smaller firms should consider investments
that track the S&P 400, consisting of the top mid-cap companies, or the
Russell 2000, which features mostly smaller companies. S&P
500 Sector and Industry Weighting Any
attempt to diversify your stock portfolio should include some attempt at
diversification according to sector and industry. In fact, some investment
strategies suggest a perfect balance of sectors, because any sector can be
the best-performing group in any given year. In
recent years, certain sectors and industries have performed better than
others, and that is now reflected in the makeup of the S&P 500. It also
means that many sectors won't be as represented in the index. As
of December 22, 2020, the breakdown of sectors in the S&P 500
was as follows, according to State Street Advisors (the creator of the SPDR
S&P 500 ETF Trust, an exchange-traded fund that seeks to track the
performance of the S&P 500): Information technology:
27.60% Health care: 13.44% Consumer discretionary:
12.70% Communication services:
10.79% Financials: 10.34% Industrials:
8.47% Consumer
staples: 6.55% Utilities:
2.73% Materials:
2.64% Real
estate: 2.41% Energy:
2.33% As
you can see, the S&P is
heavily weighted toward tech, health care, and consumer discretionary stocks.
Meanwhile, there aren't as many
utilities, real estate companies, or firms involved in producing and selling
raw materials. This weighting has changed
greatly over the years. Look back 25 years, and you’ll likely see far fewer
tech companies and more emphasis on consumer discretionary and communications
companies. Go back 50 years, and the mix will look even more different. Why
It Matters The weighting of the S&P
500 should be important to you, because the index is not always a
representation of the types of companies performing the best in any given
year. For example, while consumer discretionary
may have been the top-performing sector in 2015, it ranked third in 2017 and
seventh in 2019. The communications services sector was last in performance
in 2017 but had ranked second just one year earlier. The financials sector
was dead last in 2007 and 2008, in the midst of the financial crisis, but it
claimed the top spot in 2012 and performed third-best in 2019.4 Predicting which sectors
will perform best in any given year is very difficult, which is why
diversification is key. How To Supplement the
S&P 500 Investing
in the S&P 500 through a low-cost index fund can provide a very strong
base for most stock portfolios. But to get broad diversification among market
caps and sectors, it may help to expand your reach. Fortunately, there are
mutual funds and exchange-traded funds (ETFs) that provide exposure to
whatever you may be seeking. An investor who is looking to boost their
portfolio by purchasing small-cap stocks can buy shares of an index fund
designed to mirror the Russell 2000. If you want to invest more in financial
stocks, you can access funds comprising a wide range of banks and financial
services firms. There are also mutual funds
and ETFs that offer broad exposure to the entire stock market, including all
market caps and sectors. Vanguard’s Total Stock Market ETF and the S&P
Total Stock Market ETF from iShares are two popular examples. How to Calculate
the Weights of Stocks The weights of your stocks can play a big role
in your investment strategy. Here's how to calculate them. Calculating the weights of stocks you own can be
useful to your investment strategy. For example, if your investment goal is
to allocate no more than 15% of your portfolio to any single stock,
determining the weights of the stocks in your portfolio can tell you whether
or not you need to make any changes. Here's how to calculate the weights of
stocks, what this information means to you, and an example of how you can use
this. Calculating the
weights of stocks You'll also need your total portfolio value. If
you want to determine the weights of your stock portfolio, simply add up the
cash value of all of your stock positions. If you want to calculate the
weights of your stocks as a portion of your entire portfolio, take your
entire account's value – including stocks, bonds, cash, and any other
investments. The calculation is simple enough. Simply divide
each of your stock position's cash value by your total portfolio value, and
then multiply by 100 to convert to a percentage.
What the weights
tell you So, when your
heavily weighted stocks do well, your portfolio can go up quickly. For
example, if a stock with a 20% weight in a $50,000 portfolio doubles, it
would mean a $10,000 gain. On the other hand, if a stock only makes up 2% of
your portfolio, your gain would only be $1,000, even though the stock itself
was a home run. Conversely,
heavily weighted stocks can drag your portfolio down during tough times,
while lower-weighted stocks will have a smaller effect. Examining your
portfolio: An example
In this example, Johnson & Johnson carries
twice the weight of Microsoft; therefore, a big move in J&J will have
double the effect on your overall portfolio than the same move in Microsoft
would.
HW chapter 5 -1 (Due
with the second mid-term exam) 1
Calculate the monthly stock return and risk of Apple and
SP500 in the past five years. And draw a conclusion regarding the tradeoff
between risk and return. Steps: From finance.yahoo.com, collect stock prices
of the above firms, in the past five years Steps: · Goto finance.yahoo.com, search for the
companies (Apple and S&P500, repectively) · Click on “Historical prices” in the left
column on the top and choose monthly stock prices. · Change the starting date and ending date to
“Oct 19th, 2016” and “Oct 19th, 2021”, respectively. · Download it to Excel · Delete all inputs, except “adj close” –
this is the closing price adjusted for dividend. Evaluate the performance of each stock: · Calculate the monthly stock returns. · Calculate the average return · Calculate standard deviation as a proxy for
risk Please
use the following excel file as reference.
FYI Excel
(or template) (From Oct 2016 – Sept 2021) 2. Calculate the most
recent weight of Apple in SP500. Also calculate the weight of GOOGLE,
Amazon, Netflix. Hint: please use 40.3 trillion (40,300,000,000,000) as of August 31, 2021 for SP500 market
cap. The website for this information is here: http://siblisresearch.com/data/total-market-cap-sp-500. 3.
Compare the above top 8 best and worst stocks in 2020 and give it a try
to summarizes about the similarities among stocks in each group,
such as location, industry sector, etc. if you can find any. Want to improve your personal
finances? Start by taking this quiz to get an idea of your investment risk
tolerance – one of the fundamental issues to consider when planning your
investment strategy, either alone or in consultation with a financial
services professional. Discussion: Based on your risk tolerant score, which of the follow
shall you choose? Why? Example: Optimally
diversified portfolio 1. 3. For class discussion: 1.
What is value stock? Example? What is a Value Stock -
Value Investing (youtube)
2. What is
small cap value? Example? Large cap? Small Cap
Stocks vs Large Cap Stocks - Which are Better Investments
3. Shall
we consider bond for diversification purpose? 4. Shall we
include international stocks to establish a diversified portfolio? 5. What
benefits can be gained from diversification with bond and international
stocks? How
Diversification Works (youtube)
Mutual fund vs. ETF What is ETF? (Video) Mutual Funds vs. ETFs -
Which Is Right for You? (Video)
For discussion: What one of the above funds
is the most favorite one to you? Why?
1.
How to tell the risk
level based on standard deviation shown in step 1? 2.
What is the difference
between rewarded risk and unrewarded risk? Example? 3.
Write down the CAPM
model. 4.
Among the four models
shown in step 3, which one is the best? Dark Side of ETFs CNBC (Video)
ETF Investing Strategies (Video)
For class discussion: What
is ETF? What
is the pro and cons to invest in ETF? Examples
of ETF? Examples of ETF: Powershares (QQQ) – NASDAQ 100 Index (Large-cap
growth stocks) Understanding QQQE: Nasdaq-100 Equal Weighted Index
Shares ETF (Video)
For class discussion: When we compare QQQ with S&P500, which one is
better in terms of performance in the past ten years? Which one is riskier? Why? Average Volume: 36.1 million Expenses: 0.20% 12-Month Yield: 1.00% Sector Weightings (top 5): Information Technology 54.47%; Healthcare 14.62%; Consumer
Cyclical: 13.26%; Consumer Defensive: 6.89%; Communication Services: 6.62% Market-Cap Allocations: Large-cap growth: 62.86%; large-cap blend: 20.53%; large-cap
value: 7.38%; mid-cap growth: 4.57%; mid-cap blend: 2.98%; mid-cap value:
1.69% Top 5 Holdings: Apple Inc. (AAPL):
14.53% Microsoft Corp. (MSFT):
6.79% Google Inc. (GOOG):
3.80% Facebook Inc. (FB):
3.73% Amazon.com, Inc. (AMZN):
3.73% Performance: 1-Year: 21.63% 3-Year: 17.10% 5-Year: 18.29% 10-Year: 12.07% 15-Year: -0.19% Dividend yield 0.74% dividend on yearly basis https://www.investopedia.com/ask/answers/061715/what-qqq-etf.asp
ETF Battles:
QQQ Vs. SPY, Who Wins? https://seekingalpha.com/instablog/18416022-etfguide/5418872-etf-battles-qqq-vs-spy-who-wins Mar. 10, 2020
7:38 PM ETInvesco QQQ ETF (QQQ), SPY This is an
excerpt from the video titled, ETF Battles: QQQ vs. SPY with Ron DeLegge at
ETF guide. During normal
markets, daily trading volume for QQQ averages around 75 million shares
while SPY averages 173 million shares. During the
latest market correction, daily volume skyrocketed to record levels with QQQ
topping 149,247,100 shares traded in a single session while SPY booked
385,764,000 shares. (Both trading volume peaks occurred on Feb. 28, 2020)
Cost The first
category for comparing QQQ vs. SPY is cost. Who wins? SPY charges annual
expenses of just 0.09% compared to 0.20% for QQQ. Put another way, QQQ is
more than double the cost of SPY! While SPY isn't necessarily the cheapest
S&P 500 ETF, compared to QQQ it's a bargain. Bid ask spreads are another
element of an ETF costs. And ETFs with tight bid ask spreads reduce the
frictional trading costs associated with buying and selling funds. In this
regard, QQQ and SPY are evenly matched with both funds having very narrow
bid ask spreads that hover around 0.01%. Dividends First, both
funds distribute dividends from their equity holdings every quarter. SPY
has a 12-month trailing yield of 1.90% while QQQ is at 0.77%. Clearly,
SPY wins but there's more behind the reason why. SPY, unlike QQQ, contains
significant exposure to key dividend paying industry sectors like financials,
real estate, and utilities. On the other hand, QQQ is overweight technology
(63.91% of its portfolio is committed to this sector at the time of
publication) and the tech sector is a historically low dividend yielding
industry group. SPY beats QQQ by having a higher dividend. Also the fact
that SPY obtains its dividends across a far more diversified base of 11
industry groups compared to the technology heavy QQQ makes it a winner. Diversification
Almost 65%
of QQQ's sector exposure is to technology companies, which isn't very
diversified at all and if you blindfolded me and asked me to guess what type
of ETF that QQQ is, I would immediately describe it as an industry sector
fund. In contrast, SPY beats QQQ on diversification because not only does
it have more stocks - 500 - but the stocks it owns are scattered across 11
different industry groups which include technology along with a whole
bunch of other important industry sectors like healthcare, materials, and
industrials. Performance Excluding
dividends, QQQ has gained around 20% over the past year while SPY has
gained around 7%. So QQQ wins the short-term performance race.
What about longer time frames? QQQ outperformed SPY over the past 10 and 15
year period too. But if we go back 20 years, SPY wins because it gained
around 197% not including dividends while QQQ gained just 101%. At the end of
the day, QQQ's lights out performance during the past 1, 10, and 15 years is
largely due to its concentrated portfolio in technology. SPY's less
concentrated exposure to tech during this time frame resulted in a lower
return. Nevertheless, over 20 years SPY did manage to outperform QQQ by a not so small 96%. This is a
split decision with QQQ winning the shorter term performance race while SPY
wins the longer-term race. Final Winner
of ETF Battles Who wins the
ETF battle between QQQ vs. SPY? The final winner of today's hard fought
battle between QQQ and SPY is...the SPDR S&P 500 ETF (SPY). It's got
lower cost, better diversification, a higher dividend yield, and better
long-term performance. How to tell the performance of a
fund? Alpha, often considered the active
return on an investment, gauges the performance of an investment against
a market index used as a benchmark, since they are often considered to represent the market’s movement as a whole. The
excess returns of a fund relative to the return of a
benchmark index is the fund's alpha. Alpha is most often used for
mutual funds and other similar investment types. It is often represented as a single number (like 3 or -5), but
this refers to a percentage measuring how the portfolio or fund
performed compared to the benchmark index (i.e. 3% better or 5% worse). Alpha is often used with beta,
which measures volatility or risk, and is also often referred to as “excess return” or “abnormal rate of return”. (Investorpedia) Bond mutual fund What Type of
Bond Funds Do You Need? (youtube)
Bond Fund https://www.investopedia.com/terms/b/bondfund.asp By
ADAM HAYES Updated June 30, 2021 What
Is a Bond Fund? A
bond fund, also referred to as a debt fund, is a pooled investment vehicle that invests primarily in bonds
(government, municipal, corporate, convertible) and other debt instruments,
such as mortgage-backed securities (MBS). The primary goal of a bond fund is often that of generating monthly
income for investors. KEY TAKEAWAYS ·
A bond fund invests primarily in a
portfolio of fixed-income securities. ·
Bond funds provide instant diversification
for investors for a low required minimum investment. ·
Due to the inverse relationship between
interest rates and bond prices, a long-term bond has greater interest rate
risk than a short-term bond. ·
Understanding Bond Funds ·
A bond fund is simply a mutual fund that
invests solely in bonds. For many investors, a bond fund is a more efficient
way of investing in bonds than buying individual bond securities. Unlike
individual bond securities, bond funds do not have a maturity date for the
repayment of principal, so the principal amount invested may fluctuate from
time to time. Additionally,
investors indirectly participate in the interest paid by the underlying bond
securities held in the mutual fund. Interest payments are made monthly and
reflect the mix of all the different bonds in the fund, which means that the
interest income distribution will vary monthly. An
investor who invests in a bond fund is putting their money into a pool
managed by a portfolio manager. Typically, a bond fund manager buys and sells
according to market conditions and rarely holds bonds until maturity. Types of Bond Funds Most
bond funds are comprised of a certain type of bond, such as corporate or government
bonds, and are further defined by time period to maturity, such as
short-term, intermediate-term, and long-term. Some bond funds include only
the safest of bonds, such as government bonds.
Investors should note that U.S. government bonds are considered to be of the
highest credit quality and are not subject to ratings. In effect, bond funds
that specialize in U.S. Treasury securities, including Treasury
inflation-protected securities (TIPS), are the safest but offer the lowest
potential return. Other funds invest in only
the riskiest category of bonds—high-yield or junk
bonds. Bond funds that invest in more volatile
types of bonds tend to offer higher potential returns. There
are also bond funds that have a mix of the different types of bonds in order
to create multi-asset class options. For investors interested in bonds, a Morningstar bond style box can be used
to sort out the investing options available for bond funds. The types of bond
funds available include: US government bond funds; municipal bond funds;
corporate bond funds; mortgage-backed securities (MBS) funds; high-yield bond
funds; emerging market bond funds; and global bond funds. Mutual
funds have been investing in bonds for many years. Some of the oldest
balanced funds, which include allocations to both stock and bonds, date back
to the late 1920s. Bond Fund Benefits Bond funds are attractive
investment options as they are usually easier for investors to participate in
than purchasing the individual bond instruments
that make up the bond portfolio. By investing in a bond fund, an investor
need only pay the annual expense ratio that covers marketing, administrative
and professional management fees. The alternative is to purchase multiple
bonds separately and deal with the transaction costs associated with each of
them. Bond funds provide instant
diversification for investors for a low required minimum investment.
Since a fund usually has a pool of different bonds of varying maturities, the
impact of any single bond’s performance is lessened
if that issuer should fail to pay interest or principal. Another
benefit of a bond fund is that it provides access to professional portfolio
managers who have the expertise to research and analyze the creditworthiness
of bond issuers and market conditions before buying into or selling out of
the fund. For example, a fund manager may replace bonds when the issuer's
credit is downgraded or when the issuer "calls," or pays off the
bond before the maturity date. Special
Considerations Bond funds can be sold at
any time for their current market net asset value (NAV), which may result in
a capital gain or loss. Individual bonds can be harder to unload. From
a tax perspective, some investors in higher tax brackets may find that they
have a higher after-tax yield from a tax-free municipal bond fund investment
instead of a taxable bond fund investment. Due to the inverse relationship between
interest rates and bond prices, a long-term bond carries greater interest
rate risk than a short-term bond. Therefore, the NAV of bond funds with
longer-term maturities will be impacted greatly by changes in interest rates.
This, in turn, will affect how much interest income the fund can
distribute to its participants monthly. Bond
ETFs Bond
ETFs have been around for less time than bond mutual funds, with iShares
launching the first bond ETF fund in 2002. Most of these offerings seek to
replicate various bond indices, although a growing number of actively managed
products are also available. ETFs often have lower fees
than their mutual fund counterparts, potentially making them the more
attractive choice to some investors, all
else being equal. Like stocks, ETFs trade throughout the day. The prices for
shares can fluctuate moment by moment and may vary quite a bit over the course
of trading. Bond ETFs operate much like
closed-end funds, in that they are purchased through a brokerage account
rather than directly from a fund company. Likewise, when an investor wishes
to sell, ETFs must be traded on the open market.
A buyer must be found because the fund company will not purchase the shares
as they would for open-ended mutual funds. HW chapter 5 -2 (Due with the second mid-term exam) 1.
Work on this investment risk
tolerance test and report your score. Make a
self-evaluation about yourself in terms of your risk tolerance level. Based
on your risk level, set up a investment strategy! Please provide a rationale. 2.
Compare ETF with mutual fund 3.
Compare QQQ with SPY 4.
What is Alpha? What is Beta? What is CAPM? |
What
Apple’s Stock Split Means for You · By STEVEN RUSSOLILLO WHAT IF APPLE NEVER SPLIT ITS STOCK? Apple has now split its stock
four times throughout its history. It previously conducted 2-for-1 splits on
three separate occasions: February 2005, June 2000 and June 1987. According
to some back-of-the-envelop math by
S&P’s Howard Silverblatt, if Apple never split its stock, you’d have eight shares for
each original one prior to the most recent split. So Friday’s $645.57 closing
level would translate to $5164.56 unadjusted for splits. No Here are five things you need to know
about Apple’s stock split. WHO DOES THE STOCK SPLIT IMPACT? Investors who
owned Apple shares as of June 2 qualify for the stock split, meaning they get
six additional shares for every share held. So if an investor held one Apple
share, that person would now hold a total of seven shares. Apple also
previously paid a dividend of $3.29, which now translates into a new
quarterly dividend of $0.47 per share. WHY IS APPLE DOING THIS? The iPhone and iPad maker says it is trying to attract a
wider audience. “We’re taking this action to make Apple stock more accessible
to a larger number of investors,” Apple CEO Tim Cook said in
April. But the comment also marked an about-face from two years earlier. At
Apple’s shareholder meeting in February 2012, Mr. Cook said he didn’t see the
point of splitting his company’s stock, noting such a move does “nothing” for
shareholders. WILL APPLE GET ADDED TO THE DOW? It’s unclear
at the moment, although a smaller stock price certainly makes Apple a more
attractive candidate to get added to blue-chip Dow. Apple, the bigge, your screens aren’t lying to you. Shares of
Apple Inc. now trade under $100, a development that hasn’t happened in years. Apple’s unorthodox 7-for-1 stock split,
announced at the end of April, has finally arrived. The stock started trading
on a split-adjusted basis Monday morning, and recently rose 1% to $93.14. In a stock split, a company increases the
number of shares outstanding while lowering the price accordingly. Splits
don’t change anything fundamentally about a company or its valuation, but
they tend to make a company’s stock more attractive to mom-and-pop investors.
Apple shares rallied 23% from late April, when the company announced the
split in conjunction with a strong quarterly report, through Friday. A poll conducted by our colleagues at MarketWatch found 50% of respondents said they would
buy Apple shares after the split. Some 31% said they already owned the stock
and 19% said they wouldn’t buy it. The survey received more than 20,000
responses. st U.S. company by market capitalization,
has never been part of the historic 30-stock index, a factor that many
observers attributed to its high stock price. The Dow is a price-weighted
measure, meaning the bigger the stock price, the larger the sway for a
particular component. That is different from indexes such as the S&P 500,
which are weighted by market caps (each company’s stock price multiplied by
shares outstanding). WILL APPLE KEEP RALLYING? Since the financial
crisis, companies that have split their stocks have struggled in the short
term and outperformed the broad market over a longer time horizon. Since
2010, 57 companies in the S&P 500 have split their shares. Those stocks
have averaged a 0.2% gain the day they started trading on a split-adjusted
basis, according to New York research firm Strategas Research Partners. A month later, they
have risen just 0.5%. But longer term, the average gains are more pronounced.
Since 2010, these stocks have averaged a 5.4% increase three months after a
split and a 28% surge one year later, Strategas says. WHAT IF APPLE NEVER SPLIT ITS STOCK? Apple has
now split its stock four times throughout its history. It previously
conducted 2-for-1 splits on three separate occasions: February 2005, June
2000 and June 1987. According to some back-of-the-envelop math by S&P’s Howard Silverblatt, if Apple never split its stock, you’d have
eight shares for each original one prior to the most recent split. So
Friday’s $645.57 closing level would translate to $5164.56 unadjusted for
splits. For class discussion: Why Apple needs to do so? Is that necessary? Why Google does not
follow Apple and make its stock price cheaper and affordable? Mutual Funds, ETFs Nab $20.77 Billion for Week Ended Oct. 18,
Biggest Since June Oct. 25, 2017, at 5:27 p.m. NEW YORK (Reuters) - Total estimated inflows to long-term
mutual funds and exchange-traded funds (ETFs) were $20.77 billion for the
week ended Oct. 18, the biggest attraction of cash since mid-June, as investors
put money to work at the start of the fourth quarter against the backdrop of
rising global equity markets, the Investment Company Institute reported
Wednesday. Estimated mutual fund inflows were $3.91 billion while
estimated net issuance for ETFs was $16.86 billion. Equity funds had estimated
inflows of $12.61 billion for the week, compared to estimated inflows of
$3.41 billion in the previous week. Domestic equity funds had estimated inflows of $6.97 billion,
and world equity funds had estimated inflows of $5.64 billion. Jim Paulsen,
chief investment strategist at The Leuthold Group, said investors
face a difficult asset allocation decision as 2017 comes to a close. "Should you stay invested for further gains in the
stock market yet this year, or should you begin to get more defensive considering
economic surprise momentum is likely to fade early next year?" Paulsen
asked. "Our best guess is the stock market will trend higher through
year-end but may struggle during the first half of next year." So far this year, the Standard & Poor 500 Index has
posted returns of over 14 percent while the
Hang Seng Indexes Co has posted returns of 28.65 percent. The ferocious appetite for income has also pushed investors
into bond funds despite falling yield levels. Bond funds had estimated inflows of $9.31 billion for the
week, compared to estimated inflows of $9.14 billion during the previous week.
Taxable bond funds saw estimated inflows of $8.38 billion, and municipal bond
funds had estimated inflows of $931 million. Commodity funds, which are ETFs that invest primarily in
commodities, currencies, and futures, had estimated outflows of $428 million
for the week, compared to estimated inflows of $265 million in the previous
week. For discussion: People are no aware of the market turmoil. Can
you believe it? Are we all rational investors? The big mistake mutual-fund investors
make Published: Apr 21, 2017 4:04 a.m. ET 11By PAULA. MERRIMAN You have probably heard about what's known as the DALBAR
effect. It's the fact that, as a group, mutual-fund investors underperform
the funds in which they invest. Quick background: The reason for this effect, amply documented
over nearly a quarter-century by a Boston research firm, is investors'
behavior. In short, mutual fund shareholders tend to buy and sell based
on their emotional reactions to bull markets and bear markets, real or
expected. Their timing is usually wrong, and in the end they would have done
better by buying and holding. OK, here's the bad news: If you're average, chances are you
will underperform the funds that you own. But here's the good news: I've discovered a group of investors
who are apparently doing just the opposite: They are outperforming the
funds they own. To understand how that's possible, you'll need to bear with me
as I walk through some steps. For your patience, you will be rewarded at the
end with my suggestion for how you too may be able to perform what seems to
be a minor financial miracle. I first discovered this anomaly while I was comparing
target-date retirement funds offered by Fidelity and Vanguard. What I found is more than just coincidence: It appears in the latest
10-year performance results in four pairs of retirement funds — those with
target dates of 2020, 2030, 2040 and 2050. Let's take the Vanguard and Fidelity 2020 funds as examples.
The numbers are clear on two points. · The Vanguard fund has higher returns. · While investors in the Fidelity fund
(consistent with the DALBAR effect noted above), achieved lower returns than
those of the fund itself, investors in Vanguard's 2020 fund achieved higher
results than the fund. Here are the numbers: For the 10 years ended March 31, 2017, the Fidelity 2020
Freedom Fund FFFDX compounded at 4.47%, while investor
returns (provided by Morningstar Inc.) were only 3.13%. The Vanguard Target
Retirement 2020 Fund VTWNX compounded at 5.23%, and investor returns were
6.53%. How is it possible to have such a large additional return? The Vanguard fund return is based on the assumption of a
lump-sum initial investment made at the end of March 2007 with no further
additions or withdrawals other than reinvestment of dividends. The investor return tracks the dollars that investors as a
group actually invested, and when they invested them. (I'll come back to that
point in a moment.) Here are the comparable results for three other pairs of target-date
funds. 2030: Fidelity FFFEX grew at 4.66%; investor
returns were only 3.53%. Vanguard VTHRX grew at 5.31%;
investor returns were 7.58%. 2040: Fidelity FFFFX grew at 4.78%;
investor returns were only 4.17%. Vanguard VFORX, -0.40%
grew at 5.69%; investor returns were 8.49%. 2050: Fidelity FFFHX, -0.41%
grew at 4.61%; investor returns were 6.92%. (No, that's not a typo; stay
tuned.) Vanguard VFIFX, -0.39%
grew at 5.71%; investor returns were 8.70%. In every case, the Vanguard funds achieved higher performance.
That's not hard to explain: Fidelity's funds charge higher expenses, hold
more cash, use active management and have much higher turnover. But those things don't explain how investors in five of these
eight funds did the seemingly impossible: outperformed the funds in which
they invested. I think the answer is to be found in investor behavior. Target-date fund shareholders are typically setting money
aside methodically for their eventual retirement through regular withdrawals
from their paychecks. You probably know the name for this practice: dollar-cost
averaging (DCA), investing the same amount every month or every pay period. DCA lets investors take advantage of the rise and fall of
stock prices by automatically buying more shares when prices are low and
fewer shares when prices are high. The result: The average price paid per
share is lower than the average of all the prices at which those shares were
bought. I think this explains the higher investor returns in five of
these eight funds. Two questions remain: · Why did Vanguard investors outperform while
those in three of the four Fidelity funds lagged? · Why did investors in Fidelity's 2050 fund do
better than investors in the other three Fidelity funds under study? Though I can't back up my answers with numbers, I'll take a
stab at answering these questions. Both answers, I believe, come down once
again to investors' collective behavior. To answer the first question, I think Vanguard simply attracts
a different sort of investor than Fidelity. · Vanguard marketing emphasizes the firm's low
costs, its index funds, the higher quality of its stocks and bonds and its
buy-and-hold culture. Vanguard urges investors to accept the returns of the
market. · Fidelity's marketing focuses on active
managers who pick stocks, backed up by impressive stock analysts. Fidelity
urges investors to seek higher performance. OK, but so why did investors in Fidelity's 2050 fund
outperform the fund itself, while those in the 2020, 2030 and 2040 funds
underperformed? Here I have to speculate. I'm guessing that investors with an
eye on a 2050-ish retirement are younger and often have less money with which
they want to try to beat the odds. For this reason, I suspect that such investors are less likely
to try to second-guess the market's ups and downs and more likely to simply
trust their funds. I promised a suggestion for how you might be able to
outperform a fund you're invested in. My best suggestion is to use dollar-cost averaging. This will
keep your average cost-per-share down. And it will keep you investing
regularly. Both are extremely good habits. However, at the risk of throwing cold water on a good idea, I
have to point out that DCA makes a positive difference only over extended
periods, and only during periods when the market ends up higher than it
started. (The reason for this is simple: Even if you buy at below-average
prices, if your investment loses money over the long run, it loses money.
Sorry about that.) The latest 10-year period (like most 10-year periods) was a
positive one for stock investors. The most recent eight years were especially
strong, with the S&P 500 index SPX, -0.47% appreciating
by more than 300% (including reinvestment of dividends). Although things won't always be that good, the market
historically goes up about two-thirds of the time and down only one-third. So if you take a long-term perspective, keep your expectations
realistic and adopt excellent investing habits, I think there's a good chance
you, like many of Vanguard's target-date investors, will be able to do the
seemingly impossible. For discussion: What is suggested by the author? Do you agree? Index funds are more
popular than ever—here’s why they’re a smart investment Published Thu, Sep 19 201911:40 AM EDT Alicia Adamczyk@ALICIAADAMCZYK U.S. stock index funds are more popular than
actively managed funds for the first time ever, according to investment research firm Morningstar. As of August 31, these index funds held
$4.27 trillion in assets, compared to $4.25 trillion in active funds. Index funds were created by Jack Bogle almost 45 years ago as a way for everyday investors to
compete with the pros. They’re designed to be simple, all-in-one investments:
Rather than picking stocks you or your fund manager thinks will out-perform
the market, you own all of the stocks in a certain market index, like the
S&P 500 or the Dow Jones Industrial Average. The thinking isn’t that you’ll beat the
market, but rather that you’ll keep up with it. And considering that
the stock market has
historically increased in value over time, that pays off for retirement investors. Index funds have turned out to be a huge win
for retirement savers and other non-finance professionals for many reasons.
First, because you’re not paying someone to pick stocks for you anymore,
index funds tend to be less expensive for investors than actively managed
funds: The average expense ratio of passive funds was 0.15% in
2018, compared to 0.67% for active funds, Morningstar reported. The original index fund,the Vanguard 500, has an expense ratio of just 0.04%. Index funds also typically make trades less
often than active funds, which leads to fewer fees and lower taxes. Consistently buy an S&P 500 low-cost
index fund. I think it’s the thing that makes the most sense practically all
of the time. Warren Buffett CEO
OF BERKSHIRE HATHAWAY “Costs really matter in investments,”
investing icon Warren Buffett told CNBC in 2017. “If returns are going to be seven or 8% and you’re paying 1%
for fees, that makes an enormous difference in how much money you’re going to
have in retirement.” Second, index funds tend to perform better
over the long term than actively managed funds, making them ideal for people
investing for retirement. It’s incredibly hard for a person to pick stocks
that will beat the market and even harder to do so consistently over decades. In fact, the majority of large-cap funds have
under-performed the S&P 500 for nine years running. “While a fund manager may outperform for a
year or two, the outperformance does not persist,” CNBC reported. “After 10
years, 85% of large-cap funds underperformed the S&P 500, and after 15
years, nearly 92% are trailing the index.” Large-cap funds are made up of the
publicly traded companies with the biggest market capitalizations. Where active funds theoretically have a leg
up is during periods of market volatility. The theory is that the managers
will be able to shield their investors from some of the market’s deviations.
But that wasn’t the case in 2018, for example, when managers still
under-performed indexes, despite a rocky fourth quarter. For the everyday investor looking to build
wealth long term, that all adds up to make low-cost index funds a go-to
investment. “Consistently buy an S&P 500 low-cost index fund,” Buffett said. “I think it’s the thing that makes the most sense
practically all of the time.” Bitcoin had a wild weekend, briefly
topping $10,000, after China’s Xi sang blockchain’s praises PUBLISHED MON,
OCT 28 20195:42 AM EDTUPDATED MON, OCT 28 20199:49 AM EDT Bitcoin’s price
rose sharply over the weekend, recovering from a plunge just days
earlier, after Chinese President Xi Jingping gave a speech embracing
blockchain technology and calling on his country to advance development in
the field. The value of the world’s best-known
cryptocurrency jumped as high as $10,332 on Saturday, according to data from
industry website CoinDesk. The price has since eased to around $9,370 as of
Monday morning, up about 1% on the day. The virtual currency’s jump came as China’s
leader sang the praises of blockchain, the technology that underpins
cryptocurrencies like bitcoin. According to state media, Xi said Friday that China has a strong
foundation and should look to take a leading position in the sector. He reportedly said China should “seize the
opportunity” offered by blockchain, adding the technology could benefit a
range of industries including finance, education and health care. A
blockchain is a digital ledger that maintains a record of transactions or
other data across a network of computers. Beijing has taken a tough stance on cryptocurrencies, banning a fundraising
exercise known as an initial coin offering and forcing local trading
platforms to shut down in 2017. China’s central bank, the People’s Bank of
China (PBOC), has been working on its own digital currency. It has
accelerated its development in recent months as Facebook and a handful
of other companies look to shake up the global financial services industry
with a cryptocurrency called libra. The PBOC set up a research team back in 2014
to explore the use of virtual currencies to reduce the costs involved in
circulating traditional paper-based money. A senior official at the bank said
last month that the planned digital token would bear some similarities to libra. Libra has come under intense scrutiny from
regulators around the world, who worry Facebook’s proposed digital asset
would disrupt the financial system and could be open to risks like money
laundering and terrorist financing. Lawmakers last week grilled Facebook CEO Mark Zuckerberg over the project. Zuckerberg at one point said the social
network would not take part in launching libra “until U.S. regulators
approve.” Though Facebook has led the initiative so far,
the tech giant has been trying to keep a distance between it and the Switzerland-based Libra Association that oversees the
currency’s development. The consortium lost key initial supporters
including Mastercard and Visa earlier this month, leaving it
with just 21 founding members. Bitcoin has been on the rise this year and is
currently up nearly 150% year-to-date. That marks a significant turnaround
from last year, when the digital coin tanked to as low as $3,122 after
hitting an all-time high of close to $20,000 in December 2017. Analysts had attributed some of the cryptocurrency’s 2019 gains to headlines around companies like Facebook, Fidelity and New York Stock Exchange owner International Exchange getting involved in the space, the logic being that it brings some much-needed legitimacy to an industry that has in the past been clouded by major cyber attacks and scams. |
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Chapter 8 Stock Market Part I: Stock
Market Popular Websites Stock screening tools Reuters stock screener to help select stocks http://stockscreener.us.reuters.com/Stock/US/ FINVIZ.com http://finviz.com/screener.ashx WSJ stock screen http://online.wsj.com/public/quotes/stock_screener.html Simply the Web's Best
Financial Charts How to pick stocks Capital Asset Pricing Model (CAPM)Explained https://www.youtube.com/watch?v=JApBhv3VLTo Fama French 3 Factor Model Explained https://www.youtube.com/watch?v=zWrO3snZjuA Ranking stocks using PEG ratio https://www.youtube.com/watch?v=bekW_hTehNU Class discussion topics and homework
(Are the following statements right or wrong? Why?, due with the second
mid-term exam) 1: My investment in company A is a sure thing. 2: I would never buy stocks now because the
market is doing terribly. 3: I just hired a great new broker, and I am
sure to beat the market. 4: My investments are well diversified
because I own a mutual fund that tracks the S&P 500. 5: I made $1,000 in the stock market today. 6: GM’s
earning report is better than expected. But GM stock price went down instead
of going up after the earning news was released. How come? 7: Paypal’s price has gone up so much in the past
several months. I should invest in Paypal now. |
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Part II: Behavior
Finance Behavior Finance
Introduction PPT Vanguard Behavior Finance
Lecture PPT - FYI Behavior
Finance Class Notes - FYI Anchoring •
Test
yourself first: A stock
price jumps to $40 from $20 but it suddenly dropped back to $20. Shall you
buy the stock or not? •
The
concept of anchoring draws on the tendency to attach or "anchor"
our thoughts to a reference point - even though it may have no logical
relevance to the decision at hand. •
Avoiding Anchoring –
Be
especially careful about which figures you use to evaluate a stock's
potential. –
Don't base
decisions on benchmarks –
Evaluate
each company from a variety of perspectives to derive the truest picture of
the investment landscape. Mental Accounting •
Test
yourself –
Shall
you payoff your credit card debt or start saving for a vocation? –
How do you
spend your tax refund? •
Mental
Accounting refers to the tendency for people to separate their money into
separate accounts based on a variety of subjective criteria, like the source
of the money and intent for each account.
Example: People
have a special "money jar" set aside for a vacation while still
carrying credit card debt. Confirmation Bias •
Confirmation
bias: First impression can be hard to shake –
people
selectively filter information that supports their opinion –
People
ignore the rest opinions. –
In
investing, people look for information that supports original idea •
Generate
faulty decision making because of the bias Example: investor finds all sorts of green flags about the
investment (such as growing cash flow or a low debt/equity ratio), while
glossing over financially disastrous red flags, such as loss of critical
customers or dwindling markets. Gambler’s fallacy: –
An
individual erroneously believes that the onset of a certain random event is
less likely to happen following an event or a series of events. Example: •
Example:
–
You
liquidate a position after it has gone up in several days. –
You hold
on to a stock that has fallen in several days because you view further
declines as "improbable". •
Avoiding
Gambler's Fallacy –
Investors
should base decisions on fundamental
or technical
analysis before determining what will happen. It is irrational to buy a stock because you believe it is
likely to reverse. Herding: –
Example:
Dotcom herd –
The
tendency for individuals to mimic the actions of a larger group. •
Social
pressure of conformity is one of the causes. –
This is
because most people are very sociable and have a natural desire to be
accepted by a group •
The
second reason is the common rationale that a large group could not be wrong. –
This is especially
prevalent when an individual has very little experience. –
Overconfidence: •
Confidence
implies realistically trusting in one's abilities •
Overconfidence
implies an overly optimistic assessment of one's knowledge or control over a
situation. Disposition
effect –
which is
the tendency for investors to hold on to losing stocks for too long and sell
winning stocks too soon. »
The most
logical course of action would be to hold on to winning stocks to further
gains and to sell losing stocks to prevent escalating losses. »
investors
are willing to assume a higher level of risk in order to avoid the negative
utility of a prospective loss. »
Unfortunately,
many of the losing stocks never recover, and the losses incurred continued to
mount . Avoiding the Disposition Effect •
When you have a choice of thinking of one large gain or a
number of smaller gains (such as finding $100 versus finding a $50 bill from
two places), thinking of the latter can maximize the amount of positive
utility. •
When you have a choice of thinking of one large loss or a
number of smaller losses (losing $100 versus losing $50 twice), think of one
large loss would create less negative utility. •
When you can think of one large gain with a smaller loss
or a situation where you net the two to create a smaller gain ($100 and -$55,
versus +$45), you would receive more positive utility from the smaller gain. •
When you can think of one large loss with a smaller gain
or a smaller loss (-$100 and +$55, versus -$45), try to separate losses from
gains. 12 Cognitive
Biases Explained - How to Think Better and More Logically Removing Bias
(video, FYI)
0:18 Anchoring Bias 1:22 Availability Bias 2:22 Bandwagon Effect 3:09 Choice Supportive Bias 3:50 Confirmation Bias 4:30 Ostrich Bias 5:20 Outcome Bias 6:12 Overconfidence 6:52 Placebo Effect 7:44 Survivorship Bias 8:32 Selective Perception 9:08 Blindspot Bias
Homework: (due with the second mid-term
exam) · Explain with
examples of the following concepts: gambler’ fallacy, mental accounting,
disposition effect |
Some of your behavioral biases could be
causing you more financial harm than you realize, study suggests (FYI) PUBLISHED
TUE, MAY 25 20219:46 AM EDT Sarah O’Brien KEY
POINTS •
There’s a correlation between high levels
of some biases and unfavorable financial outcomes, research shows. •
These connections hold true even when
controlling for demographic information like age, education or income. •
Even if you can’t eliminate your biases,
there are ways to minimize how they impact your financial decisions. •
The ILO estimated that people in informal
work have experienced a 60% drop in income in the first month of the Some of
your behavioral tendencies might be causing harm to your financial wellbeing,
research suggests. Regardless
of factors such as age, income and education, there’s a connection between
certain biases and financial health, according to a Morningstar study about
behavioral finance released on Tuesday. The research shows that high levels
of these biases (noted below) correlate with things like lower checking and
savings account balances, smaller retirement savings and lower self-reported
credit scores, among other measures of a person’s financial picture. “Most
Americans suffer from these biases in one form or another, and they are
directly related to financial outcomes,” said Steve
Wendel, head of behavioral science at Morningstar. The
research, based on a survey of 1,211 participants, focuses on four common
biases: Present bias:
Tendency to overvalue immediate
smaller rewards at the expense of long-term goals. Base rate neglect:
Tendency to ignore the probability of
something happening and instead judge its likelihood by new, readily
available information. Overconfidence: Tendency to overweigh
one’s own abilities or information when making an investment decision. Loss aversion: Tendency to be excessively
fearful of experiencing losses relative to gains. Most
survey respondents — 98% —
exhibited at least one of the four biases highlighted in the research.
Participants were assessed for their financial health as well as the
existence of biases, and then rated on how minimal or severe those tendencies
are. Overall,
the lower the level of bias, the
better the financial wellness exhibited. For example, people with low “present bias” are 7.5 times more
likely to plan for their future and 2.4 times more likely to pay their bills
on time than individuals with a high score in that category, the research
shows. Younger survey participants showed the
highest level of overconfidence bias, compared with their older counterparts. At some
point in the next few months, Wendel said, Morningstar plans to offer a free
online tool that will help investors assess their own biases. While
you may not be able to eliminate your own biases, there are things you can do
to minimize their potential to negatively impact your financial life, Wendel
said. For instance, you can set up
what he calls “decision-making speed bumps.” “It’s doing something to slow the
decisions down,” he said. For
example, before making a major change
to your investment portfolio, you could employ a three-day wait rule (not
acting on a decision for three days) so you don’t act on impulse. Additionally,
it’s best to ignore the daily noise. That is, avoid focusing on daily price updates of any particular stock or
other investments, especially moment to moment, Wendel said. “That’s
just not healthy,” he said. “It
warps our decision-making process and it warps how we judge the value of
something.” |
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Second Mid-term exam (close book, close notes, in class exam) Second Mid Term Exam Study Guide 1. Draw cash flow graph of a bond with 6 years left to maturity, 6% coupon rate. 2. 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? 2. Why does Moody downgrade Delta’s bond to Junk bond? Do you support the decisions of the other two rating agencies giving an investment grade bond rating to Delta’s bond? (based on “Moody's cuts Delta credit rating to 'junk' status”. What are the differences between investment grade bond and junk bond? 3.
Write down the names of the three credit
rating agencies. How much do you trust those rating agencies? Are those
rating agencies private or public firms? 4.
How are the credit ratings assigned? 5.
What is yield curve? How can a yield curve become inverted? What
does an inverted yield curve tell us? 6.
What is a steepening yield curve? What does it tell us about the
future economy?
·
Date 1 Mo 3 Mo 6
Mo 1 Yr 2 Yr 3 Yr 5 Yr 7
Yr 10 Yr 20 Yr 30 Yr 01/03/17 0.52 0.53 0.65 0.89 1.22 1.50 1.94 2.26 2.45 2.78 3.04
·
What do the above graphs tell us from the
perspective of diversification? 8.
What is S&P500 index? What is QQQ? What are the advantages
to invest in the ETFs such as S&P500 and QQQ? 9.
Components of the S&P 500
Based on the above table, explain how to
calculate the weight of each company. Why the weight of Microsoft is higher than that
of Apple? Note that the stock price of Apple is much higher than that of
Microsoft. 10. Explain what does the above graph tell us? Please be specific
and detailed. 11. What is value stock?
Example? 12. What is ETF? What are the differences between ETF and
mutual fund. 13. Compare QQQ with SPY 14.
How can we evaluate the performance of a
mutual fund? 15.
What is a bond fund?
How to find a suitable bond fund? 16.
What is CAPM? What
is the risk factor in CAPM? 17.
My investment in
company A is a sure thing. T/F? Why? 18.
I would never buy
stocks now because the market is doing terribly. T/F? Why? 19.
I just hired a great
new broker, and I am sure to beat the market. T/F? Why? 20.
My investments are
well diversified because I own a mutual fund that tracks the S&P 500.
T/F? Why? 21.
I made $1,000 in the
stock market today. T/F? Why? 22.
GM’s earning report
is better than expected. But GM stock price went down instead of going up
after the earning news was released. How come? T/F? Why? 23.
Paypal’s price has
gone up so much in the past several months. I should invest in Paypal
now. T/F? Why? 24.
Use an example to
explain what is over confidence bias 25.
Use an example to
explain what is mental accounting 26.
Use an example to
explain what is gambler’s fallacy 27.
Use an example to
explain what is disposition effect 28.
Use an example to
explain what is anchoring bias? |
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Class discussion
topics: · Apple price will go up because of the
holiday shopping season. Google price could fall based on some news you just
heard. Anticipating large changes in stock prices of Apple and Google, how
shall you act? · You just bought GM stocks. You worried
for GM price might fall. What can you do to ease your mind? Options are derivative
contracts that give the holder the right, but not the obligation, to buy or
sell the underlying instrument at a
specified price on or before a specified future date. Although the holder
(also called the buyer) of the option is not obligated to exercise the
option, the option writer (known as the seller) has an obligation to buy
or sell the underlying instrument if the option is exercised. Call options: Learn the basics of
buying and selling By James
Royal, 11/1/2021 https://www.bankrate.com/investing/what-are-call-options-learn-basics-buying-selling Call options are a type of option that increases
in value when a stock rises. They’re the best-known kind of
option, and they allow the owner to lock in a price to buy a specific stock
by a specific date. Call options are appealing because they can appreciate
quickly on a small move up in the stock price. So that makes them a favorite
with traders who are looking for a big gain. What is a call option? A call option gives you the right, but not the
requirement, to purchase a stock at a specific price (known as the strike
price) by a specific date, at the option’s expiration. For this
right, the call buyer will pay an amount of money called a premium, which the
call seller will receive. Unlike stocks, which can live in perpetuity, an
option will cease to exist after expiration, ending up either worthless or
with some value. The following components comprise the major traits
of an option: Strike price: The price at which you can buy the underlying
stock Premium: The price of the option, for either buyer or
seller Expiration: When the option expires and is settled One option is called
a contract, and each contract represents 100 shares of the underlying stock. Exchanges quote options prices in terms of the
per-share price, not the total price you must pay to own the contract. For
example, an option may be quoted at $0.75 on the exchange. So to purchase one
contract it will cost (100 shares * 1 contract * $0.75), or $75. How a call option works Call options
are “in the money” when the stock
price is above the strike price at expiration. The call owner can exercise
the option, putting up cash to buy the stock at the strike price. Or the
owner can simply sell the option at its fair market value to another buyer
before it expires. A call owner profits when the premium paid is less
than the difference between the stock price and the strike price. For example,
imagine a trader bought a call for $0.50 with a strike price of $20, and the
stock is $23 at expiration. The option is worth $3 (the $23 stock price minus
the $20 strike price) and the trader has made a profit of $2.50 ($3 minus the
cost of $0.50). If the stock
price is below the strike price at expiration, then the call is “out of the
money” and expires worthless. The call seller keeps any premium received for
the option. Why buy a call option? The biggest advantage of buying a call option is
that it magnifies the gains in a stock’s price. For a
relatively small upfront cost, you can enjoy a stock’s gains above the strike
price until the option expires. So if you’re buying a call, you usually
expect the stock to rise before expiration. Call options vs. put options The other
major kind of option is called a put
option, and its value increases as the stock price goes down. So traders
can wager on a stock’s decline by buying put options. In this sense, puts act
like the opposite of call options, though they have many similar risks and
rewards: Like buying a
call option, buying a put option
allows you the opportunity to earn back many times your investment. Like buying a call
option, the risk of buying a put option is that you could lose all your
investment if the put expires worthless. Like selling a
call option, selling a put option earns a premium, but then the seller takes
on all the risks if the stock moves in an unfavorable direction. Unlike selling
a call option, selling a put option exposes you to capped losses (since a
stock cannot fall below $0). Still, you could lose many times more money than
the premium received. Call Options & Put
Options Explained Simply In 8 Minutes
Call
and Put price of AAPL on Google Finance Call
and Put price of AAPL on Nasdaq https://www.nasdaq.com/market-activity/stocks/aapl/option-chain
Learn THIS
before Trading Options - The GREEKS explained for beginners & how options
are priced (video, FYI)
Part
II: Futures Futures market explained
(video) Bitcoin Futures
for Dummies - Explained with CLEAR Examples! (video)
How to Invest in Bitcoin Futures By PRABLEEN
BAJPAI Reviewed by
ERIKA RASURE on August 25, 2021 https://www.investopedia.com/articles/investing/012215/how-invest-bitcoin-exchange-futures.asp What Are Bitcoin Futures? Bitcoin futures enable investors to gain exposure
to Bitcoin (BTCUSD) without having to hold the underlying cryptocurrency. They are
similar to a futures contract for a commodity or stock index in that they
allow investors to speculate on the cryptocurrency’s future price. The Chicago Mercantile Exchange (CME) offers
monthly contracts for cash settlement. This means that an investor takes cash
instead of physical delivery of bitcoin upon settlement of the contract. The Cboe Options Exchange offered the first
bitcoin futures contract on Dec. 10, 2017. But it discontinued offering
new contracts in March 2019. The CME opened its bitcoin futures platform on
Dec. 18, 2017. In addition to standard bitcoin contracts, the exchange offers
Micro Bitcoin futures, which are 1/10th the size of a standard bitcoin
contract, and options on bitcoin futures. Other venues, like Bakkt and
Intercontinental Exchange, offer daily and monthly bitcoin futures contracts
for physical delivery. KEY TAKEAWAYS · As with a stock or commodities futures, bitcoin futures allow investors to speculate on the future price of Bitcoin. · Investors can choose from a variety of venues to trade monthly bitcoin futures. Some are regulated; others are not. ·
Bitcoin
is known for its volatile price swings, which makes an investment in bitcoin
futures risky Understanding Bitcoin Futures Investing Bitcoin
futures serve many purposes, each one unique, for different actors in the
Bitcoin ecosystem. For Bitcoin miners,
futures are a means to lock in prices that ensure a return on their mining
investments, regardless of the crypto’s future price trajectory. Investors
use bitcoin futures to hedge against their positions in the spot market.
For example, if an investor bets on a price increase for bitcoin in the spot
market, then she might short its futures as a hedge. Thus, she stands to make
money even if the bitcoin price moves in a direction opposite to the one
specified in her bet. Speculators and traders, who frequently move in and out
of futures trades, might use bitcoin futures for short- and long-term
profits. There are several benefits to trading bitcoin
futures instead of the underlying cryptocurrency. First, bitcoin futures
contracts are traded on an exchange regulated by the Commodity Futures
Trading Commission, which might give large institutional investors
some measure of confidence to participate. For most of its short existence,
the cryptocurrency has traded outside the bounds of regulation, making it a
risky asset for institutional money. Second,
because the futures are cash-settled, a Bitcoin wallet is not required. No
physical exchange of bitcoin takes place in the transaction. Thus, a bitcoin futures trade eliminates
the risk of holding a volatile asset class with steep price changes.
Also, holding bitcoin in custody can be an expensive affair and add to the
overall costs. Finally, futures contracts have position limits and price
limits that enable investors to curtail their risk exposure to a given asset
class. Note that as
of October 2021, investors can gain exposure to bitcoin without buying or
selling futures themselves. The ProShares’ Bitcoin Strategy Fund (BITO)
tracks CME bitcoin futures. The
exchange-traded fund (ETF) started trading on Oct. 19, 2021, as the first
bitcoin ETF. Where can you trade bitcoin futures? Growth of the bitcoin futures market has
paralleled that of the cryptocurrency’s spot market. Cryptocurrency exchanges
were the first venues to offer bitcoin futures trading capability. But the
absence of regulation for cryptocurrencies made them risky venues for serious
traders. The launch of
bitcoin futures trading at CME and Cboe changed the status quo. While Cboe
has discontinued bitcoin futures trading at its venue, CME has doubled down
on cryptocurrencies and introduced other derivative products related to it.
For example, the Micro Bitcoin futures is 1/10th the size of a standard
bitcoin futures contract at CME. Bakkt, which
is backed by NYSE owner Intercontinental Exchange, was launched in 2019 and
advertises itself as an end-to-end solution to promote regulated price
discovery and market liquidity. It also offers trading in physically settled
bitcoin futures and options. ErisX is
a Chicago-based trading firm that offers cash-settled bounded bitcoin futures
trading capability that limits exposure to the cryptocurrency by setting
upper and lower bounds. Exchanges like
Seychelles-based OKEx and Malta-based Binance are some of the biggest venues
for trading in bitcoin futures. The latter exchange, in fact, is ranked first
based on the numbers for open interest contracts on its platform. However, it
is not regulated by U.S. authorities. How does bitcoin futures trading work? The rules and
setup for bitcoin futures is the same as that for regular futures trading.
First, you need to set up an account with the brokerage or exchange to begin
trading. Once your account is approved, you can begin trading. Futures
trading makes heavy use of leverage to execute trades. In the unregulated
Wild West of cryptocurrencies, the leverage amount can vary wildly between
exchanges. For example, Binance offered leverage of up to 125 percent of the
trading amount to traders when it first launched futures trading capability
for cryptocurrencies. It reduced the leverage amount to 20 percent in July
2021. The main considerations for bitcoin futures
accounts are margin requirements and contract details. Margins are
the minimum collateral that you must have in your account to execute trades.
The higher the amount of the trade, the greater the margin amount required by
the broker or exchange to execute the trade. A point to note here is that exchanges and
brokerages can have different margin requirements. For example,
CME has a base margin requirement, and brokerages like TD Ameritrade that offer
CME bitcoin futures trading as part of their product suite can set margin
rates on top of the base rate set by CME. Because
Bitcoin is a risky and volatile asset, regulated
exchanges generally require higher margin amounts compared to other assets. Some
cryptocurrency exchanges, like Binance, allow the use of cryptocurrencies as
margin. For example, you can use stablecoins like Tether or bitcoin as
margin for your trades at Binance. Depending on bitcoin’s price fluctuations, the
investor can either hold onto the futures contracts or sell them to another
party.
At the end of her contracts’ duration, the investor has the option to either
roll them over to new ones or let them expire and collect the cash settlement
due. Some contracts, like the ones at Bakkt and ErisX, are physically
settled. This means that the investor will get final delivery of the
commodity—in this case, Bitcoin—upon expiration. Remember that there are costs associated
with custody and storage of Bitcoin, once you get final delivery of the
cryptocurrency in a physically settled futures contract. In 2021, CME introduced Micro Bitcoin futures
(MBT) trading. The size of an MBT contract is 1/10th of one bitcoin or
1/50th of the larger BTC futures contract. Thus, if the Bitcoin Reference
Rate is set at $20,000, then the notional value of one Bitcoin Reference Rate
is $400. More than 3,500 accounts traded in Micro Bitcoin futures after it
was first launched. Special considerations for trading bitcoin futures While it has
increased in volume, bitcoin futures trading is still nascent in terms of
market dynamics and constituents. Therefore, it is unlike other futures
trading for other asset types. Here are some special considerations that you
should note while trading bitcoin futures. Bitcoin
futures trading resembles spot markets for the cryptocurrency in that it lacks the deep pool of liquidity or
sufficient number of actors in its ecosystem that are present for other
commodities. Therefore, trading
volumes can be low and price fluctuations can be high, especially during
volatile stretches of the cryptocurrency’s price. Futures trading for
other commodities can provide indicators or predict spot market prices in
advance. Bitcoin futures, however, either follow spot market prices or trade
at a significant premium or discount. The regulatory landscape for bitcoin futures
trading is still unclear. As mentioned above, there are very few exchanges
that offer regulated futures trading. Bitcoin
futures trading offered at exchanges located outside the United States do not
come under the purview of agencies situated in the country. Such situations
have the potential for profits through regulatory arbitrages, but they can
also result in exponential risk. The price for
bitcoin futures is dependent on the price of a volatile underlying asset.
While there is a theoretical formula to calculate the price of Bitcoin
futures, several other factors come
into play in a real-world scenario. Investor perception of an asset’s
volatility is one. Big news events are another. With its massive price swings
and bubbles, Bitcoin already has a reputation among investors for price
volatility. And there is no dearth of commentary about a cryptocurrency
that was originally designed to become a medium for daily transactions but
has, so far, failed to fulfill that promise. All of this means that bitcoin futures are not an effective
hedge against their underlying asset’s volatility.
https://www.cmegroup.com/markets/cryptocurrencies/bitcoin/bitcoin.quotes.html# · o Home
Work Please
refer the articles on the right and answer the following questions. 1. Why
is there a futures market for bitcoin? 2. Why
shall you consider investing in Bitcoin futures market? Or otherwise, why
should not you? 3. What is
call option? What is put option? Between a call option holder and a put
option holder, who is going to benefit from the stock price falling? Who is
going to benefit from stock price rising? |
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Chapter 11 - 14:
Commercial Banking and Investment Banking PPT2
Commercial banking II (Balance sheet) Wells Fargo’s Balance Sheet http://www.nasdaq.com/symbol/wfc/financials?query=balance-sheet
Topics
for class discussion 1. Anything wrong
of the above balance sheet of Wells Fargo? Where do the loans and deposits
go? Finance & Accounting
Facts : Understanding Bank Financial Statements (VIDEO) FRM: Bank Balance Sheet
& Leverage Ratio (VIDEO) 2. What is bank run? It is rare.
Why? 3. Why are banks reluctant to
lend out to small business, but offer loans to
homebuyers? For example, the
bank has one million dollars that can be lent out. Shall the bank lend it out
to a small business owner or to a house buyer? Use the
following information to make your judgment. –
Risk level of Example 0% US
gov bond 20% Muni
issued by city, state, and Fannie and Freddie 50% Mortgage 100% Anything
else such as loans to business Basel III
requires 7% of capital based on the risk weighted assets (RWA). 4.
How can you tell that banks are getting bigger and bigger? Who
need big banks? What is
too big to fail (Bloomberg university) video
Benefits of Local Banks vs. Big Banks BY JUSTIN
PRITCHARD REVIEWED BY
KHADIJA KHARTIT on May 30, 2021 When you
choose a bank, it’s critical to find the products, services, and rates that
meet your needs. As you evaluate large
national banks vs. local banks and credit unions, you may wonder if the size
of an institution matters. To some degree, it does, but big banks and
small banks can offer essential services like checking and savings accounts. Here’s what to
consider as you compare banks: Convenience Choose a bank
that’s easy to work with on your terms. If you prefer to bank in-person, some
institutions might have a better presence than others in your area. Cost Fees are often
lower at small institutions, but that’s not always the case. Identify your
banking needs and compare fees for the services you need. Services Small
institutions can have a surprisingly large offering of products and services.
But sometimes you need the horsepower of a megabank.
Banking with a
local institution helps to support your local economy, and it may make your
banking experience easier. But there are always pros and cons. Let’s explore
the differences between big banks and local banks in more detail. Megabanks Have
a National Reach Potential
Convenience Large national
banks with household names dominate large cities, and they even reach into
smaller markets. If you value in-person banking, a bank with branches nearby
might be a decent option. They can offer one-stop shopping, allowing you to
get multiple services from the same institution. For example, you might be
able to use one login for your checking and savings accounts, credit cards,
and loans. Large banks
that have a national reach include Bank
of America, Capital One, Chase Bank, Wells Fargo, and many other large
institutions. Sometimes
Frustrating Big
banks often have rigid systems and processes, which makes dealing with
them difficult. If you need help from customer service, you may be forced to
call a national toll-free number, even though you know and trust the local
bankers. You may have to speak with relatively new hires or answer multiple
fraud department questions just to open an account. Contrast that experience
with a local bank, where the same person can handle everything for you in one
sitting. Costs Vary Free checking
is increasingly hard to find at megabanks. You can typically qualify for fee
waivers by keeping sufficient cash in your account or setting up direct
deposit, but genuinely free accounts are rare. You can occasionally find
fee-free business checking at national banks, while local banks charge modest
fees. Local Banks
Engage in the Community Community
banks and local credit unions are an excellent option for most banking needs.
Just because they’re small doesn’t mean they can’t meet your needs. Some
institutions limit their offerings, others outsource services, and some
provide everything you need in-house. Competitive
Fees and Rates Local banks
are often a good bet for free checking accounts—the account you probably need
most. Some offer standard free checking to everybody, while others waive fees
if you just agree to receive electronic statements. They also compete with
attractive rates on savings accounts and loans. Savings rates might still be
higher at online banks, but there’s nothing to prevent you from having
multiple accounts (online and local). Local
Knowledge Because they’re engaged in local matters, local
banks may make transactions easier. That’s particularly true if you need
to borrow money. For example, megabanks might be unwilling to fund your local
business, investment property, or agriculture loan, but local banks are
accustomed to evaluating loans in your area. Personal
Service For better or
worse, local banks typically provide
more personal service than big banks. It’s not uncommon to work with the
same person over time. Bank staff can
even learn about your needs and suggest bank products that may be helpful.
You develop relationships and know what to expect and who to talk to when you
have questions. At the same time, you lose the anonymity that comes with
being a big bank customer. If you live in a particularly small town, you may
prefer to keep a low profile. Offerings Vary While local
banks and credit unions can offer everything from checking accounts to
merchant accounts to wealth management, some institutions focus on basic
consumer needs. If your favorite local bank doesn’t handle business accounts
and you start freelancing, you’ll need to look elsewhere. Community
Involvement Your banking
needs to drive your choice of banks, but you may feel a sense of satisfaction
when working with a local institution. Local
banks and credit unions are part of the local economy, and they often give
back. You’re likely to see a local institution’s logo at charity races
and other events, signaling that they contributed money or other resources to
help make the event a reality. 6. The scope of investment banks ·
Market Making ·
Merger and Acquisition Advisory ·
Prop trading ·
IPO and SEO underwriter ·
Structured financial products 7. How can you draw your own
conclusions from the following table.
http://graphics.wsj.com/bank-earnings/ Part II: Governmental Regulations on
Banking Industry (FYI) A Brief History of U.S. Banking
Regulation (FYI) By MATTHEW
JOHNSTON Reviewed by
MICHAEL J BOYLE on July 30, 2021 https://www.investopedia.com/articles/investing/011916/brief-history-us-banking-regulation.asp As early as
1781, Alexander Hamilton recognized that “Most commercial nations have found
it necessary to institute banks, and they have proved to be the happiest
engines that ever were invented for advancing trade.” Since then, America has
developed into the largest economy in the world, with some of the biggest
financial markets in the world. But the path from then to now has been
influenced by a variety of different factors and an ever-changing regulatory
framework. The changing nature of that framework is best characterized by the
swinging of a pendulum, oscillating between the two opposing poles of greater
and lesser regulation. Forces, such as the desire for greater financial
stability, more economic freedom, or fear of the concentration of too much
power in too few hands, are what keep the pendulum swinging back and forth. Early Attempts
at Regulation in Antebellum America From the
establishment of the First Bank of the United States in 1791 to the National
Banking Act of 1863, banking regulation in America was an experimental mix of
federal and state legislation.1 2 The regulation was motivated, on the
one hand, by the need for increased centralized control to maintain stability
in finance and, by extension, the overall economy. While on the other hand,
it was motivated by the fear of too much control being concentrated in too
few hands. Despite
bringing a relative degree of financial and economic stability, the First
Bank of the United States was opposed to being unconstitutional, with many
fearing that it relegated undue powers to the federal government.
Consequently, its charter was not renewed in 1811. With the government
turning to state banks to finance the War of 1812 and the significant
over-expansion of credit that followed, it became increasingly apparent that
financial order needed to be reinstated. In 1816, the Second Bank of the
United States would receive a charter, but it too would later succumb to
political fears over the amount of control it gave the federal government and
was dissolved in 1836. Not only at
the federal level, but also at the level of state banking, obtaining an
official legislative charter was highly political. Far from being granted on
the basis of proven competence in financial matters, successful acquisition
of a charter depended more on political affiliations, and bribing the
legislature was commonplace. By the time of the dissolution of the Second
Bank, there was a growing sense of a need to escape the politically corrupt
nature of legislative chartering. A new era of “free banking” emerged with a
number of states passing laws in 1837 that abolished the requirement to
obtain an officially legislated charter to operate a bank. By 1860, a
majority of states had issued such laws. In this
environment of free banking, anyone could operate a bank on the condition,
among others, that all notes issued were back by proper security. While this
condition served to reinforce the credibility of note issuance, it did not
guarantee immediate redemption in specie (gold or silver), which would serve
to be a crucial point. The era of free banking suffered from financial
instability with several banking crises occurring, and it made for a
disorderly currency characterized by thousands of different banknotes
circulating at varying discount rates. It is this instability and disorder
that would renew the call for more regulation and central oversight in the
1860s. Increasing
Regulation from the Civil War to the New Deal The free
banking era, characterized as it was by a complete lack of federal control
and regulation, would come to an end with the National Banking Act of 1863
(and its later revisions in 1864 and 1865), which aimed to replace the old
state banks with nationally chartered ones. The Office of the Comptroller of
the Currency (OCC) was created to issue these new bank charters as well as
oversee that national banks maintained the requirement to back all note
issuance with holdings of U.S. government securities. While the new
national banking system helped return the country to a more uniform and
secure currency that it had not experienced since the years of the First and
Second Banks, it was ultimately at the expense of an elastic currency that
could expand and contract according to commercial and industrial needs. The
growing complexity of the U.S. economy highlighted the inadequacy of an
inelastic currency, which led to frequent financial panics occurring
throughout the rest of the nineteenth century. With the occurrence
of the bank panic of 1907, it had become apparent that America’s banking
system was out of date. Further, a committee gathered in 1912 to examine the
control of the nation’s banking and financial system. It found that the money
and credit of the nation were becoming increasingly concentrated in the hands
of relatively few men. Consequently, under the presidency of Woodrow Wilson,
the Federal Reserve Act of 1913 was approved to wrest control of the nation’s
finances from banks while at the same time creating a mechanism that would
enable a more elastic currency and greater supervision over the nation’s
banking infrastructure. Although the
newly established Federal Reserve helped to improve the nation’s payments
system and created a more flexible currency, it's a misunderstanding of the
financial crisis following the 1929 stock market crash served to roil the
nation in a severe economic crisis that would come to be known as the Great
Depression. The Depression would lead to even more banking regulation
instituted by President Franklin D. Roosevelt as part of the provisions under
the New Deal. The Glass-Steagall Act of 1933 created the Federal Deposit
Insurance Corporation (FDIC), which implemented regulation of deposit
interest rates, and separated commercial from investment banking. The Banking
Act of 1935 served to strengthen and give the Federal Reserve more
centralized power. 1980s
Deregulation and Post-Crisis Re-Regulation The period
following the New Deal banking reforms up until around 1980 experienced a
relative degree of banking stability and economic expansion. Still, it has
been recognized that the regulation has also served to make American banks
far less innovative and competitive than they had previously been. The
heavily regulated commercial banks had been losing increasing market share to
less-regulated and innovative financial institutions. For this reason, a wave
of deregulation occurred throughout the last two decades of the twentieth
century. In 1980,
Congress passed the Depository Institutions Deregulation and Monetary Control
Act, which served to deregulate financial institutions that accept deposits
while strengthening the Federal Reserve’s control over monetary policy.6 Restrictions on the opening of bank
branches in different states that had been in place since the McFadden Act of
1927 were removed under the Riegle-Neal Interstate Banking and Branching
Efficiency Act of 1994. Finally, the Gramm-Leach-Bliley Act of 1999 repealed
significant aspects of the Glass-Steagall Act as well as the Bank Holding Act
of 1956, both of which had served to sever investment banking and insurance
services from commercial banking.7 From 1999
onwards, a bank could now offer commercial banking, securities, and insurance
services under one roof. All of this
deregulation helped to accelerate a trend towards increasing the complexity
of banking organizations as they moved to greater consolidation and
conglomeration. Financial institution mergers increased with the total number
of banking organizations consolidating to under 8000 in 2008 from a previous
peak of nearly 15,000 in the early 1980s.8 While banks
have gotten bigger, the conglomeration of different financial services under
one organization has also served to increase the complexity of those
services. Banks began offering new financial products like derivatives and
began packaging traditional financial assets like mortgages together through
a process of securitization. At the same
time that these new financial innovations were being praised for their
ability to diversify risk, the sub-prime mortgage crisis of 2007 that
transformed into a global financial crisis and the need for the bailout of
U.S. banks that had become “too big to fail” has caused the government to
rethink the financial regulatory framework. In response to the crisis, the
Obama administration passed the Dodd-Frank Wall Street Reform and Consumer
Protection Act in 2010, aimed at many of the apparent weaknesses within the
U.S. financial system.9 It may take
some time to see how these new regulations affect the nature of banking
within the U.S. The Bottom
Line In antebellum
America, numerous attempts at increased centralized control and regulation of
the banking system were tried, but fears of concentrated power and political
corruption served to undermine such attempts. Nevertheless, as the banking
system grew, the need for ever-increasing regulation and centralized control,
led to the creation of a nationalized banking system during the Civil War,
the creation of the Federal Reserve in 1913, and the New Deal reforms under
Roosevelt.4 While the
increased regulation led to a period of financial stability, commercial banks
began losing business to more innovative financial institutions,
necessitating a call for deregulation. Once again, the deregulated banking
system evolved to exhibit even greater complexities and precipitated the most
severe economic crisis since the Great Depression. Dodd-Frank was the
response, but if history is any guide, the story is far from over, or perhaps,
the pendulum will continue to swing. Why Are
Banks Regulated? (FYI) January
30, 2017 By Julie L Stackhouse This
post is the first in a series titled “Supervising Our
Nation’s Financial Institutions.”
Supervising Our Nation’s Financial Institutions The
series, written by Julie Stackhouse, executive vice president and
officer-in-charge of supervision at the St. Louis Federal Reserve, is
expected to appear at least once each month throughout 2017. The
topic of financial deregulation is once again generating news stories. It
raises a foundational question: “Why is the U.S.
banking system so heavily regulated?” Banking
regulation has existed in some form since the chartering of banks and its
goals have evolved over time. Today, banking regulation serves four main
purposes. Financial
Stability Instability
in the financial system can have material ripple effects into other parts of
the domestic and international financial sectors. Supervision that is focused
on financial stability (often called macro-prudential supervision) looks at
trends and analyzes the likelihood for financial contagion and the possible
impacts across firms that pose systemic risks. Protection
of the Federal Deposit Insurance Fund Since
Jan. 1, 1934, the Federal Deposit Insurance Corp. has insured the deposits
held in U.S. banks up to a defined amount (currently $250,000 per depositor
per bank). The federal government serves as a backstop to the insurance fund. In
exchange for this insurance guarantee, banks pay an insurance premium and are
also subject to safety and soundness examinations by state and/or federal
regulators. Oversight of individual financial institutions by banking
regulators is called micro-prudential supervision. While
the insurance fund protects depositors, it does not protect shareholders of
banks. When inappropriate risks are taken and prove unsuccessful, banks will
fail and be liquidated. Consumer
Protection Since
the creation of the Federal Trade Commission in 1914, the federal government
has had a formal obligation to protect consumers across industries. Since
that time, numerous laws and regulations have been crafted by various
agencies to protect bank customers and promote fair and equal access to
credit. Banks
conduct financial transactions with consumers either directly (lending to
consumers and taking consumer deposits) or indirectly (through financial
technology on the front end, for example). Banking regulators enforce
consumer protection regulations by conducting comprehensive reviews of bank
lending and deposit operations and investigating consumer complaints. Competition A
competitive banking system is a healthy banking system. Banking regulators
actively monitor U.S. banking markets for competitiveness and can deny bank
mergers that would negatively affect the availability and pricing of banking
services. Although
fewer than 40 banks account for more than 70 percent of all U.S. banking
assets, as shown in the table below, there are nearly 6,000 institutions of
all sizes operating in communities across the country. US
BankSystem While
all banks are regulated, not all regulations apply to every bank. We’ll discuss some of these differences in future posts. In
my next post, I’ll discuss how the banking system has
changed over time—especially over the past 25 years—adding to the complexity and scope of banking regulation
in the U.S. For discussion: As
compared with small banks, do big banks are relatively more burdened by
regulations? Or vice versa? Homework (Due with final) Question 1: the bank has
one million dollars that can be lent out. Shall the bank lend it out to a
small business owner or to a house buyer? Use the following information to make your judgment. – Risk level of Example 0% US gov bond 20% Muni issued by city, state, and Fannie
and Freddie 50% Mortgage 100%
Anything else such as loans to
business Basel III requires 7% of capital based on the risk
weighted assets (RWA). Question 2: Too big too fail. What is your opinion on this statement?
Should we worry about banks getting bigger and bigger? Why or why not? Question 3: What are the pro
and con for big banks? |
Examples of the products of investment banks Mortgage backed securities (MBS)
Mortgage Backed Securites Explained
by Analogy
Explaining Credit Default Swaps
Explaining proprietary trading and its risks
High-Frequency Trading:- Corporate super computers cornering share
Top 10 Disastrous Mergers & Acquisitions (M&A)
Understanding Investment Banking
How does the banking system work part 1. https://www.youtube.com/watch?v=Ssa5WNnbGsw&feature=relmfu How does the banking system work part 2. https://www.youtube.com/watch?v=bhBQizelZP8&list=ULbhBQizelZP8 Basel III in 10 minutes (FYI) Big banks are getting even
bigger, raising alarms in Washington By
Paul R. La Monica, CNN Business Updated
12:18 PM ET, Fri July 16, 2021 https://www.cnn.com/2021/07/16/investing/bank-mergers-stocks/index.html New
York (CNN Business) Banks have been on a shopping spree for the past year — and that's raising some alarm bells in Washington. Senators
Elizabeth Warren and Sherrod Brown have been critical of the top banks for
their deal making, citing concerns that the spate of mergers will hurt average consumers and make it tougher for
smaller community banks to remain competitive. There were 52 banks with
more than $50 billion in assets at the end of the first quarter of 2021, up
from 39 banks at the end of 2017, according
to data from S&P Global Market Intelligence. This
year alone, PNC (PNC) bought BBVA USA Bancshares, a deal that allowed PNC to
become the fifth-largest bank in the United States by assets. And Huntington
Bancshares (HBAN) merged with TCF. Meanwhile,
several other regional banking deals announced earlier this year are pending
approval, including M&T Bank's (MTB) purchase of People's United (PBCT),
the acquisition of Flagstar Bancorp (FBC) by New York Community Bancorp
(NYCB) and a merger between Webster Financial (WBS) and Sterling Bancorp
(SBT). Congress is partly
responsible for bank merger bonanza The frenetic pace of bank
shotgun weddings is largely a result of changes in financial regulations over
the past few years. It's no coincidence that there
have been a slew of bank mergers since
lawmakers ruled in 2018 that banks had to have $250 billion in assets, and
not "just" $50 billion, in order to be considered systemically
important financial institutions (SIFIs) that are subject to more regulations. Only
a dozen US banks currently are large enough to get a SIFI designation,
including JPMorgan Chase (JPM), Bank of America (BAC), Wells Fargo (WFC),
Citigroup (C), Truist (TFC), US Bancorp (USB) and PNC. The SIFI change from $50
billion to $250 billion opened the door for many mid-size banks to scoop up
rivals without fear that they would suddenly be required to go through more
strict and onerous oversight. Banks have took advantage of the change
and began pairing up. The reasons for doing so
are pretty obvious: Larger
institutions can cut costs and improve efficiencies to boost profits. The pandemic jump-started
more deals, too. The Federal Reserve's emergency rate cuts have made it more
difficult for banks to make money on loans since interest rates are near zero
— and likely to stay there for the foreseeable
future. That
was evident from the latest quarterly results of top banks that were reported
this week. Revenue for the second quarter fell at JPMorgan Chase, Bank of
America, Citi and BNY Mellon (BK) when compared with a year ago. Changes
from DC on the horizon? But
it's not clear how much longer the bank M&A wave will last. It is worth noting that the most recent
changes to bank laws in Washington were accomplished during the Trump
administration and with a Republican-controlled Senate. President Biden recently
signaled with a sweeping executive order that he intends to scrutinize
mergers more closely than his predecessor. Warren,
along with Democratic Congressman Jesus "Chuy" Garcia, also introduced a Bank Merger Review
Modernization Act bill in December 2019 that could possibly be reintroduced
now that the Democrats have a slim majority in the Senate due to a
tie-breaking vote from Vice President Harris. The goal of the
Warren-Garcia legislation is to "end rubber stamping of bank merger
applications." That's
likely to get a sympathetic ear from Brown, the Ohio senator who is chair of
the Senate's Banking, Housing, and Urban Affairs Committee. Brown
grilled Federal Reserve chairman Jerome Powell Thursday about bank mergers
during Powell's appearance before the committee for his semiannual testimony
about the economy. "We can't let big banks merge into bigger
and bigger megabanks, making it harder for small banks to compete and leaving
rural and Black and brown communities behind," Brown said in his
prepared remarks to Powell. |
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Federal Reserve and Monetary Policy Part I - Fed Introduction Banking Industry and
the Fed – PPT (Prepared by Madeline, Jack, and Thomas. Thanks) Videos from the PPT https://www.youtube.com/watch?v=npyzKn7PprQ https://www.youtube.com/watch?v=e3G5e3qsHgc https://www.youtube.com/watch?v=Xoz4jbEZzlc https://www.youtube.com/watch?v=fTTGALaRZoc https://www.youtube.com/watch?v=5euiUJPB308 In Plain Enlgish Fed St.
Louise (Cool video about Fed)
For discussion: 3.
What is FOMC? How many members? How
many time does FOMC meet? What is determined at FOMC meeting? 4.
What is reserve bank? For our area,
where is the reserve bank located? 5.
What is board of governor? How many
members? Who is the chair? Macro 4.5- The
Federal Reserve System- Quick Overview (video)
For discussion: 1.
How to conduct monetary policy? 2.
What is the role of Fed? 3.
What is the role of New York Fed?
The FOMC holds eight regularly scheduled meetings
during the year and other meetings as needed. Links to policy statements
and minutes are in the calendars below. The minutes of regularly
scheduled meetings are released three weeks after the date of the policy
decision. https://www.federalreserve.gov/monetarypolicy/fomccalendars.htm Meeting calendars, statements, and minutes
(2016-2021) The FOMC holds eight
regularly scheduled meetings during the year and other meetings as needed.
Links to policy statements and minutes are in the calendars below. The
minutes of regularly scheduled meetings are released three weeks after the
date of the policy decision. Committee membership changes at the first
regularly scheduled meeting of the year. FOIA 2021 | 2020 | 2019 | 2018 | 2017 | 2016 2021 FOMC
Meetings January 26-27 Statement: Press Conference Minutes: March 16-17* Statement: Press Conference Minutes: April 27-28 Statement: Minutes: June 15-16* Statement: Press Conference Minutes: July 27-28 Statement: Minutes: September 21-22* Statement: Press Conference Minutes: November 2-3 Statement: December 14-15* * Meeting associated with a Summary of Economic
Projections. For discussion: Are FOMC minutes useful? Do we
need to read them carefully? ***** FRB – Federal Reserve Banks ******* Federal Reserve Bank
of Atlanta Federal Reserve
Bank of Atlanta's Boardroom Video (youtube)
2021
Commencement Keynote: Raphael Bostic President & CEO of the Federal
Reserve Bank of Atlanta (youtube)
Federal Reserve Bank
of Atlanta – Jacksonville regional office https://www.atlantafed.org/rein/jacksonville ATLANTA FED GOES TO THE
GRASSROOTS: OBSERVING WHAT'S HAPPENING IN THE ECONOMY – Jacksonville
(video)
********** Fed Balance
Sheet *************** Explaining the
Federal Reserve’s balance sheet (youtube)
Fed Balance Sheet Nov 12th, 2021 https://www.federalreserve.gov/releases/h41/current/ H.4.1 5. Consolidated
Statement of Condition of All Federal Reserve Banks Millions of
dollars
Note: Components
may not sum to totals because of rounding. Footnotes appear at the end of the
table.
H.4.1 5. Consolidated
Statement of Condition of All Federal Reserve Banks (continued) Millions of
dollars
Note: Components may
not sum to totals because of rounding. 6. Statement of
Condition of Each Federal Reserve Bank, November 10, 2021 Millions of
dollars
Note: Components
may not sum to totals because of rounding. Footnotes appear at the end of the
table.
H.4.1 6. Statement of
Condition of Each Federal Reserve Bank, November 10, 2021 (continued) Millions of
dollars
Note: Components
may not sum to totals because of rounding. Footnotes appear at the end of the
table. Federal Reserve Balance
Sheet Update May 2018: QT Ramp Up in October 2018 Will Break Something? (video)
Part
II: Monetary Policy The Fed Explains Monetary
Policy (video) The Tools of Monetary
Policy (video) For class discussion: 1. Three approaches to conduct Monetary policy. 2. What
is easing (expansionary) monetary (policy? What
is contractionary monetary policy? 3. Draw
supply and demand curve to show the results when Fed purchases (sells)
Treasury securities. 4. Compare
fed fund rate with discount rate. Which
rate is targeted by Fed to implement monetary policy? 6. What
is open market operation? Segment 406: Open Market
Operations(video of Philadelphia Fed) ********** Fed Funds Rate *********
Release date: November 17, 2021 Selected
Interest Rates
https://www.federalreserve.gov/releases/h15/ ******* Effective
Federal Funds Rate **********
The federal funds market
consists of domestic unsecured borrowings in U.S. dollars by depository
institutions from other depository institutions and certain other entities,
primarily government-sponsored enterprises.
FEDERAL
FUNDS DATA https://www.newyorkfed.org/markets/reference-rates/effr
*********** Interest Rates on Reserve Balances ********** The Financial
Services Regulatory Relief Act of 2006 authorized the Federal
Reserve Banks to pay interest on balances held by or on behalf of eligible
institutions in master accounts at Reserve Banks, subject to regulations of
the Board of Governors, effective October 1, 2011. The effective date of this
authority was advanced to October 1, 2008, by the Emergency
Economic Stabilization Act of 2008. The interest rate on reserve balances (IORB rate) is
determined by the Board and is an important tool for the Federal Reserve's
conduct of monetary policy. For the current setting of the IORB rate, see the
most recent implementation
note issued by the FOMC. This note provides the operational
settings for the policy tools that support the FOMC's target range for the
federal funds rate. The current IORB rate is captured in the table below and in
the Board's Data Download Program (DDP).
The table and DDP are generally updated each business day at 4:30 p.m.,
Eastern Time, with the next business day's rate. They are not updated on
federal holidays. https://www.federalreserve.gov/monetarypolicy/reserve-balances.htm
********** Discount rate ********* http://www.frbdiscountwindow.org/currentdiscountrates.cfm?hdrID=20&dtlID= (Discount
window borrowing rate) Current Discount Rates
https://www.frbdiscountwindow.org/pages/discount-rates/current-discount-rates No Homework assignment.
Please find time to work on term project which is due with final. |
http://www.federalreserve.gov/releases/h41/20071129/ Fed Balance Sheet as of Nov 29th, 2007 (At that time, Fed assets = 882,848) http://www.federalreserve.gov/releases/h41/20081128/ Fed Balance Sheet as of Nov 28th, 2008 http://www.federalreserve.gov/releases/h41/20091127/ Fed Balance Sheet as of Nov 27th, 2009 http://www.federalreserve.gov/releases/h41/20101126/ Fed Balance Sheet as of Nov 26th, 2010 http://www.federalreserve.gov/releases/h41/20111125/ Fed Balance Sheet as of Nov 25th, 2011 https://www.federalreserve.gov/releases/h41/20121129/ Fed Balance Sheet as of Nov 29th, 2012 Fed Balance Sheet as of Nov 29th, 2013 https://www.federalreserve.gov/releases/h41/20141128/ Fed Balance Sheet as of Nov 28th, 2014 Fed Balance Sheet as of Nov 27th, 2015 https://www.federalreserve.gov/releases/h41/20161125/ Fed Balance Sheet as of Nov 25th, 2016 https://www.federalreserve.gov/releases/h41/20171124/ Fed Balance Sheet as of Nov 24th, 2017 Open market operation (video) https://www.youtube.com/watch?v=FNq_C4h3Srk The Tools of Monetary Policy https://www.youtube.com/watch?v=rcPEkmstDek |
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Study guide for Final (non-comprehensive,
in class, close book, close notes) 11/20, 4-6 pm: Final Exam; Term
project due Will choose 15 questions out of the following 25 questions 1. Anything wrong of the above balance sheet of
Wells Fargo? Where do the loans and deposits go? 3. What is bank run? It is rare. Why? 4. Why are banks reluctant to lend out to small
business, but offer loans to homebuyers? 5. Too big too fail. What is your opinion on this
statement? Should we worry about banks getting bigger and bigger? Why or why not? 6. Similar to the homework question. Bank has one million dollars that can be lent out.
Shall the bank lend it out to a small business owners or to a house buyer?
Why? 7. How to
explain the uniqueness of banks’ balance sheet. For example, banks are highly
leveraged. 8. What are
the differences between commercial bank and investment bank? 9. What are the pro and con for big banks? 10. As compared with small banks, do big banks are
relatively more burdened by regulations? Or vice versa? 11. What is
the purpose of the Fed? The structures
of the Fed? 12. The
duties of the Fed? 13. What are the changes in monetary policy? 14. The three approaches to conduct Monetary
policy. 15. Compare fed fund rate with discount rate.
Which rate is targeted by Fed to implement monetary policy? 16. What is interest rate on bank reserve balance?
17. What is open market operation? When Fed plans to increase interest rate,
how can Fed do so via open market operation? Draw the supply and demand curve
to show the results. 18. What is your opinion regarding the interest
rate that Fed will determine in the upcoming FOMC meeting 19. If Fed does increase interest rate in mid Dec,
what is your prediction of its impact in the stock market? If Fed does not
increases interest rate, what will happen to the stock market? 20. What
is easing monetary policy? What is contractary monetary policy? 21. Why is
there a futures market for bitcoin? 22. Why shall you consider investing in Bitcoin
futures market? Or otherwise, why should not you? 23. What is call option? What is put option?
Between a call option holder and a put option holder, who is going to benefit
from the stock price falling? Who is going to benefit from stock price rising? 24.
Name three professions in the banking industry 25.
Name three types of banks |
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Happy Holidays! Happy Holidays! |
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