Flow of funds describes the financial assets flowing from various sectors through financial intermediaries for the purpose of buying physical or financial assets.

*** Household, non-financial business, and our government

Financial institutions facilitate exchanges of funds and financial products.

*** Building blocks of a financial system. Passing and transforming funds and risks during transactions.

*** Buy and sell, receive and deliver, and create and underwrite financial products.

*** The transferring of funds and risk is thus created. Capital utilization for individual and for the whole economy is thus enhanced.

For class discussion:

1. What is the business model of each player in the above graph?

2. Which player is the most important one in the financial market?

3. Can any of the players be removed from the system?

4. What might trigger the next financial crisis

Part II: 2007-2008 Financial crisis and its causes

The 2007–2008 Financial Crisis in Review

By MANOJ SINGH, Updated May 17, 2022, Reviewed by MARGUERITA CHENG, Fact checked by PETE RATHBURN

https://www.investopedia.com/articles/economics/09/financial-crisis-review.asp#:~:text=Key%20Takeaways,worthless%20investments%20in%20subprime%20mortgages.

How it Happened - The 2008 Financial Crisis: Crash Course Economics #12

The financial crisis of 2007-2008 was years in the making. By the summer of 2007, financial markets around the world were showing signs that the reckoning was overdue for a years-long binge on cheap credit. Two Bear Stearns hedge funds had collapsed. Yet despite the warning signs, few investors suspected that the worst crisis in nearly eight decades was about to engulf the global financial system, bringing Wall Street's giants to their knees and triggering the Great Recession.

It was an epic financial and economic collapse that cost many ordinary people their jobs, their life savings, their homes, or all three.

KEY TAKEAWAYS

· The 2007-2009 financial crisis began years earlier with cheap credit and lax lending standards that fueled a housing bubble.

· When the bubble burst, financial institutions were left holding trillions of dollars worth of near-worthless investments in subprime mortgages.

· Millions of American homeowners found themselves owing more on their mortgages than their homes were worth.

· The Great Recession that followed cost many their jobs, their savings, or their homes.

· The turnaround began in early 2009 after the passage of the infamous Wall Street bailout kept the banks operating and slowly restarted the economy.

The 2007-08 Financial Crisis In Review

Sowing the Seeds of the Crisis

The seeds of the financial crisis were planted during years of rock-bottom interest rates and loose lending standards that fueled a housing price bubble in the U.S. and elsewhere. It began, as usual, with good intentions. Faced with the bursting of the dot-com bubble, a series of corporate accounting scandals, and the September 11 terrorist attacks, the Federal Reserve lowered the federal funds rate from 6.5% in May 2000 to 1% in June 2003. The aim was to boost the economy by making money available to businesses and consumers at bargain rates. The result was an upward spiral in home prices as borrowers took advantage of the low mortgage rates. Even subprime borrowers, those with poor or no credit history, were able to realize the dream of buying a home. The banks then sold those loans on to Wall Street banks, which packaged them into what were billed as low-risk financial instruments such as mortgage-backed securities and collateralized debt obligations (CDOs). Soon a big secondary market for originating and distributing subprime loans developed. Fueling greater risk-taking among banks, the Securities and Exchange Commission (SEC) in October 2004 relaxed the net capital requirements for five investment banks—Goldman Sachs (NYSE: GS), Merrill Lynch (NYSE: MER), Lehman Brothers, Bear Stearns, and Morgan Stanley (NYSE: MS). That freed them to leverage their initial investments by up to 30 times or even 40 times.

Signs of Trouble

Eventually, interest rates started to rise and homeownership reached a saturation point. The Fed started raising rates in June 2004, and two years later the Federal funds rate had reached 5.25%, where it remained until August 2007. There were early signs of distress. By 2004, U.S. homeownership had peaked at 69.2%. Then, during early 2006, home prices started to fall. This caused real hardship to many Americans. Their homes were worth less than they paid for them. They couldn't sell their houses without owing money to their lenders. If they had adjustable-rate mortgages, their costs were going up as their homes' values were going down. The most vulnerable subprime borrowers were stuck with mortgages they couldn't afford in the first place. Subprime mortgage company New Century Financial made nearly $60 billion in loans in 2006, according to the Reuters news service. In 2007, it filed for bankruptcy protection. As 2007 got underway, one subprime lender after another filed for bankruptcy. During February and March, more than 25 subprime lenders went under. In April, New Century Financial, which specialized in sub-prime lending, filed for bankruptcy and laid off half of its workforce. By June, Bear Stearns stopped redemptions in two of its hedge funds, prompting Merrill Lynch to seize $800 million in assets from the funds. Even these were small matters compared to what was to happen in the months ahead.

August 2007: The Dominoes Start to Fall

It became apparent by August 2007 that the financial markets could not solve the subprime crisis and that the problems were reverberating well beyond the U.S. borders. The interbank market that keeps money moving around the globe froze completely, largely due to fear of the unknown. Northern Rock had to approach the Bank of England for emergency funding due to a liquidity problem. In October 2007, Swiss bank UBS became the first major bank to announce losses—$3.4 billion—from sub-prime-related investments. In the coming months, the Federal Reserve and other central banks would take coordinated action to provide billions of dollars in loans to the global credit markets, which were grinding to a halt as asset prices fell. Meanwhile, financial institutions struggled to assess the value of the trillions of dollars worth of now-toxic mortgage-backed securities that were sitting on their books.

March 2008: The Demise of Bear Stearns

By the winter of 2008, the U.S. economy was in a full-blown recession and, as financial institutions' liquidity struggles continued, stock markets around the world were tumbling the most since the September 11 terrorist attacks. In January 2008, the Fed cut its benchmark rate by three-quarters of a percentage point—its biggest cut in a quarter-century, as it sought to slow the economic slide. The bad news continued to pour in from all sides. In February, the British government was forced to nationalize Northern Rock. In March, global investment bank Bear Stearns, a pillar of Wall Street that dated to 1923, collapsed and was acquired by JPMorgan Chase for pennies on the dollar.

September 2008: The Fall of Lehman Brothers

By the summer of 2008, the carnage was spreading across the financial sector. IndyMac Bank became one of the largest banks ever to fail in the U.S., and the country's two biggest home lenders, Fannie Mae and Freddie Mac, had been seized by the U.S. government. Yet the collapse of the venerable Wall Street bank Lehman Brothers in September marked the largest bankruptcy in U.S. history, and for many became a symbol of the devastation caused by the global financial crisis. That same month, financial markets were in free fall, with the major U.S. indexes suffering some of their worst losses on record. The Fed, the Treasury Department, the White House, and Congress struggled to put forward a comprehensive plan to stop the bleeding and restore confidence in the economy.

The Aftermath

The Wall Street bailout package was approved in the first week of October 2008.The package included many measures, such as a huge government purchase of "toxic assets," an enormous investment in bank stock shares, and financial lifelines to Fannie Mae and Freddie Mac. The amount spent by the government through the Troubled Asset Relief Program (TARP). It got back $442.6 billion after assets bought in the crisis were resold at a profit. The public indignation was widespread. It appeared that bankers were being rewarded for recklessly tanking the economy. But it got the economy moving again. It also should be noted that the investments in the banks were fully recouped by the government, with interest. The passage of the bailout package stabilized the stock markets, which hit bottom in March 2009 and then embarked on the longest bull market in its history. Still, the economic damage and human suffering were immense. Unemployment reached 10%. About 3.8 million Americans lost their homes to foreclosures.

About Dodd-Frank

The most ambitious and controversial attempt to prevent such an event from happening again was the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010. On the financial side, the act restricted some of the riskier activities of the biggest banks, increased government oversight of their activities, and forced them to maintain larger cash reserves. On the consumer side, it attempted to reduce predatory lending. By 2018, some portions of the act had been rolled back by the Trump Administration, although an attempt at a more wholesale dismantling of the new regulations failed in the U.S. Senate. Those regulations are intended to prevent a crisis similar to the 2007-2008 event from happening again.

The 2007-2008 financial crisis was a global event, not one restricted to the U.S. Ireland's vibrant economy fell off a cliff. Greece defaulted on its international debts. Portugal and Spain suffered from extreme levels of unemployment. Every nation's experience was different and complex.

What Was the Cause of the 2008 Financial Crisis?

Several interrelated factors were at work. First, low-interest rates and low lending standards fueled a housing price bubble and encouraged millions to borrow beyond their means to buy homes they couldn't afford. The banks and subprime lenders kept up the pace by selling their mortgages on the secondary market in order to free up money to grant more mortgages. The financial firms that bought those mortgages repackaged them into bundles, or "tranches," and resold them to investors as mortgage-backed securities. When mortgage defaults began rolling in, the last buyers found themselves holding worthless paper.

Who Is to Blame for the Great Recession?

Many economists place the greatest part of the blame on lax mortgage lending policies that allowed many consumers to borrow far more than they could afford. But there's plenty of blame to go around, including:

The predatory lenders who marketed homeownership to people who could not possibly pay back the mortgages they were offered.

The investment gurus who bought those bad mortgages and rolled them into bundles for resale to investors.

The agencies who gave those mortgage bundles top investment ratings, making them appear to be safe.

The investors who failed to check the ratings, or simply took care to unload the bundles to other investors before they blew up.

Which Banks Failed in 2008?

The total number of bank failures linked to the financial crisis cannot be revealed without first reporting this: No depositor in an American bank lost a penny to a bank failure. That said, more than 500 banks failed between 2008 and 2015, compared to a total of 25 in the preceding seven years, according to the Federal Reserve of Cleveland. Most were small regional banks, and all were acquired by other banks, along with their depositors' accounts. The biggest failures were not banks in the traditional Main Street sense but investment banks that catered to institutional investors. These notably included Lehman Brothers and Bear Stearns. Lehman Brothers was denied a government bailout and shut its doors. JPMorgan Chase bought the ruins of Bear Stearns on the cheap. As for the biggest of the big banks, including JPMorgan Chase, Goldman Sachs, Bank of American, and Morgan Stanley, all were, famously, "too big to fail." They took the bailout money, repaid it to the government, and emerged bigger than ever after the recession.

The Bottom Line

Bubbles occur all the time in the financial world. The price of a stock or any other commodity can become inflated beyond its intrinsic value. Usually, the damage is limited to losses for a few over-enthusiastic buyers. The financial crisis of 2007-2008 was a different kind of bubble. Like only a few others in history, it grew big enough that, when it burst, it damaged entire economies and hurt millions of people, including many who were not speculating in mortgage-backed securities.

Part III – Are we in recession yet?

The factors that could cause the next financial crisis are (based on class discussion)

· Pandemic

· Global warming

· War

· Inflation

· QE

· student loan

· government debt

· tax reform

· unemployment rate

· stimulus check

· recession

· War between Ukraine and Russia

· Covid

· Used car price

· ?

Is the economy in a recession? ‘What you call it is less relevant,’ says one economist: Here’s ‘what really matters’

AUG 5 20227:30 AM Jessica Dickler

https://www.cnbc.com/2022/08/05/is-the-economy-in-a-recession-top-economists-weigh-in.html

KEY POINTS

· There’s a lot of speculation about whether the U.S. is officially in a recession.

· A former chief economist at the U.S. Department of Labor and a former acting chair of the White House Council of Economic Advisers weigh in.

· Regardless of the country’s economic standing, there are steps Americans should take now to prepare for a slowdown.

Are we in a recession or what?

There’s a lot of speculation lately about whether the U.S. is officially in a recession.

Both President Joe Biden and Federal Reserve Chair Jerome Powell said we’re not there just yet, pointing to the strong labor market and rising wages. The official declaration typically comes from the National Bureau of Economic Research, and it has yet to call it.

But regardless of the country’s economic standing, consumers are struggling in the face of sky-high prices, and nearly half of Americans say they are falling deeper in debt.

“What really matters is paychecks aren’t reaching as far,” said Tomas Philipson, a professor of public policy studies at the University of Chicago and former acting chair of the White House Council of Economic Advisers. “What you call it is less relevant.”

Amid fears of a recession and rising interest rates, most people said they are already seeing their standard of living declining, according to recent reports.

‘We should have an objective definition’

Officially, the NBER defines a recession as “a significant decline in economic activity that is spread across the economy and lasts more than a few months.” In fact, the latest quarterly gross domestic product report, which tracks the overall health of the economy, showed a second consecutive contraction this year.

Still, if the NBER ultimately declares a recession, it could be months from now, and it will factor in other considerations, as well, such as employment and personal income.

What really matters is their paychecks aren’t reaching as far.

Tomas Philipson

FORMER ACTING CHAIR OF THE WHITE HOUSE COUNCIL OF ECONOMIC ADVISERS

That puts the country in a gray area, Philipson said.

“Why do we let an academic group decide?” he said. “We should have an objective definition, not the opinion of an academic committee.”

Consumers are behaving like we’re in a recession

For now, consumers should be focusing on energy price shocks and overall inflation, Philipson added. “That’s impacting everyday Americans.”

To that end, the Federal Reserve is making aggressive moves to temper surging inflation, but “it will take a while for it to work its way through,” he said.

Here’s how to get ahead of a rise in interest rates

“Powell is raising the federal funds rate, and he’s leaving himself open to raise it again in September,” said Diana Furchtgott-Roth, an economics professor at George Washington University and former chief economist at the Labor Department. “He’s saying all the right things.”

However, consumers “are paying more for gas and food so they have to cut back on other spending,” Furchtgott-Roth said.

“Negative news continues to mount up,” she added. “We are definitely in a recession.”

What comes next: ‘The path to a soft landing’

The direction of the labor market will be key in determining the future state of the economy, both experts said.

Decreases in consumption come first, Philipson noted. “If businesses can’t sell as much as they used to because consumers aren’t buying as much, then they lay off workers.”

How to prepare for a recession

On the upside, “we have twice the number of job openings as unemployed people so employers are not going to be so quick to lay people off,” according to Furchtgott-Roth.

“That’s the path to a soft landing,” she said.

3 ways to prepare your finances for a recession

While the impact of record inflation is being felt across the board, every household will experience a pullback to a different degree, depending on their income, savings and job security.

Still, there are a few ways to prepare for a recession that are universal, according to Larry Harris, the Fred V. Keenan Chair in Finance at the University of Southern California Marshall School of Business and a former chief economist of the Securities and Exchange Commission.

Here’s his advice:

Streamline your spending. “If they expect they will be forced to cut back, the sooner they do it, the better off they’ll be,” Harris said. That may mean cutting a few expenses now that you just want and really don’t need, such as the subscription services that you signed up for during the Covid pandemic. If you don’t use it, lose it.

Avoid variable-rate debts. Most credit cards have a variable annual percentage rate, which means there’s a direct connection to the Fed’s benchmark, so anyone who carries a balance will see their interest charges jump with each move by the Fed. Homeowners with adjustable-rate mortgages or home equity lines of credit, which are pegged to the prime rate, will also be affected.

That makes this a particularly good time to identify the loans you have outstanding and see if refinancing makes sense. “If there’s an opportunity to refinance into a fixed rate, do it now before rates rise further,” Harris said.

Consider stashing extra cash in Series I bonds. These inflation-protected assets, backed by the federal government, are nearly risk-free and pay a 9.62% annual rate through October, the highest yield on record. Although there are purchase limits and you can’t tap the money for at least one year, you’ll score a much better return than a savings account or a one-year certificate of deposit, which pays less than 2%. (Rates on online savings accounts, money market accounts and certificates of deposit are all poised to go up but it will be a while before those returns compete with inflation.)

Homework of chapter 1-I (due with the first midterm exam)

1. Are we in recession yet? What is your opinion? How to prepare yourself for a recession?

2. What is stagflation? Why is stagflation bad for the economy?

3. What Was the Cause of the 2008 Financial Crisis? Who Is to Blame for the Great Recession?

Part IV – Stagflation

Stagflation Explained in One Minute

Stagflation in 2022 | Ray Dalio

80% of economists see ‘stagflation’ as a long-term risk. What it is and how to prepare for it

JUN 21 2022, Lorie Konish

https://www.cnbc.com/2022/06/21/what-stagflation-is-and-how-to-prepare-for-it.html

KEY POINTS

· Stagflation is a term coined in the 1970s to refer to a combination of high inflation and high unemployment.

· Recent surveys show economists and fund managers see increased risks of stagflation on the horizon.

· There are steps you can take now to get in a better financial position in case stagflation or a recession does happen.

Runaway inflation has raised fears that the economy is headed towards a return of stagflation but a host of Wall Street banks such as Goldman Sachs and HSBC believe there remains opportunities for investors to safely navigate this tricky backdrop.

UCG | Getty Images

The next big risk to the U.S. economy may be summed up in one word.

And no, it’s not necessarily recession, though economists are evenly split on the risks one is coming.

Instead, 80% of economists in the same survey named stagflation as the greater long-term risk to the economy, according to the Securities Industry and Financial Markets Association. The next biggest risk they identified was deflation, with 13% of respondents ( 'Japanification’: As U.S. Inflation Surges, Here’s Why Japan’s Prices Have Held Steady | WSJ (video))

Moreover, a recent Bank of America global fund manager survey found fears of stagflation are the highest they have been since June 2008. Stagflation is “by far and away the most popular description of what the economic backdrop will be in the next 12 months,” according to the report.

What is stagflation?

Stagflation is a term coined in the 1970s when there was simultaneous high inflation and economic stagnation or high unemployment, according to Jonathan Wright, professor of economics at Johns Hopkins University.

While there were some nasty recessions back then, many economists aren’t expecting a return to anything like that now, he said.

“The sense in which you had stagflation in the 1970s is not one that I think is at all in the cards,” Wright said.

However, high inflation is prompting the Federal Reserve to raise interest rates — known as tightening monetary policy. With that, it is “quite likely” the unemployment rate will rise “a fair bit” from the 3.6% it is at now, Wright said.

Here’s how the Fed hopes to rein in inflation without harming the labor market

The result may at least be a mild recession, he said.

Stagflation may happen if a recession sets in before inflation has gone down to where the Fed wants it to be, Wright said. For example, if unemployment were to go up to about 5% and consumer price index inflation were also at above 5% in 2023, that would be a kind of stagflation, though not to the degree we experienced in the 1970s, he said.

“It certainly would mean that the job market would be a lot less hot than it’s been,” Wright said.

In the near term, the labor market may cool simply by having fewer vacancies, he said.

How likely is stagflation?

Despite surveys sounding the alarm on stagflation, not everyone agrees it’s inevitable.

“It doesn’t seem like a high probability,” said Josh Bivens, director of research at the Economic Policy Institute.

To have stagflation, you need both high unemployment and high inflation at the same time, which Bivens does not see as likely.

I think it’s inevitable that we’re going to hit a recession. Whether this is a mild recession or we go into stagflation will be the big question.

Ted Jenkin

CEO OF OXYGEN FINANCIAL

“If we had a situation where unemployment rose pretty sharply, I actually think that would likely cause inflation to start coming down pretty sharply,” Bivens said.

A more likely scenario is that if we end the year with a series of interest rate hikes by the Federal Reserve, we could be in a recession by 2023, he said.

“If that happens, I just expect inflation to relent pretty quickly,” Bivens said.

How can you prepare for a recession or stagflation?

A combination of inflation and shrinkflation, where product companies reduce the contents of everything that we buy, is making it so people’s money just doesn’t go as far now, said Ted Jenkin, a certified financial planner and CEO of Oxygen Financial in Atlanta.

Now, stagflation is also a possibility that clients are asking about, Jenkin said.

“I think it’s inevitable that we’re going to hit a recession,” he said. “Whether this is a mild recession or we go into stagflation will be the big question.”

Consequently, now is a great time to revisit your personal financial plan.

“This is the absolute time for people to batten down the hatches and beef up the foundation of their financial house,” Jenkin said.

Try to aim for at least six months’ worth of emergency expenses in case a downturn does happen, he said. Also make sure you have prepared a recent budget to see if there are places where you can cut back.

Additionally, take a look at any adjustable-rate debt you may have — credit cards, mortgages, student loans — and see if you can pare those balances down or refinance them. Now that interest rates are poised to go up, those balances will become more expensive.

Moreover, it’s a great time to invest in yourself to be more marketable professionally if layoffs become the norm.

“Make sure you’ve really brushed up on your skills and competencies or education so that if the job market gets tighter, you’re marketable,” Jenkin said.

Part V – Why is inflation so high?

Benjamin Curry, Aug 10, 2022, 9:31am

https://www.forbes.com/advisor/investing/why-is-inflation-rising-right-now/

Inflation Explained | What is causing inflation? | Why is inflation so high? | How to fix inflation?

The era of ever-rising prices may be over.

Hopes that inflation has begun to moderate gained steam after the Labor Department reported that the consumer price index (CPI) was relatively unchanged in July compared to June.

“This is a good number,” said Rusty Vanneman, chief investment strategist at Orion Advisor Solutions. “If this is truly the peak in inflation, this could officially signal an economic tide shift that both consumers and investors can appreciate.”

Still, the positive report doesn’t mean everything has suddenly become cheap. The CPI rose 8.5% in July compared to the prior year. While that’s an improvement from last month, it’s still very high.

The main reason for prices leveling off: energy. The gas price index fell by 7.7% in the month, which helped to overcome increases in the costs of food and housing.

In a twist, the news was worse for so-called core CPI, which strips out volatile food and energy prices, where prices gained by 0.3% in the month, and are 5.9% higher than last year.

The inflation report comes after the Federal Reserve raised interest rates to a range of 2.25%–2.5%, a dramatic increase in a short period. While this report won’t stop the Fed from increasing rates further, it may give the nation’s central bank hope that they’re making progress.

“The deceleration in the consumer price index for July is likely a big relief for the Federal Reserve, especially since the Fed insisted that inflation was transitory, which was incorrect,” said Nancy Davis, founder of Quadratic Capital Management.

CPI Inflation Finally Moderates

The headline July CPI data follows a shocking June report that shows year-over-year CPI growth surged to 9.1% after an 8.6% gain in May.

Drivers were perhaps the main group of Americans who could have presaged such a decline was nigh. The gasoline index’s massive decline came after an 11.2% year-over-year increase in June. Overall, energy prices dropped 4.6% over the same period.

Car owners, though, shouldn’t get too comfortable. Gas prices dropped 6.1% in April this year from the month before jumping in the subsequent month, and gas prices are still 45% higher than last year.

Meanwhile, the news was less sanguine when it comes to another staple of life: food.

The price of buying groceries and dining out surged in July, now 13.1% and 7.6% higher than a year ago, respectively. The overall food index gained 10.9%, the biggest 12–month jump since May 1979.

But there’s a reason why Fed officials and economists generally look at core inflation seriously: food and energy prices tend to jump around, even if they are vital to household budgets.

The core CPI data, though, shows just how much work the Fed has to do. According to this metric, prices gained 0.3% in the month, and are 5.9% higher than last year. That’s well above the Fed’s 2% target.

Shelter was a major driver here. Housing prices grew 0.5% in July and are up by 5.7% compared to a year prior.

The latest CPI numbers come after some confusing data. Employers added 528,000 jobs in July, exceeding economist, while wages were up 5.2% over the past year. Still, inflation-adjusted earnings were down 3% over the same period, and the nation’s gross domestic product dropped for another successive quarter, which is a common, but not definitive, definition of recession.

The Commerce Department reported that the core personal consumption expenditures (PCE) price index, the Federal Reserve’s favorite inflation metric, was up 4.8% in June, slightly higher than its 4.7% year-over-year gain in April. Still, that’s below the February reading of 5.3%.

Inflation Remains Enemy #1 for the Fed

Inflation has been the Federal Reserve‘s enemy number one in 2022. The Federal Open Market Committee (FOMC) has made aggressive changes to U.S. monetary policy to bring inflation down to its long-term target of around 2%.

In July, the FOMC raised its target range for the federal funds rate by 75 basis points (bps) for a consecutive month.

It looks like the Fed won’t raise rates so high when it reconvenes on Sept 20-21. Market observers are expecting the Fed hikes rates by 50 bps, according to the CME Group’s FedWatch tool.

Markets are currently pricing in a 62% chance of such a hike bps rate hike, which would bring the fed funds rate to between 2.75% and 3%. The market is only pricing in a 39% chance for a 75 bps rate increase.

“The Fed will have another inflation report before September’s FOMC meeting and if August’s inflation report is as good as this one, we could expect a 50 basis point hike instead of a more aggressive increase in rates,” said Jeffrey Roach, chief economist for LPL Financial.

Could Inflation Help Spark a Recession?

The Fed is facing a difficult balancing act, needing to raise interest rates aggressively to bring down inflation without triggering a U.S. recession.

Rising interest rates increase borrowing costs for companies and consumers, weighing on economic activity. Up to this point, the U.S. labor market has been solid, but the S&P 500’s 13.5% year-to-date decline reflects concerns on Wall Street that the economy may not take spiking interest rates in stride.

Growth stocks are particularly sensitive to rising interest rates because fund managers typically use discounted cash flow models to determine their price targets for growth stocks. Future cash flows are considered less valuable when the discounted rate is higher.

So far in 2022, the Russell 1000 Growth Index is down 19.2%, while the Russell 1000 Value Index is down 7.3%.

Inflation isn’t necessarily bad news for every stock market sector, however. Soaring oil, natural gas and other commodity prices have helped energy sector stocks generate record profits in 2022. The Energy Select Sector SPDR Fund (XLE) is up 37.8% so far this year amid broad-based market weakness.

Today’s report may buoy traders’ animal spirits.

“Stock markets will be cheered by news that the world’s largest economy’s headline inflation rate seems to have peaked,” said Nigel Green of deVere Group. “It means the Federal Reserve has more scope not to hike interest rates so aggressively to fight rising prices.”

What’s Next?

Investors will be monitoring the Fed’s commentary on the economy at its upcoming meeting. The U.S. Bureau of Economic Analysis (BEA) will release the July PCE reading on Aug. 26. CPI and PCE measure inflation based on pricing a basket of goods.

The two baskets are different, and the formulas used to calculate each measure are not the same. The CPI calculation is based on a survey of goods consumers buy, whereas the PCE is based on a survey of goods businesses sell.

It’s important to remember today’s release is but one data point, and the Fed will digest more information before its next confab.

The Fed is trying to lower inflation without harming employment too dramatically. While it has many more miles to go, this report offers hope.

Part VI – What is QE?

What is Quantitative Easing? (video)

What Is Quantitative Easing (QE)?

By THE INVESTOPEDIA TEAM, Updated August 03, 2022, Reviewed by ERIKA RASURE, Fact checked by KATRINA MUNICHIELLO

https://www.investopedia.com/terms/q/quantitative-easing.asp

Quantitative easing (QE) is a form of monetary policy in which a central bank, like the U.S. Federal Reserve, purchases securities from the open market to reduce interest rates and increase the money supply.

Quantitative easing creates new bank reserves, providing banks with more liquidity and encouraging lending and investment. In the United States, the Federal Reserve implements QE policies.

Understanding Quantitative Easing (QE)

Quantitive easing is often implemented when interest rates hover near zero and economic growth is stalled. Central banks have limited tools, like interest rate reduction, to influence economic growth. Without the ability to lower rates further, central banks must strategically increase the supply of money.

To execute quantitative easing, central banks buy government bonds and other securities, injecting bank reserves into the economy. Increasing the supply of money lowers interest rates further and provides liquidity to the banking system, allowing banks to lend with easier terms.

During the COVID-19 pandemic, quantitative easing was used and the Federal Reserve increased its holdings, accounting for 56 percent of the Treasury issuance of securities through the first quarter of 2021.

A government's fiscal policy may be implemented concurrently to expand the money supply. While the Federal Reserve can influence the supply of money in the economy, The U.S. Treasury Department can create new money and implement new tax policies with fiscal policy, sending money, directly or indirectly, into the economy. Quantitative easing can be a combination of both monetary and fiscal policy.

Does Quantitative Easing (QE) Work?

Most economists believe that the Federal Reserve's quantitative easing program helped to rescue the U.S. and global economy following the 2007-2008 financial crisis, however, the results of QE are difficult to quantify.

Globally, central banks have attempted to deploy quantitative easing as a means of preventing recession and deflation in their countries with similarly inconclusive results. While QE policy is effective at lowering interest rates and boosting the stock market, its broader impact on the economy isn’t apparent.

Commonly, the effects of quantitative easing benefit borrowers over savers and investors over non-investors, and there are pros and cons to QE, according to Stephen Williamson, a former economist with the Federal Reserve Bank of St. Louis.

Risks of Quantitative Easing (QE)

Inflation

As money is increased in an economy, the risk of inflation looms. As the liquidity works through the system, central banks remain vigilant, as the time lag between the increase in the money supply and the inflation rate is generally 12 to 18 months.

A quantitative easing strategy that does not spur intended economic growth but causes inflation can also create stagflation, a scenario where both the inflation rate and the unemployment rate are high.

Limited Lending

As liquidity increases for banks, a central bank like the Fed cannot force banks to increase lending activities nor can they force individuals and businesses to borrow and invest. This creates a “credit crunch,” where cash is held at banks or corporations hoard cash due to an uncertain business climate.

Devalued Currency

Quantitative easing may devalue the domestic currency as the money supply increases. While a devalued currency can help domestic manufacturers with exported goods cheaper in the global market, a falling currency value makes imports more expensive, increasing the cost of production and consumer price levels.

Chapter 1-II

Chapter 1 -II

ppt

1. What are the six parts of the financial markets

Money:

· To pay for purchases and store wealth (fiat money, fiat currency)

What is Bitcoin for BEGINNERS in 7-Min. & Bitcoin Explained | What is Cryptocurrency Explained 2019

For example, one featured Bitcoin mining rig costs USD $1,767 to build and operate and generates $4.56 in profit per day at current prices. Thus, it would need to run for 387 days to become profitable. From https://bitcoinist.com/what-cost-to-build-bitcoin-mining-rig-today/

Financial Instruments:

· To transfer resources from savers to investors and to transfer risk to those best equipped to bear it.

Where do student loans go? (video)

An Introduction to Securitized Products: Asset-Backed Securities (ABS) (video)

Financial Markets:

· Buy and sell financial instruments

· Channel funds from savers to investors, thereby promoting economic efficiency

· Affect personal wealth and behavior of business firms. Example?

Financial Institutions.

· Provide access to financial markets, collect information & provide services

· Financial Intermediary: Helps get funds from savers to investors

Central Banks

· Monitor financial Institutions and stabilize the economy

Regulatory Agencies

· To provide oversight for financial system.

The role of financial regulation (Video)

What Does the Federal Reserve Do? (youtube)

What is the FDIC? (video)

The Federal Deposit Insurance Corporation (FDIC) was created by the Glass-Steagall Act of 1933 to provide insurance on deposits to guarantee the safety of funds kept by depositors at banks. Its mandate is to protect up to $250,000 per depositor. The catalyst for creating the FDIC was the run on banks during the Great Depression of the 1920s.

Checking accounts, savings accounts, CDs, and money market accounts are generally 100% covered by the FDIC. Coverage extends to individual retirement accounts (IRAs), but only the parts that fit the type of accounts listed previously. Joint accounts, revocable and irrevocable trust accounts, and employee benefit plans are covered, as are corporate, partnership, and unincorporated association accounts.

FDIC insurance does not cover products such as mutual funds, annuities, life insurance policies, stocks, or bonds. The contents of safe-deposit boxes are also not included in FDIC coverage. Cashier's checks and money orders issued by the failed bank remain fully covered by the FDIC. (investopedia.com)

What Is The SEC? (video)

The SEC acts independently of the U.S. government and was established by the Securities Exchange Act of 1934.11 One of the most comprehensive and powerful agencies, the SEC enforces the federal securities laws and regulates the majority of the securities industry. Its regulatory coverage includes the U.S. stock exchanges, options markets, and options exchanges as well as all other electronic exchanges and other electronic securities markets. It also regulates investment advisors who are not covered by the state regulatory agencies.

The SEC consists of six divisions and 24 offices.12 Their goals are to interpret and take enforcement actions on securities laws, issue new rules, provide oversight of securities institutions, and coordinate regulation among different levels of government.

Financial Industry Regulatory Authority (FINRA)

The Securities and Exchange Commission (SEC) vs. Financial Industry Regulatory Authority (FINRA) (youtube)

The Financial Industry Regulatory Authority (FINRA) was created in 2007 from its predecessor, the National Association of Securities Dealers (NASD). FINRA is considered a self-regulatory organization (SRO) and was originally created as an outcome of the Securities Exchange Act of 1934.

FINRA oversees all firms that are in the securities business with the public. It is also responsible for training financial services professionals, licensing and testing agents, and overseeing the mediation and arbitration processes for disputes between customers and brokers. (investopedia.com)

2. What are the five core principals of finance

Time has value
Risk requires compensation
Information is the basis for decisions
Markets determine prices and allocation resources
Stability improves welfare

3. An example of the financial market innovation: High Frequency Trading

Ppt

As of now, it is only 10% of all trades that are executed the old-school way — via regular stock picking. The rest is automated trading. Currently, high-frequency trading is responsible for 50–60% of all trading activity. If we take a look at HFT’s trading volume as a percentage of the total stock trading volume during the last decade in the US, then things don’t change much. In fact, it has never fallen below 50%.

https://viktortachev.medium.com/sorry-but-high-frequency-trading-is-not-dead-51bb71034d05

High Frequency Trading (video)

High frequency trading
Spoofing
Regulatory reform to prevent HFT from exploiting the market

The Hummingbird Project (2019) | Official US Trailer HD

High-Frequency Trading (HFT)

By JAMES CHEN, Updated August 25, 2021, Reviewed by MICHAEL J BOYLE, Fact checked by KATRINA MUNICHIELLO

https://www.investopedia.com/terms/h/high-frequency-trading.asp

What Is High-Frequency Trading (HFT)?

High-frequency trading, also known as HFT, is a method of trading that uses powerful computer programs to transact a large number of orders in fractions of a second. It uses complex algorithms to analyze multiple markets and execute orders based on market conditions. Typically, the traders with the fastest execution speeds are more profitable than traders with slower execution speeds.

In addition to the high speed of orders, HFT is also characterized by high turnover rates and order-to-trade ratios. Some of the best-known HFT firms include Tower Research, Citadel LLC, and Virtu Financial.

KEY TAKEAWAYS

· HFT is complex algorithmic trading in which large numbers of orders are executed within seconds.

· It adds liquidity to the markets and eliminates small bid-ask spreads.

· HFT is criticized for allowing large companies to gain an upper hand in trading.

· Another complaint is that the liquidity produced by this type of trading is momentary—it disappears within seconds, making it impossible for traders to take advantage of it.

Understanding High-Frequency Trading (HFT)

HFT became popular when exchanges started to offer incentives for companies to add liquidity to the market. For instance, the New York Stock Exchange (NYSE) has a group of liquidity providers called Supplemental Liquidity Providers (SLPs) that attempts to add competition and liquidity for existing quotes on the exchange.

The SLP was introduced following the collapse of Lehman Brothers in 2008, when liquidity was a major concern for investors. As an incentive to companies, the NYSE pays a fee or rebate for providing said liquidity. With millions of transactions per day, this results in a large amount of profits.

Benefits of High-Frequency Trading (HFT)

HFT has improved market liquidity and removed bid-ask spreads that previously would have been too small. This was tested by adding fees on HFT, which led bid-ask spreads to increase. One study assessed how Canadian bid-ask spreads changed when the government introduced fees on HFT. It found that market-wide bid-ask spreads increased by 13% and the retail spreads increased by 9%.

Critiques of High-Frequency Trading (HFT)

HFT is controversial and has been met with some harsh criticism. It has replaced a number of broker-dealers and uses mathematical models and algorithms to make decisions, taking human decision and interaction out of the equation.

Decisions happen in milliseconds, and this could result in big market moves without reason. As an example, on May 6, 2010, the Dow Jones Industrial Average (DJIA) suffered its largest intraday point drop ever, declining 1,000 points and dropping 10% in just 20 minutes before rising again. A government investigation blamed a massive order that triggered a sell-off for the crash.

An additional critique of HFT is it allows large companies to profit at the expense of the "little guys." Its "ghost liquidity" is also a source of criticism: the liquidity provided by HFT is available to the market one second and gone the next, preventing traders from actually being able to trade this liquidity.

Flash crash

From Wikipedia, the free encyclopedia

A flash crash is a very rapid, deep, and volatile fall in security prices occurring within an extremely short time period. A flash crash frequently stems from trades executed by black-box trading, combined with high-frequency trading, whose speed and interconnectedness can result in the loss and recovery of billions of dollars in a matter of minutes and seconds.

Occurrences

The Flash Crash

This type of event occurred on May 6, 2010. A $4.1 billion trade on the New York Stock Exchange (NYSE) resulted in a loss to the Dow Jones Industrial Average of over 1,000 points and then a rise to approximately previous value, all over about fifteen minutes. The mechanism causing the event has been heavily researched and is in dispute. On April 21, 2015, the U.S. Department of Justice laid "22 criminal counts, including fraud and market manipulation" against Navinder Singh Sarao, a trader. Among the charges included was the use of spoofing algorithms.

2017 Ethereum Flash Crash

On June 22, 2017, the price of Ethereum, the second-largest digital cryptocurrency, dropped from more than $300 to as low as $0.10 in minutes at GDAX exchange. Suspected for market manipulation or an account takeover at first, later investigation by GDAX claimed no indication of wrongdoing. The crash was triggered by a multimillion-dollar selling order which brought the price down, from $317.81 to $224.48, and caused the following flood of 800 stop-loss and margin funding liquidation orders, crashing the market.

British pound flash crash

On October 7, 2016, there was a flash crash in the value of sterling, which dropped more than 6% in two minutes against the US dollar. It was the pound's lowest level against the dollar since May 1985. The pound recovered much of its value in the next few minutes, but ended down on the day's trading, most likely due to market concerns about the impact of a "hard Brexit"—a more complete break with the European Union following Britain's 'Leave' referendum vote in June. It was initially speculated that the flash crash may have been due to a fat-finger trader error or an algorithm reacting to negative news articles about the British Government's European policy.

FLASH CRASH! Dow Jones drops 560 points in 4 Minutes! May 6th 2010 (video)

Flash Crash 2010 - VPRO documentary – 2011 (video, optional)

For discussion:

· Next time, when a flash crash happens, can you think of a strategy to make money from this incident? Why or why not?

· After the flash crash, the price will recover almost completely. So why the market is afraid of it. It is not a big deal, right?

Spoofing https://en.wikipedia.org/wiki/Spoofing_(finance)

Spoofing is a disruptive algorithmic trading activity employed by traders to outpace other market participants and to manipulate markets.

· Spoofers feign interest in trading futures, stocks and other products in financial markets creating an illusion of the demand and supply of the traded asset. In an order driven market, spoofers post a relatively large number of limit orders on one side of the limit order book to make other market participants believe that there is pressure to sell (limit orders are posted on the offer side of the book) or to buy (limit orders are posted on the bid side of the book) the asset.

· Under the 2010 Dodd–Frank Act spoofing is defined as "the illegal practice of bidding or offering with intent to cancel before execution."

· High-frequency trading, the primary form of algorithmic trading used in financial markets is very profitable as it deals in high volumes of transactions.

· The five-year delay in arresting the lone spoofer, Navinder Singh Sarao, accused of exacerbating the 2010 Flash Crash—one of the most turbulent periods in the history of financial markets—has placed the self-regulatory bodies such as the Commodity Futures Trading Commission (CFTC) and Chicago Mercantile Exchange & Chicago Board of Trade under scrutiny. The CME was described as being in a "massively conflicted" position as they make huge profits from the HFT and algorithmic trading.

JPMorgan to Pay $920 Million in Record Spoofing Case (youtube)

Spoofing & Layering - Market Manipulation - Self-Study | Online Courses (youtube)

Homework of the 1st week (due with the first mid-term exam):

1. Name at least one factor that might trigger the next financial crisis and provide the rational.

2. Compare between SEC and FINRA, FDIC and the Fed

3. What is high frequency trading (HFT)? How does it work?

4. What is spoofing? Why is it harmful to the market?

5. What is flash crash? How does it make investors so worried? How can HFT trigger flash crash?

6. What is QE? Do you think that QE can result in inflation?

7. Why is inflation so high in 2022?

Citi’s Painful Flash Crash Highlights Risks From Algo Trades

· Monday’s shock spread quickly from one erroneous trade

· Selloff briefly erased $315 billion from European equities

ByKsenia Galouchko, Albertina Torsoli, and Jonas Ekblom

May 3, 2022 at 8:44 AM EDTUpdated onMay 3, 2022 at 12:09 PM EDT

https://www.bloomberg.com/news/articles/2022-05-03/citi-s-painful-flash-crash-highlights-market-risks-from-algos

Video

A rare flash crash in European stocks caused by a Citigroup Inc. trader highlights the risks from computer-initiated sell orders exacerbating a single human error.

The OMX Stockholm 30 Index slumped as much as 8% in just five minutes before 10 a.m. CET on Monday, but quickly recovered most of the losses. A trader at Citi’s London desk made an error inputting a transaction, sparking an abrupt selloff across European equities that briefly wiped out 300 billion euros ($315 billion).

“The problem is not the mistake per se, but all the algorithms and stops that were triggered,” said John Plassard, a director at Mirabaud & Cie. “It shows the market is always vulnerable to human error and that algorithms and various CTAs are far too present in markets,” he added, referring to the commodity trading advisors that often use rapid systematic orders to pursue market trends.

On Monday, there was added pressure: a public holiday in the U.K. left European stock markets with about a quarter less liquidity than normal, giving the remaining trades an outsized chance of moving prices.

It was “the worst day possible for this to happen,” Guillermo Hernandez Sampere, head of trading at asset manager Manfred Piontke Vermoegensverwalt EK in Germany, said by phone. While the circumstances were unusual, he said the flash crash demonstrated a broader need to take action and prevent such moves in the future.

“We shouldn’t wait for the regulator to do something, that’ll take too long -- instead, brokers, banks and stock exchanges need to implement changes now, such as introducing circuit breakers,” he said.

Black Monday

Previous sudden crashes include the slide in the pound in 2016, as well as Wall Street’s Black Monday in October 1987 and the flash crash in May 2010. In the U.S., regulators have tried to stave off further shocks to share prices with new rules including greater disclosure for big traders, as well as circuit breakers to cool off overheated price moves and curbs on algos to prevent shares moving too quickly.

Europe, though, governs its markets mostly on a country-by-country basis.

Nasdaq Stockholm, where Monday’s crash originated, has volatility guards for individual stocks, according to spokesperson David Augustsson. These guards halt trading if a share price moves a certain amount from its last price or that day’s opening price. Each stock has its own thresholds, he added. About two-thirds of all trading is based on algorithmic dealing now, compared with about 30% a decade ago, he said.

Between 9:57 a.m. and 10:05 a.m. CET on Monday, the Nasdaq Nordic’s total turnover was 378 million euros, about five times the average volume, according to Augustsson. The exchange is in touch with Citi and doesn’t see a reason to cancel any trades, he said.

Sweden’s financial regulator is in ongoing contact with Nasdaq, said Susan Vo Bergqvist, a spokesperson for the Financial Supervisory Authority. It is too early to say whether any action will be taken, she added.

“It’s hard to know the outcome, but this could perhaps be a trigger to look at European system for managing trading halts and circuit breakers,” said Anish Puaar, European market structure analyst at Rosenblatt Securities.

— With assistance by Jonas Ekblom, Thyagaraju Adinarayan, Jan-Patrick Barnert, and Anton Wilen

U.S. exchanges defeat high-frequency trading lawsuit

By Jonathan Stempel March 28, 2022

https://www.reuters.com/business/finance/us-exchanges-defeat-high-frequency-trading-lawsuit-2022-03-28/

NEW YORK, March 28 (Reuters) - A federal judge on Monday dismissed long-running litigation accusing seven U.S. stock exchanges of defrauding ordinary investors by quietly allowing high-frequency traders to trade faster and at better prices.

Exchanges including the New York Stock Exchange, Nasdaq (NDAQ.O) and BATS Global Markets were accused of providing high-frequency trading firms with enhanced data feeds and faster order processing, and letting them locate their servers near the exchanges' own so trading signals would be sent faster.

But in a 46-page decision, U.S. District Judge Jesse Furman in Manhattan said investors in the proposed class action could not prove they suffered harm because of the exchanges' actions, which they said violated federal securities law.

The judge said reports from the plaintiffs' expert witness, a former high-frequency trader who now consults on market structure, were "not based on reliable methodology," and did not track the trading firms' use of the specialized services.

Because those reports were inadmissible, "it follows that plaintiffs have adduced no admissible evidence that their own trades were harmed by the exchanges' challenged conduct," depriving them of legal standing to sue, Furman wrote.

The investors were led by the city of Providence, Rhode Island and several pension plans, including for the city of Boston. Their lawyers did not respond to requests for comment.

High-frequency traders use computer algorithms to gain split-second trading advantages.

They were the subject of Michael Lewis' best-seller "Flash Boys," published in March 2014. The lawsuit began the next month.

The NYSE and its parent Intercontinental Exchange Inc (ICE.N) said they were pleased with the decision. Neither the other defendants nor their lawyers provided comments. BATS is now part of CBOE Global Markets Inc .

Furman had also dismissed the investors' claims in 2015, finding the exchanges absolutely immune from liability under federal law, but an appeals court overturned that finding two years later.

The case is City of Providence, Rhode Island et al v BATS Global Markets Inc et al, U.S. District Court, Southern District of New York, No. 14-02811.

Special topic: Blockchain, NFT, Metaverse, Crypto Currency and Inflation, and CBDC

Part 1 - Blockchain and Bitcoin

Blockchain Technology Explained (2 Hour Course) (optional)

By ADAM HAYES Updated June 24, 2022, Reviewed by JEFREDA R. BROWN, Fact checked by SUZANNE KVILHAUG

https://www.investopedia.com/terms/b/blockchain.asp

What Is a Blockchain?

A blockchain is a distributed database or ledger that is shared among the nodes of a computer network. As a database, a blockchain stores information electronically in digital format. Blockchains are best known for their crucial role in cryptocurrency systems, such as Bitcoin, for maintaining a secure and decentralized record of transactions. The innovation with a blockchain is that it guarantees the fidelity and security of a record of data and generates trust without the need for a trusted third party.

One key difference between a typical database and a blockchain is how the data is structured. A blockchain collects information together in groups, known as blocks, that hold sets of information. Blocks have certain storage capacities and, when filled, are closed and linked to the previously filled block, forming a chain of data known as the blockchain. All new information that follows that freshly added block is compiled into a newly formed block that will then also be added to the chain once filled.

A database usually structures its data into tables, whereas a blockchain, as its name implies, structures its data into chunks (blocks) that are strung together. This data structure inherently makes an irreversible timeline of data when implemented in a decentralized nature. When a block is filled, it is set in stone and becomes a part of this timeline. Each block in the chain is given an exact timestamp when it is added to the chain.

KEY TAKEAWAYS

· Blockchain is a type of shared database that differs from a typical database in the way that it stores information; blockchains store data in blocks that are then linked together via cryptography.

· As new data comes in, it is entered into a fresh block. Once the block is filled with data, it is chained onto the previous block, which makes the data chained together in chronological order.

· Different types of information can be stored on a blockchain, but the most common use so far has been as a ledger for transactions.

· In Bitcoin’s case, blockchain is used in a decentralized way so that no single person or group has control—rather, all users collectively retain control.

· Decentralized blockchains are immutable, which means that the data entered is irreversible. For Bitcoin, this means that transactions are permanently recorded and viewable to anyone.

How Does a Blockchain Work?

The goal of blockchain is to allow digital information to be recorded and distributed, but not edited. In this way, a blockchain is the foundation for immutable ledgers, or records of transactions that cannot be altered, deleted, or destroyed. This is why blockchains are also known as a distributed ledger technology (DLT).

First proposed as a research project in 1991, the blockchain concept predated its first widespread application in use: Bitcoin, in 2009. In the years since, the use of blockchains has exploded via the creation of various cryptocurrencies, decentralized finance (DeFi) applications, non-fungible tokens (NFTs), and smart contracts.

Imagine that a company owns a server farm with 10,000 computers used to maintain a database holding all of its client’s account information. This company owns a warehouse building that contains all of these computers under one roof and has full control of each of these computers and all of the information contained within them. This, however, provides a single point of failure. What happens if the electricity at that location goes out? What if its Internet connection is severed? What if it burns to the ground? What if a bad actor erases everything with a single keystroke? In any case, the data is lost or corrupted.

What a blockchain does is to allow the data held in that database to be spread out among several network nodes at various locations. This not only creates redundancy but also maintains the fidelity of the data stored therein—if somebody tries to alter a record at one instance of the database, the other nodes would not be altered and thus would prevent a bad actor from doing so. If one user tampers with Bitcoin’s record of transactions, all other nodes would cross-reference each other and easily pinpoint the node with the incorrect information. This system helps to establish an exact and transparent order of events. This way, no single node within the network can alter information held within it.

Because of this, the information and history (such as of transactions of a cryptocurrency) are irreversible. Such a record could be a list of transactions (such as with a cryptocurrency), but it also is possible for a blockchain to hold a variety of other information like legal contracts, state identifications, or a company’s product inventory.

To validate new entries or records to a block, a majority of the decentralized network’s computing power would need to agree to it. To prevent bad actors from validating bad transactions or double spends, blockchains are secured by a consensus mechanism such as proof of work (PoW) or proof of stake (PoS). These mechanisms allow for agreement even when no single node is in charge.

Transparency

Because of the decentralized nature of Bitcoin’s blockchain, all transactions can be transparently viewed by either having a personal node or using blockchain explorers that allow anyone to see transactions occurring live. Each node has its own copy of the chain that gets updated as fresh blocks are confirmed and added. This means that if you wanted to, you could track Bitcoin wherever it goes.

For example, exchanges have been hacked in the past, where those who kept Bitcoin on the exchange lost everything. While the hacker may be entirely anonymous, the Bitcoins that they extracted are easily traceable. If the Bitcoins stolen in some of these hacks were to be moved or spent somewhere, it would be known.

Of course, the records stored in the Bitcoin blockchain (as well as most others) are encrypted. This means that only the owner of a record can decrypt it to reveal their identity (using a public-private key pair). As a result, users of blockchains can remain anonymous while preserving transparency.

Is Blockchain Secure?

Blockchain technology achieves decentralized security and trust in several ways. To begin with, new blocks are always stored linearly and chronologically. That is, they are always added to the “end” of the blockchain. After a block has been added to the end of the blockchain, it is extremely difficult to go back and alter the contents of the block unless a majority of the network has reached a consensus to do so. That’s because each block contains its own hash, along with the hash of the block before it, as well as the previously mentioned timestamp. Hash codes are created by a mathematical function that turns digital information into a string of numbers and letters. If that information is edited in any way, then the hash code changes as well.

Let’s say that a hacker, who also runs a node on a blockchain network, wants to alter a blockchain and steal cryptocurrency from everyone else. If they were to alter their own single copy, it would no longer align with everyone else’s copy. When everyone else cross-references their copies against each other, they would see this one copy stand out, and that hacker’s version of the chain would be cast away as illegitimate.

Succeeding with such a hack would require that the hacker simultaneously control and alter 51% or more of the copies of the blockchain so that their new copy becomes the majority copy and, thus, the agreed-upon chain. Such an attack would also require an immense amount of money and resources, as they would need to redo all of the blocks because they would now have different timestamps and hash codes.

Due to the size of many cryptocurrency networks and how fast they are growing, the cost to pull off such a feat probably would be insurmountable. This would be not only extremely expensive but also likely fruitless. Doing such a thing would not go unnoticed, as network members would see such drastic alterations to the blockchain. The network members would then hard fork off to a new version of the chain that has not been affected. This would cause the attacked version of the token to plummet in value, making the attack ultimately pointless, as the bad actor has control of a worthless asset. The same would occur if the bad actor were to attack the new fork of Bitcoin. It is built this way so that taking part in the network is far more economically incentivized than attacking it.

Bitcoin vs. Blockchain

Blockchain technology was first outlined in 1991 by Stuart Haber and W. Scott Stornetta, two researchers who wanted to implement a system where document timestamps could not be tampered with. But it wasn’t until almost two decades later, with the launch of Bitcoin in January 2009, that blockchain had its first real-world application.

The Bitcoin protocol is built on a blockchain. In a research paper introducing the digital currency, Bitcoin’s pseudonymous creator, Satoshi Nakamoto, referred to it as “a new electronic cash system that’s fully peer-to-peer, with no trusted third party.”

The key thing to understand here is that Bitcoin merely uses blockchain as a means to transparently record a ledger of payments, but blockchain can, in theory, be used to immutably record any number of data points. As discussed above, this could be in the form of transactions, votes in an election, product inventories, state identifications, deeds to homes, and much more.

Currently, tens of thousands of projects are looking to implement blockchains in a variety of ways to help society other than just recording transactions—for example, as a way to vote securely in democratic elections. The nature of blockchain’s immutability means that fraudulent voting would become far more difficult to occur. For example, a voting system could work such that each citizen of a country would be issued a single cryptocurrency or token. Each candidate would then be given a specific wallet address, and the voters would send their token or crypto to the address of whichever candidate for whom they wish to vote. The transparent and traceable nature of blockchain would eliminate both the need for human vote counting and the ability of bad actors to tamper with physical ballots.

Pros and Cons of Blockchain

For all of its complexity, blockchain’s potential as a decentralized form of record-keeping is almost without limit. From greater user privacy and heightened security to lower processing fees and fewer errors, blockchain technology may very well see applications beyond those outlined above. But there are also some disadvantages.

Pros

· Improved accuracy by removing human involvement in verification

· Cost reductions by eliminating third-party verification

· Decentralization makes it harder to tamper with

· Transactions are secure, private, and efficient

· Transparent technology

· Provides a banking alternative and a way to secure personal information for citizens of countries with unstable or underdeveloped governments

Cons

· Significant technology cost associated with mining bitcoin

· Low transactions per second

· History of use in illicit activities, such as on the dark web

· Regulation varies by jurisdiction and remains uncertain

· Data storage limitations

Part II - Non-Fungible Token (NFT)

By RAKESH SHARMA Updated June 22, 2022, Reviewed by DORETHA CLEMON, Fact checked by PETE RATHBURN

https://www.investopedia.com/non-fungible-tokens-nft-5115211

NFT Explained In 5 Minutes | What Is NFT? - Non Fungible Token | NFT Crypto Explained | Simplilearn (youtube)

NFTs and the Metaverse: The internet enters a new phase (youtube)

What Is a Non-Fungible Token (NFT)?

Non-fungible tokens (NFTs) are cryptographic assets on a blockchain with unique identification codes and metadata that distinguish them from each other.

Unlike cryptocurrencies, they cannot be traded or exchanged at equivalency. This differs from fungible tokens like cryptocurrencies, which are identical to each other and, therefore, can serve as a medium for commercial transactions.

KEY TAKEAWAYS

· NFTs (non-fungible tokens) are unique cryptographic tokens that exist on a blockchain and cannot be replicated.

· NFTs can represent real-world items like artwork and real estate.

· "Tokenizing" these real-world tangible assets makes buying, selling, and trading them more efficient while reducing the probability of fraud.

· NFTs can also function to represent individuals' identities, property rights, and more.

Understanding Non-Fungible Tokens (NFTs)

NFTs evolved from the ERC-721 standard. Developed by some of the same people responsible for the ERC-20 smart contract, ERC-721 defines the minimum interface—ownership details, security, and metadata—required for the exchange and distribution of gaming tokens. The ERC-1155 standard takes the concept further by reducing the transaction and storage costs required for NFTs and batching multiple types of non-fungible tokens into a single contract.

NFTs have the potential for several use cases. For example, they are an ideal vehicle to digitally represent physical assets like real estate and artwork. Because they are based on blockchains, NFTs can also work to remove intermediaries and connect artists with audiences or for identity management. NFTs can remove intermediaries, simplify transactions, and create new markets.

Much of the current market for NFTs is centered around collectibles, such as digital artwork, sports cards, and rarities. Perhaps the most hyped space is NBA Top Shot, a place to collect non-fungible tokenized NBA moments in digital card form. Some of these cards have sold for millions of dollars.

Recently, Twitter's (TWTR) Jack Dorsey tweeted a link to a tokenized version of the first tweet ever, in which he wrote: "just setting up my twttr." The NFT version of the first-ever tweet sold for more than $2.9 million.

NFTs shift the crypto paradigm by making each token unique and irreplaceable, thereby making it impossible for one non-fungible token to be equal to another. They are digital representations of assets and have been likened to digital passports because each token contains a unique, non-transferable identity to distinguish it from other tokens. They are also extensible, meaning you can combine one NFT with another to “breed” a third, unique NFT.

Just like Bitcoin, NFTs also contain ownership details for easy identification and transfer between token holders. Owners can also add metadata or attributes pertaining to the asset in NFTs. For example, tokens representing coffee beans can be classified as fair trade. Or, artists can sign their digital artwork with their own signature in the metadata.

Examples of NFTs

Perhaps the most famous use case for NFTs is that of cryptokitties. Launched in November 2017, cryptokitties are digital representations of cats with unique identifications on Ethereum’s blockchain. Each kitty is unique and has a price in ether. They reproduce among themselves and produce new offspring, which have different attributes and valuations compared to their parents.

Within a few short weeks of their launch, cryptokitties racked up a fan base that spent $20 million worth of ether to purchase, feed, and nurture them. Some enthusiasts even spent upward of $100,000 on the effort.

More recently, the Bored Ape Yacht Club has garnered controversial attention for its high prices, celebrity following, and high-profile thefts of some of its 10,000 NFTs.

Though the cryptokitties and Bored Ape Yacht Club use cases may sound trivial, others have more serious business implications. For example, NFTs have been used in private equity transactions as well as real estate deals.

One of the implications of enabling multiple types of tokens in a contract is the ability to provide escrow for different types of NFTs—from artwork to real estate—into a single financial transaction.

Why NFTs Are Important

Non-fungible tokens are an evolution of the relatively simple concept of cryptocurrencies. Modern finance systems consist of sophisticated trading and loan systems for different asset types, ranging from real estate to lending contracts to artwork. By enabling digital representations of physical assets, NFTs are a step forward in the reinvention of this infrastructure.

To be sure, the idea of digital representations of physical assets is not novel nor is the use of unique identification. However, when these concepts are combined with the benefits of a tamper-resistant blockchain of smart contracts, they become a potent force for change.

Perhaps, the most obvious benefit of NFTs is market efficiency. The conversion of a physical asset into a digital one streamlines processes and removes intermediaries. NFTs representing digital or physical artwork on a blockchain remove the need for agents and allow artists to connect directly with their audiences. They can also improve business processes. For example, an NFT for a wine bottle will make it easier for different actors in a supply chain to interact with it and help track its provenance, production, and sale through the entire process. Consulting firm Ernst & Young has already developed such a solution for one of its clients.

Non-fungible tokens are also excellent for identity management. Consider the case of physical passports that need to be produced at every entry and exit point. By converting individual passports into NFTs, each with its own unique identifying characteristics, it is possible to streamline the entry and exit processes for jurisdictions. Expanding this use case, NFTs can serve an identity management purpose within the digital realm as well.

What Are Some Examples of Non-Fungible Tokens?

Non-fungible tokens can digitally represent any asset, including online-only assets like digital artwork and real assets such as real estate. Other examples of the assets that NFTs can represent include in-game items like avatars, digital and non-digital collectibles, domain names, and event tickets.

How Can I Buy NFTs?

Many NFTs can only be purchased with Ether, so owning some of this cryptocurrency—and storing it in a digital wallet—is usually the first step. You can then purchase NFTs via any of the online NFT marketplaces, including OpenSea, Rarible, and SuperRare.

Are NFTs Safe?

Non-fungible tokens, which use blockchain technology just like cryptocurrency, are generally secure. The distributed nature of blockchains makes NFTs difficult (although not impossible) to hack. One security risk for NFTs is that you could lose access to your non-fungible token if the platform hosting the NFT goes out of business.

Part III - Metaverse

What is the metaverse? (CNBC, youtube)

What's next for tech's big bet on the metaverse? (CNBC, youtube)

How The Metaverse Will Change The World | Brian Jung | TEDxRockville (optional)

By JEAN FOLGER Updated August 05, 2022, Reviewed by JEFREDA R. BROWN, Fact checked by VIKKI VELASQUEZ

https://www.investopedia.com/metaverse-definition-5206578#:~:text=The%20metaverse%20is%20a%20digital,allow%20users%20to%20interact%20virtually.

What Is the Metaverse?

The metaverse is a digital reality that combines aspects of social media, online gaming, augmented reality (AR), virtual reality (VR), and cryptocurrencies to allow users to interact virtually. Augmented reality overlays visual elements, sound, and other sensory input onto real-world settings to enhance the user experience. In contrast, virtual reality is entirely virtual and enhances fictional realities.

KEY TAKEAWAYS

· The metaverse is a shared virtual environment that people access via the Internet.

· Cryptocurrency is an aspect of the metaverse.

· Technologies like virtual reality (VR) and augmented reality (AR) are combined in the metaverse to create a sense of "virtual presence."

· Meta (formerly Facebook) CEO Mark Zuckerberg believes augmented reality glasses will eventually be as widespread as smartphones.

· In October 2021, Meta announced plans to create 10,000 new high-skilled jobs in the European Union (EU) to help shape the metaverse.

How Does the Metaverse Work?

An exact definition of the metaverse may be hard to explain because of its depths, but most technology experts agree, that the metaverse is a vast network where individuals via their avatars can interact socially and professionally, invest in currency, take classes, work, and travel in 3-D virtual reality.

As the metaverse grows, it may likely create online spaces where user interactions are more multidimensional than current technology supports. In simple terms, the metaverse will allow users to go beyond just viewing digital content, users in the metaverse will be able to immerse themselves in a space where the digital and physical worlds converge.

Meta and the Metaverse

In July 2021, Mark Zuckerberg talked with journalist Casey Newton about the metaverse and the changes he envisioned for Facebook. Then rumors began swirling in mid-October 2021 about a Facebook rebrand—complete with a new name—to embrace the company’s commitment to the metaverse. Unnamed sources told The Verge that an announcement could come soon. And it did.

Proponents of the metaverse view the concept as the next stage in developing the Internet. Meta, for example, has already invested heavily in AR and VR, developing hardware such as its Oculus VR headsets, while AR glasses and wristband technologies are in the works. Zuckerberg, who believes AR glasses will one day be as ubiquitous as smartphones, told The Verge that over the next several years, Facebook "will effectively transition from people seeing us as primarily being a social media company to being a metaverse company."

How Do I Invest in the Metaverse?

There are several ways you could invest in the metaverse. You could purchase and invest in cryptocurrency, you could invest in companies working on areas of the metaverse, like Meta and Niantic, or invest in an exchange-traded fund (ETF) that focuses on gaming and technology companies.

How OpenSea cornered the $17 billion market for NFTs (cnbc video)

NFTs have been taking over the art world. And at the center of the NFT craze is a company called OpenSea. OpenSea is the Amazon of NFTs, or non-fungible tokens. It’s an online marketplace that allows people to easily create, sell and buy NFTs. It’s one of the largest NFT trading platforms with more than 1.5 million active users, according to Dune Analytics. This past January was OpenSea’s busiest month yet. It recorded a monthly trading volume of nearly $5 billion, surpassing its previous high in August of 2021.

FRI, APR 15 202212:00 PM EDT

How 99-year-old publisher Time is leading legacy media into the NFT future

PUBLISHED SUN, JUL 17 20228:58 AM EDTUPDATED MON, JUL 18 20229:34 AM EDT, Riley de León

https://www.cnbc.com/2022/07/17/99-year-old-publisher-time-is-leading-legacy-media-into-the-nft-future.html

KEY POINTS

· NFTs, or non-fungible tokens, are a controversial piece of the crypto conversation, evoking both passionate criticism and praise as Web3 becomes a bigger part of popular culture.

· Keith Grossman, president of Time, has spent the past year building the 99-year-old media brand’s NFT business, TIMEPieces, and the publisher now accepts 33 cryptocurrencies for digital subscriptions.

· Since September, the media giant has created, or “dropped” as it’s known in the space, more than 20,000 TIMEPieces NFTs, generating a $10 million profit and $600,000 for charities.

NFTs, or non-fungible tokens, have become, perhaps, the most controversial piece of the crypto conversation, evoking both passionate criticism and praise as Web3 becomes a bigger part of popular culture.

NFTs are unique digital assets, like artwork and sports trading cards, that are verified and stored using blockchain technology, but critics see them as overhyped and potentially harmful to the environment given the energy-intensive nature of cryptocurrencies. Many NFTs are built on the network behind ethereum, the second-biggest token.

The rise of the internet meant that anyone could view images, videos and songs online for free. People are buying NFTs out of the belief that they’ll be able to prove ownership of a virtual item thanks to blockchain technology.

“All it is is a token that allows you to verify ownership on the blockchain. Its secondary value is allowing the owner to control their personal information,” Grossman told CNBC in a recent interview.

TIMEPieces token holders can connect their digital wallets to TIME’s website, which gives them unlimited access to TIME content, as well as exclusive invitations to both virtual and in-person events. Some of the more popular tokens within the TIMEPieces collection include photography and other forms of digital art from 89 emerging Web3 artists, including Farokh Sarmad, Joanne Hollings and Julie Pacino, daughter of actor Al Pacino, among others. It’s also attracted many well-known celebrity collectors, from Anthony Hopkins to Eva Longoria and Miguel.

In addition to auctioning off original renderings of their most famous cover stories, TIME adds its iconic red-frame to each NFT created by these emerging artists — a group curated by the media giant’s creative director, D.W. Pine. Grossman describes it as highlighting the “next generation of artists,” as the brand prepares to celebrate a century of publishing the news-related cover art it’s known for today.

Since September, TIME has created, or “dropped” as it’s known in the space, more than 20,000 TIMEPieces NFTs that are owned by roughly 12,000 digital wallets, approximately half of which are connected to Time.com, according to Grossman — that’s translated into $10 million in profit for TIME, as well as $600,000 generated for various charities.

TIME recently partnered with ethereum-based gaming platform The Sandbox to create a virtual space in the metaverse dubbed TIME Square, which will serve as a central location for the brand to host virtual art and commerce events.

With its $1.5 billion market cap, according to CoinGecko, The Sandbox is among the largest metaverse projects, due in large part to its early adoption of blockchain technology. In November, a virtual plot in The Sandbox set the record for the highest-valued digital land sale when metaverse developer Republic Realm paid $4.3 million to purchase a digital parcel from Atari.

Investors have been quick to assert that long-term value in digital assets will come from their utility. It’s a message that’s been difficult for institutional investors to digest as collectible artwork, such as the prominent Bored Ape Yacht Club, which took center stage in the early days of NFTs, and equally-hyped Crypto Punks, recently saw prices fall precipitously.

“As this new technology was getting adapted, one camp emerged around the notion of building a community that had a set of values and principles,” Grossman said. “And another emerged around what I would call ‘greed-based communities.’”

Getting past greed-based communities

Vitalik Buterin, who co-created ethereum in 2013, recently said in an interview with TIME that he is worried about trends he has observed in the space, telling the publication that “crypto itself has a lot of dystopian potential if implemented wrong.”

“The peril is you have these $3 million monkeys and it becomes a different kind of gambling,” Buterin said.

Speaking at a recent TechCrunch talk, Bill Gates described the crypto and NFT phenomenon as something that’s “100% based on greater fool theory,” referring to the idea that overvalued assets will go up in price when there are enough investors willing to pay more for them. The billionaire Microsoft co-founder joked that “expensive digital images of monkeys” would “improve the world immensely.”

The crypto industry has experienced steep cuts in valuation for currencies and metaverse projects since reaching all-time highs in November 2021, according to CoinGecko. Cryptocurrencies have seen $2 trillion in value erased. It estimates the metaverse sector to currently be worth over $6 billion.

Adding to broader crypto concerns, Celsius, a crypto lending platform that promised high yields to users who deposited their cryptocurrency, recently filed for Chapter 11 bankruptcy protection. Meanwhile, OpenSea — the world’s largest NFT marketplace and home for TIMEPieces token listings — announced on Thursday that it’s cutting its workforce by 20%.

“Forget Bored Apes for a second,” Grossman told CNBC. “When you move out of the collectible space and focus on the community [of creators and artists] ...the tokens not only allow you to verify ownership, but it allows them to affix a royalty on future sales.”

“What you’re seeing right now, as the markets are sort of unstable and correcting themselves, is that the greed-based communities without liquidity in the system, are not really performing with the expectations of the members in those communities,” Grossman said.

Turning online renters into brand owners

The past decade of technology saw the value created in the world of Web2 accrue to tech giants instead of creators, said Avery Akkineni, president of NFT consulting firm Vayner3. Blockchain allows there to be a more decentralized method of payments, incentives and rewards, which she said, “I think we’ll see play into media.”

“For enterprises, there’s never been a better time to launch a product that’s free, or very low cost, that allows your community to participate without a very high barrier to entry price point,” Akkineni said in a May interview from Gary Vaynerchuk’s VeeCon in Minneapolis.

Mathew Sweezey, director of market strategy at Salesforce — Salesforce co-founder and co-CEO Marc Benioff owns Time — said in a blog post that 2022 would be the year “pioneering brands will search for utility via NFTs,” and he referred to Time’s project as a “great example.”

Big brands from every industry, including Coca-Cola, McDonald’s, Nike, Gucci and the National Football League, have brought NFTs into their marketing initiatives.

Many analysts say TIME’s move into the metaverse heralds good opportunities ahead. “The more mainstream brands we can get transitioning into Web3, the quicker we can reach mass adoption,” Kieran Warwick, co-founder of metaverse game Illuvium, told The Defiant. “Partnering with The Sandbox is massive news for anyone in the space.”

“Media companies, for years, have looked at consumers and said ‘you’re a renter on my platform and I’ll give you access to portraying your identity on Facebook or Twitter or Instagram or the like, and in return, I’m going to extract your data,’” Grossman said. “What an NFT actually does behind the scenes is it allows consumers to own an asset, so you move from being an online renter to an online owner ... and not actually say who they are from a personally identifiable aspect.”

It’s not just Time within the legacy media industry. The Associated Press and the New York Times have also launched their own NFT collections in the past year. But Grossman’s strategy is underpinned by the thesis that online identity is just as important as physical identity.

“In September 2020, I started getting really fascinated with the crypto space from a personal perspective, because I kept hearing everyone say there’s going to be no inflation, and yet, everyone was just pumping money into the system to try and stave off Covid,” Grossman said. “That equation didn’t make sense to me.”

Covid played a big role in the NFT boom. Last year, the total value of NFT transactions reached $17.6 billion, according to a study from NonFungible and BNP Paribas-affiliated research firm L’Atelier, up from $250 million the previous year and fueled by a boom in many asset markets during the pandemic as stay-at-home restrictions resulted in people spending a lot more of their time on the internet and building more cash savings.

In February 2021, a crypto art rendition of the Nyan Cat meme from 2011 sold for about $590,000 in an online auction. Grossman said it caught the attention of Benioff, who appointed Grossman as the publication’s first president since acquiring it from Meredith Corp. for $190 million in 2018.

“And that’s when everything clicked,” Grossman said, adding that, for Time, it was a natural extension of the brand’s red-frame cover stories. “I said that within 30 days, we would start accepting cryptocurrency for digital payments. Today we accept 33 cryptocurrencies for digital subscriptions. ... And then I said within six months, we will figure out how to use a token and a blockchain to change the relationship of a consumer with our brand,” Grossman added. “To be honest, I had no clue how we were going to do that. I just knew it was possible.”

The demographics of Time platforms are varied. According to Grossman, the average reader of TIME magazine is a 50-year-old male; the reader of Time.com is a 40-year-old female; 62% of the engagers on TIME’s social feeds are under the age of 35, and one-third outside the U.S.

In the case of NFTs, “it’s small; it’s like a psychographic of people who weren’t thinking about Time before, but all of a sudden like the brand,” Grossman said.

The average price point for a digital subscription to Time.com is about $24, but the average TIMEPieces NFT is about $1,000.

“At the end of the day, we’re able to have just as strong a relationship with the consumer, if not stronger, through community building, than when we sell a $24 subscription,” he said. “Outside of the [Time] name and outside of a tiny logo in the corner, the hero is always the creator. They have a huge following and are uplifted by their community ... TIMEPieces comes in and says ‘we want you to be a part of this,’ we’re validating the creator and their community ... with the heft of our nearly 100 years of legacy and trust.”

While prominent investors continue to be believers in the long-term potential of digital assets, there are plenty of skeptics.

“I think there’s a lot of hesitancy in terms of not understanding why this wave of digital asset ownership matters,” Akkineni said. “It’s incredible how many [CEOs] are actually taking the time to spend learning, both from a business building perspective and a community building perspective, as well as a consumer engagement perspective.”

The surge in NFTs is still fairly new, but massive amounts of money have already exchanged hands among collectors. Since 2017, for example, NFT collectibles have generated over $6.2 billion in sales while digital art has generated over $1.9 billion, according to NonFungible, which tracks historical sales data of NFTs.

Ultimately, moving the technology beyond the NFT is the goal, according to Grossman, who is most bullish on the underlying concept.

“It wasn’t until Steve Jobs held up the iPod and said we’d have ‘1,000 songs in our pocket,’ that people stopped thinking about the technology and started thinking about what the experience is,” Grossman said. “In my opinion, for mass adoption, the technology has to become invisible. In this early stage [of NFTs], the technology is leading the conversation and the word NFT should disappear from the lexicon. It should literally go into the background and all the token should be doing is providing the online verification behind the experience.”

“For that to happen, you need a lot of friction to come out of the system,” he added.

What’s All the Hype About the Metaverse?

Trapped in the Metaverse: Here’s What 24 Hours in VR Feels Like | WSJ (youtube)

Brian X. Chen, Jan. 18, 2022

https://www.nytimes.com/2022/01/18/technology/personaltech/metaverse-gaming-definition.html

The term “metaverse” is everywhere.

On Tuesday, Microsoft cited the so-called metaverse as a reason for acquiring the game developer Activision Blizzard for $68.7 billion, saying the deal would provide “building blocks for the metaverse.” Facebook’s founder, Mark Zuckerberg, has also bet on the metaverse and renamed his social networking company Meta. Google has worked on metaverse-related technology for years. And Apple has its own related devices in the works.

But what does the metaverse really mean, and does it even exist? Here’s what you need to know.

What is the metaverse, anyway?

The metaverse is the convergence of two ideas that have been around for many years: virtual reality and a digital second life.

For decades, technologists have dreamed of an era when our virtual lives play as important a role as our physical realities. In theory, we would spend lots of time interacting with our friends and colleagues in virtual space. As a result, we would spend money there, too, on outfits and objects for our digital avatars.

In what techies like Mr. Zuckerberg call the metaverse, virtual reality serves as a computing platform for living a second life online. In virtual reality, you wear a headset that immerses you in a 3-D environment. You carry motion-sensing controllers to interact with virtual objects and use a microphone to communicate with others.

Matthew Ball, a venture capitalist who has written extensively about the topic, said the metaverse represented the fourth wave to computers, following mainframe computing, personal computing and mobile computing.

What Is the Metaverse, and Why Does It Matter?

The origins. The word “metaverse” describes a fully realized digital world that exists beyond the one in which we live. It was coined by Neal Stephenson in his 1992 novel “Snow Crash,” and the concept was further explored by Ernest Cline in his novel “Ready Player One.”

An expanding universe. The metaverse appears to have gained momentum during the online-everything shift of the pandemic. The term today refers to a variety of experiences, environments and assets that exist in the virtual space.

Some examples. Video games in which players can build their own worlds have metaverse tendencies, as does most social media. If you own a non-fungible token, virtual-reality headset or some cryptocurrency, you’re also part of the metaversal experience.

How Big Tech is shifting. Facebook staked its claim to the metaverse last year, after shipping 10 million of its virtual-reality headsets and announcing it had renamed itself Meta. Google, Microsoft and Apple have all been working on metaverse-related technology.

The future. Many people in tech believe the metaverse will herald an era in which our virtual lives will play as important a role as our physical realities. Some experts warn that it could still turn out to be a fad or even dangerous.

“It’s moving into what people call ambient computing,” he said about the metaverse. “It’s about being within the computer rather than accessing the computer. It’s about being always online rather than always having access to an online world.”

That’s it? It’s you and your avatar interacting with others in a digital environment?

To put it simply, yes.

Does the metaverse already exist in gaming?

To some extent, there is already a metaverse in games. But — and it’s an important but — it’s rudimentary.

Some social elements of the metaverse can already be found in video games. Consider Fortnite, an online shooter game played on computers, game consoles and mobile devices. The average Fortnite player spends hundreds of hours in the game with a personal avatar, fighting with and interacting with the avatars of other players. Players also accrue virtual currency that unlocks outfits and other goodies to customize their avatars.

A precursor to the metaverse could also be found in Second Life, an online social platform developed by Linden Lab nearly two decades ago, where people created digital representations of themselves to socialize with others. In the virtual space, users could shop and build property to enrich their virtual lives.

Virtual reality is also somewhat advanced in video games. In 2016, Sony released the $400 PlayStation VR, a virtual reality headset that plugged into its PlayStation 4 console to play virtual reality games. This month, Sony said a second-generation headset was coming for the PlayStation 5, though it did not share a release date.

But those were just steppingstones toward the complete metaverse, which is still taking shape. Technologists say that thanks to a number of things — fast internet connections, powerful virtual reality headsets and a large audience of gamers — it is now more possible to live in a richly animated, lifelike 3-D simulation.

“It’s only in the last few years that a critical mass of working pieces has come together,” Mr. Ball said.

What does Activision Blizzard build for the metaverse?

Truth be told, not too much.

Activision Blizzard is well known for making online games that have a metaverse component, where players spent hundreds of hours forming communities within the games. In its role-playing game World of Warcraft, released in 2004, gamers worked together online to complete quests in an effort to make their digital avatars stronger by collecting items like weapons and armors.

But the company has not dabbled in virtual reality. It has primarily made games for personal computers and game consoles but has yet to release a virtual reality game.

What is Microsoft building for the metaverse?

So far, Microsoft’s work on the metaverse has been nascent.

For several years, the software giant has developed the HoloLens, a $3,500 headset that shows digital holograms, with a focus on applications for businesses and government agencies. The device is related to augmented reality, which some technologists consider to be part of the future metaverse.

Microsoft is also the developer of the Xbox, the second most popular game console after the Sony PlayStation. But unlike the PlayStation, the Xbox has been conspicuously absent from the virtual reality gaming space.

Bitcoin was supposed to hedge against inflation—here’s why it hasn’t worked that way

Published Fri, Jul 8 20223:57 PM EDT, Mike Winters

https://www.cnbc.com/2022/07/08/why-bitcoin-doesnt-seem-to-be-a-hedge-against-inflation.html#:~:text=The%20value%20of%20the%20cryptocurrency,%2421%2C833%2C%20according%20to%20Coin%20Metrics.

Bitcoin is not mature enough to be used as inflation hedge, says Anthony Scaramucci (youtube, CNBC)

Bitcoin has plunged in value this year, weakening the argument often made by crypto enthusiasts that it can be an effective hedge against inflation during times of economic turmoil.

Bitcoin advocates have long argued that its scarcity would protect its value during times of rising inflation. Unlike central banks — which can increase the supply of money — there are a fixed number of coins, which keeps them scarce.

Even before the market crashed, there was debate about whether or not bitcoin would hold its value. Billionaire investor Paul Tudor Jones was bullish on bitcoin as an inflation hedge, while Dallas Mavericks owner and investor Mark Cuban dismissed the idea as a “marketing slogan.”

Another argument is that bitcoin, along with other similar cryptocurrencies, will have an intrinsic store of value over time as it becomes more accepted, like gold. Supporters believe it will be seen as an asset that won’t depreciate over time.

However, this has not been proven to be true, at least not yet. The value of the cryptocurrency market overall has plummeted alongside rising inflation, with bitcoin losing half of its value since January. As of Friday, the price of bitcoin is $21,833, according to Coin Metrics.

With crypto, “the extent of [price] volatility is so significant, it’s very hard for me to view it as a long-term store of value,” Anjali Jariwala, certified financial planner and founder of Fit Advisors, tells CNBC Make It.

Jariwala says that crypto in general is a new type of asset that doesn’t yet function either as a sought-after commodity like gold, or even as a currency, “because it’s not easily exchanged for a good or service.” Despite its scarcity, the price of a cryptocurrency like bitcoin is still based largely on consumer sentiment, she says.

“It’s tricky because it’s supposed to act like a currency, it’s taxed like property and some people compare it to a commodity. At the end of the day, it really is its own asset class that doesn’t have a pure definition.”

Another consideration is that cryptocurrencies like bitcoin have only been around for just over a decade. Because of this, “there isn’t enough history there in terms of historical data to really understand what purpose it serves as an investment,” Jariwala says.

While cryptocurrencies like bitcoin are “not proven” to be a reliable, long-term store of value, they could still gain acceptance over time and become less volatile, Omid Malekan, an adjunct professor at Columbia Business School specializing in crypto and blockchain technology, tells CNBC Make It.

“Once volatility smooths out, we will have a better picture of how it responds to macro developments, like the rate of inflation or what the Fed is doing,” he says, cautioning that current crypto prices could reflect all sorts of inputs aside from inflation, like too many overleveraged cryptocurrency lenders or a lack of regulation.

Either way, crypto as a whole remains a highly speculative investment. Jariwala recommends only investing with money you’re prepared to lose. She also says to think of crypto investing as a long-term strategy and “stick to that strategy even during times like this.”

Cryptocurrency might evolve into a more mature asset that can be a hedge against inflation. But “we just don’t know yet, until we see more of a track history with it,” says Jariwala. ‘

Digital Currency: The Future Of Your Money

David Rodeck, Courtney Reilly Larke, Aug 16, 2022, 1:37pm

https://www.forbes.com/advisor/ca/investing/digital-currency/

Why central banks want to launch digital currencies | CNBC Reports (Youtube)

What Is Digital Currency?

Digital currency is any currency that’s available exclusively in electronic form. Electronic versions of currency already predominate most countries’ financial systems. In Canada, for instance, the physical Canadian currency in circulation is less than 5% of the overall money supply; the remainder is held as commercial bank deposits that translate as data points on spreadsheets and other records tracking transactions among people and businesses.

What differentiates digital currency from the electronic currency currently in most bank accounts is that it never takes physical form. Right now, you could go to an ATM and turn an electronic record of your currency holdings into physical dollars. Digital currency, however, never takes physical form. It always remains on a computer network and is exchanged via digital means.

For example, instead of using physical dollar bills, you’d make purchases by transferring digital currency to retailers using your mobile device. Functionally, this may be no different than how you currently treat your money using payment apps like Wealthsimple Cash, Paypal or Apple Pay.

Following the successful launch of decentralized cryptocurrencies like Bitcoin and Ethereum, which store value but are not managed by any central authorities, governments and central banks around the world are researching the possibility of creating their own digital currencies, commonly known as central bank digital currencies.

What Is a Central Bank Digital Currency (CBDC)?

A central bank digital currency (CBDC) is a digital currency that would be issued and overseen by a country’s central bank. Think of it like Bitcoin, but if Bitcoin were managed by the Bank of Canada and had the full backing of the Canadian government.

As of 2022, only a handful of countries and territories have a CBDC and many more are exploring central bank digital currencies or have plans to issue them. Some places CBDC is already available include the Central Bank of The Bahamas (Sand Dollar), the Eastern Caribbean Central Bank (DCash), the Central Bank of Nigeria (e-Naira) and the Bank of Jamaica (JamDex).

Are their plans for CBDC in Canada?

Canada’s central bank, the Bank of Canada, has stated that they do not have plans to issue a digital currency any time soon. That said, they are researching digital currency systems and business models while working on building the capability to issue a digital version of the Canadian dollar (a CBDC).

Still, the final say on whether or not Canada will have a CBDC (and when it will be issued) is up to Parliament and the Government of Canada.

How Would a CBDC Work?

While an Canadian CBDC may be far off currently, Jim Cunha, senior vice president at the Federal Reserve Bank of Boston, shared how a CBDC or a digital dollar might work across the border in the U.S. A CBDC would function similar to actual cash, Cunha said. “If I gave you CBDC, it’s as if I’m handing you physical money, like a $100 bill. You’d have that money in your account and it’s yours. I couldn’t take it back.”

This is a key difference versus other forms of electronic payment today, such as PayPal. “If I send you money through PayPal, it’s just a promise that money is coming. Your balance may show the funds, but money hasn’t actually moved between banks yet.”

Because of that, the transactions are not irrevocable and it’s possible for the other party to reverse; there are 60 days when an ACH transfer can be potentially unwound. With transfers through CBDC, the funds would be sent close to instantly and the other party couldn’t cancel after.

Another key advantage of a CBDC is that it could be deemed legal tender. That means all economic actors must accept it for any legal purposes. “You could pay your taxes with it. Anyone you owe debt to, like the bank or individuals, legally are required to take it,” Cunha said.

This is in contrast to other digital currencies, which are not legal tender. Only certain vendors accept crypto directly, so people may need to convert their cryptocurrency into U.S. or Canadian dollars before making most transactions. When you use crypto as a form of payment, you also currently create a taxable event, which means you may owe capital gains taxes each time you purchase something with Bitcoin or Ether. This is in addition to any sales taxes. With a CBDC, you would only owe any applicable sales taxes, just like you do using physical currency.

How Have Digital Currencies Worked Around the World?

Despite the potential benefits of a Canadian CBDC, it still remains a concept for now. Around the world, other countries are a little further along with digital currencies such as the Bahamas’ Sand Dollar, which launched in October 2020, and China’s digital yuan, which is one of the largest CBDC programs, launching a pilot project in 2014.

“They are testing a pilot in five cities. They gave out millions in currency through lotteries just to prove it works,” said Cunha. People who win the lottery receive free CBDC, which they can spend at local shops that accept it.

While it’s not at national scale yet, once China has the platform ready, it will expand through banks and mobile providers, like Alipay. The central banks of China and UAE are also working on a project to use blockchain and CBDC for regional payments between nations. If these projects are a success, they could give more motivation for other nations to create their own CBDC.

Because of these trends, Lilya Tessler, head of Sidley’s FinTech and Blockchain group, is optimistic about the future use of digital currencies. “We certainly will see mass adoption of digital currencies, but it is difficult to predict how it will look. A CBDC may replace the paper version of the U.S. dollar. At the same time, society may focus on mainstream adoption of a decentralized cryptocurrency.”

Digital Currency Benefits

· Faster payments. Using digital currency you can complete payments much faster than current means, like electronic fund transfers or wire transfers, which can take days for financial institutions to confirm a transaction.

· Less expensive international transfers. International currency transactions are very expensive; individuals are charged high fees to move funds from one country to another, especially when it involves currency conversions. “Digital assets are disrupting this marketing by making it faster and less costly,” said Andrew Kiguel, CEO of Tokens.com.

· 24/7 access. Existing money transfers often take more time during weekends and outside normal business hours because banks are closed and can’t confirm transactions. With digital currency, transactions work at the same speed 24 hours a day, seven days a week.

· Support for the unbanked and underbanked. It’s estimated 10% to 20% of Canadians are either unbanked or underbanked, meaning they have limited access to everyday banking service. They end up paying costly fees to cash their paycheques and send payments to others through money orders or remittances. If Canada launched a CBDC, unbanked individuals could access their money and pay their bills without extra charges.

· More efficient government payments. If the government developed a CBDC, it could send payments like tax refunds and child benefits to people instantly, rather than trying to mail them a cheque or using other methods.

Digital Currency Disadvantages

· Too many currencies to navigate at the moment. The current popularity of cryptocurrency is actually a downside. “There are so many digital currencies being created across different blockchains that all have their own limitations. It will take time to determine which digital currencies may be appropriate for certain use cases, including whether some are designed to scale for mass adoption,” said Tessler.

· Takes effort to learn how to use them. Digital currencies require work on the part of the user to learn how to perform fundamental tasks, like how to open a digital wallet and properly store digital assets securely. For digital currencies to be more widely adopted, the system needs to get simpler.

· Blockchain transactions can be expensive. Cryptocurrencies use the blockchain, where computers must solve complex equations to verify and record transactions. This takes considerable electricity and gets more expensive as there are more transactions. These would probably not exist for a CBDC, however, since it would likely be controlled by the central bank and the complex consensus processes are not needed.

· Large swings in digital currency prices. Cryptocurrency prices and value can change suddenly. Cunha believes this is why businesses are reluctant to use it as a medium of exchange. “As a business, do I want to accept something that’s volatile? What if I hold a Bitcoin for a week and it loses 20% of value?” With CBDC, though, the value is much stabler, like paper currency, and cannot fluctuate like this.

· Developing a CBDC will take time and tax dollars. A Canadian CBDC is still hypothetical. If the government decides to create one, there will be costs associated with its development.

How Would Digital Currency Affect You?

If Canada adopts a digital currency, it would work as an alternative to cash but would also have the built-in advantage of quick money transfer since it’s electronic. Cunha has a few ideas on what a similar digital currency for U.S. currency would look like for consumers across the border. “Our presumption is that it will be free or near free, like cash. Other private sector players may innovate on top of it and possibly add fees, but that has to be fleshed out more.”

Even though a digital currency would be electronic, it still needs to be as accessible as cash. “Anyone should be able use it, not just those with the latest smartphones,” Cunha said, suggesting chip-based cards, POS systems and web accounts as alternative ways to access the CBDC. He also believes a way to handle transactions offline will need to be developed, so two people could exchange CBDC even if they aren’t on a cell or wifi network.

There’s a lot to be done and a lot of industry input needed, Cunha admits, but it could be well worth the investment. “While no decision has been made to move past this research, I truly believe a CBDC should be fully investigated and holds great potential,” he said. “Just think of the internet and how far it’s come since the early days. With CBDC, the possibilities are endless.”

Homework of blockchiain, NFT, Metaverse, Crypto Currency and Inflation, CBDC

· Briefly describe what is blockchain.

· How does blockchain work with bitcoin?

· What is NFT? What is Metaverse? Are they worth investing in?

· Is Bitboin a hedge again inflation? Why or why not?

· What is CBDC? Do you support CBDC? Why or why not?

· Optional question: What is Luna coin and what caused it to fail? The Rise and Fall of Terra Luna. The Terra Luna Crash Explained (youtube)

· Optional question: Could digital currencies put banks out of business? What is your opinion? Please refer to the video | The Economist (video)

· Optional question: What is Web3? Is there a future in Web3?

https://101blockchains.com/future-of-web3/

What Is Web3, and Is It the Future?(youtube)

Why People Love Dogecoin’—Elon Musk Reveals One Surprise Reason Behind His Support For The ‘Joke’ Bitcoin Rival Amid Crypto Price Crash

How Dogecoin works - Tech Explained (youtube)

Elon Musk Facing $258 Billion Lawsuit Over Alleged Dogecoin Pyramid Scheme (youtube, CNBC)

Billy BambroughSenior Contributor,May 31, 2022,07:15pm EDT

https://www.forbes.com/sites/billybambrough/2022/05/31/why-people-love-dogecoin-elon-musk-reveals-one-surprise-reason-behind-his-support-for-the-joke-bitcoin-rival-amid-price-crash/?sh=ed823d9714d2

Tesla billionaire Elon Musk has repeatedly given his support to the meme-based bitcoin rival dogecoin over the last few years—helping its price to soar while mocking legendary investor Warren Buffett.

The dogecoin price has, however, crashed dramatically from its 2021 peak, falling along with bitcoin and other cryptocurrencies as a brutal crypto crash sparks fears of a "price spiral."

Now, Elon Musk, who has increasingly become embroiled in Twitter rows since his bid to take the company private was announced in April, has revealed one reason he thinks "people love dogecoin."

"Billy’s sense of humor and irreverence is a big part of why people love dogecoin," Musk posted to Twitter, replying to dogecoin co-creator Billy Markus after dogecoin's other co-creator, Jackson Palmer, launched a scathing attack on Musk, accusing him of being a "grifter."

"Palmer always forgets to mention that he never wrote a single line of dogecoin code," Musk shot back, with Markus adding, "the people after us did exponentially more than either Jackson or I did on the code base." Markus and Palmer created dogecoin, which is loosely based on a fork of bitcoin, as "a joke" that used the doge meme as inspiration.

Through early 2021 dogecoin attracted huge attention, helped on by Musk and other high-profile backers such as billionaire Mark Cuban, becoming a top ten cryptocurrency as traders piled into the memecoin. It reached a market capitalization of almost $90 billion in early May 2021. The dogecoin price has since crashed back, with its market cap falling to under $10 billion.

This week, Palmer, an outspoken crypto critic, lashed out against the crypto space, saying he thought it "would implode a bit more quickly and people would learn their lesson."

Palmer, speaking to Australia's Crikey to promote his new Griftonomics podcast, said he wishes "it was the end of crypto, but it’s not," and that "increasingly people are doing nothing but making money off doing nothing, it’s kind of fucked us all up."

Palmer also said he messaged Musk via Twitter years ago with details of a code script he claimed could detect and automatically report Twitter cryptocurrency scams. "It became apparent very quickly that [Musk] didn’t understand coding as well as he made out," Palmer said.

Musk has repeatedly railed against Twitter bots and crypto scams on the platform, accusing Twitter of underplaying the number of fake accounts and putting his bid to take the company private "temporarily on hold" until Twitter provides evidence of its assertion that fewer than 5% of its users were spam or fake accounts.

Last week, Musk announced his rocket company SpaceX will follow Tesla in accepting dogecoin for merchandise, temporariliy boosting the dogecoin price. Tesla began accepting dogecoin for merchandise purchases in January.

Tesla last year briefly began accepting bitcoin for car purchases but Musk pulled the plug just two months later, blaming bitcoin's high energy demands and carbon footprint. Musk went onto say Tesla would most likely restart accepting bitcoin though it hasn't done so yet.

What is ethereum, and how does it work? (youtube, CNBC)

Chapter 2 What is Money

Ppt

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.)

Type of money	M0	MB	M1	M2	M3
Notes and coins in circulation (outside Federal Reserve Banks and the vaults of depository institutions) (currency)	✓	✓	✓	✓	✓
Notes and coins in bank vaults (Vault cash)		✓
Federal Reserve Bank credit (required reserves and excess reserves not physically present in banks)		✓
Traveler’s checks of non-bank issuers			✓	✓	✓
Demand deposits			✓	✓	✓
Other checkable deposits (OCDs)			✓	✓	✓
Savings deposits				✓	✓
Time deposits less than $100,000 and money market deposit accounts for individuals				✓	✓
Large time deposits, institutional money market funds, short-term repurchase and other larger liquid assets					✓
All money market funds

· M0: In some countries, such as the United Kingdom, M0 includes bank reserves, so M0 is referred to as the monetary base, or narrow money.

· MB: is referred to as the monetary base or total currency. This is the base from which other forms of money (like checking deposits, listed below) are created and is traditionally the most liquid measure of the money supply.

· M1: Bank reserves are not included in M1. (M1 and Components @ Fed St. Louise website)

· M2: Represents M1 and "close substitutes" for M1. M2 is a broader classification of money than M1. M2 is a key economic indicator used to forecast inflation.(M2 and components @ Fed St. Louise website)

· M3: M2 plus large and long-term deposits. Since 2006, M3 is no longer published by the US central bank. However, there are still estimates produced by various private institutions. (M3 and components at Fed St. Louise website)

Let’s watch this money supply video: Khan academy money supply M0, M1, M2 (video)

Draw Me The Economy: Money Supply (video)

For discussion:

What could happen if we increase money supply?
What about reduce money supply?
What are the possible ways to reduce money supply?
Among M0, M1, M2, M3, which one is the correct measure of money?
Why M2 is >> M0?
Why does M2 increase much faster than M1? Does it has any impact on you?

FYI: Fed balance sheet https://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm

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:

Among M0, M1, and M2, which one is used as a measure for money supply in US?
Why is M2 multiple times of Mo?
What are the expected consequences resulted from a big increase in money supply?
What happens when money supply reduces?
Do you think that US$ will devalue in the near future?
Is a strong $ better than a weak $?

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

Related	Last	Previous	Unit	Reference
Interest Rate	2.50	1.75	percent	Jul 2022
Money Supply M1	20514.70	20545.40	USD Billion	Jul 2022
Money Supply M0	5536900.00	5506500.00	USD Million	Jul 2022
Money Supply M2	21709.20	21667.50	USD Billion	Jul 2022
Central Bank Balance Sheet	8849762.00	8879138.00	USD Million	Aug 2022
Banks Balance Sheet	22882.40	22773.30	USD Billion	Aug 2022
Foreign Exchange Reserves	35947.00	36273.00	USD Million	Jul 2022
Loans to Private Sector	2704.00	2661.89	USD Billion	Jul 2022
Repo Rate	2.31	2.31		Aug 2022

https://tradingeconomics.com/united-states/money-supply-m0

https://tradingeconomics.com/united-states/money-supply-m1

https://tradingeconomics.com/united-states/money-supply-m2

From https://www.federalreserve.gov/releases/h6/current/default.htm

te	Seasonally adjusted		Not seasonally adjusted
	M1 ¹	M2 ²	Monetary base			M1 ¹	M2 ²	Memorandum: Reserves
	M1 ¹	M2 ²	Currency in circulation ³	Reserve balances ⁴	Monetary base ⁵	M1 ¹	M2 ²	Total reserves ⁶	Total ($M) borrowings ⁷	Nonborrowed reserves ⁸
Mar. 2021	18,641.4	19,853.8	2,117.8	3,721.3	5,839.0	18,721.3	19,946.3	3,721.3	57,950.3	3,663.3
Apr. 2021	18,927.5	20,110.6	2,154.8	3,887.3	6,042.1	19,085.6	20,270.1	3,887.3	66,805.2	3,820.5
May 2021	19,259.7	20,418.8	2,169.5	3,872.4	6,041.9	19,169.9	20,319.7	3,872.4	80,781.7	3,791.6
June 2021	19,319.7	20,460.3	2,179.0	3,848.1	6,027.0	19,310.5	20,440.8	3,848.1	87,746.0	3,760.3
July 2021	19,497.5	20,620.9	2,186.3	3,943.9	6,130.2	19,459.5	20,571.9	3,943.9	87,621.1	3,856.3
Aug. 2021	19,746.6	20,853.5	2,188.6	4,140.1	6,328.7	19,683.8	20,778.1	4,140.1	80,766.7	4,059.3
Sept. 2021	19,899.0	20,992.5	2,195.6	4,193.2	6,388.8	19,874.2	20,957.9	4,193.2	68,567.7	4,124.6
Oct. 2021	20,063.5	21,143.9	2,202.8	4,128.1	6,330.9	20,021.0	21,098.0	4,128.1	54,558.8	4,073.5
Nov. 2021	20,279.9	21,349.4	2,214.1	4,180.6	6,394.7	20,267.4	21,334.5	4,180.6	45,317.6	4,135.3
Dec. 2021	20,430.7	21,490.1	2,225.2	4,187.9	6,413.1	20,591.3	21,660.4	4,187.9	38,082.2	4,149.9
Jan. 2022	20,585.4	21,649.6	2,232.8	3,871.1	6,103.9	20,549.2	21,636.7	3,871.1	32,055.1	3,839.1
Feb. 2022	20,661.2	21,708.5	2,235.5	3,804.5	6,040.0	20,528.0	21,590.3	3,804.5	28,714.6	3,775.8
Mar. 2022	20,699.1	21,739.8	2,259.8	3,874.7	6,134.5	20,800.8	21,855.8	3,874.7	26,205.8	3,848.5
Apr. 2022	20,615.3	21,655.5	2,269.8	3,615.4	5,885.2	20,817.7	21,860.3	3,615.4	23,960.3	3,591.4
May 2022	20,620.7	21,684.4	2,273.7	3,317.9	5,591.6	20,537.9	21,590.3	3,317.9	21,882.7	3,296.0
June 2022	20,545.0	21,667.3	2,278.1	3,228.4	5,506.5	20,535.3	21,645.1	3,228.4	21,422.5	3,207.0
July 2022	20,514.7	21,709.2	2,278.5	3,258.4	5,536.9	20,470.4	21,651.9	3,258.4	19,541.1	3,238.8

Part II Money Supply, Money Velocy, and Inflation

“The velocity of money is the frequency at which one unit of currency is used to purchase domestically- produced goods and services within a given time period. In other words, it is the number of times one dollar is spent to buy goods and services per unit of time.”--- https://fred.stlouisfed.org/series/M2V#:~:text=The%20velocity%20of%20money%20is,services%20per%20unit%20of%20time

https://fred.stlouisfed.org/series/M2V

What Is the Velocity of Money?

The velocity of money is a measurement of the rate at which money is exchanged in an economy. It is the number of times that money moves from one entity to another. It also refers to how much a unit of currency is used in a given period of time. Simply put, it's the rate at which consumers and businesses in an economy collectively spend money.

The velocity of money is usually measured as a ratio of gross domestic product (GDP) to a country's M1 or M2 money supply.

Velocity of Money = GDP ÷ Money Supply

What Does Velocity of Money Measure?

The velocity of money estimates the movement of money in an economy—in other words, the number of times the average dollar changes hands over a single year. A high velocity of money indicates a bustling economy with strong economic activity, while a low velocity indicates a general reluctance to spend money.

How Do You Calculate the Velocity of Money?

The velocity of money is calculated by dividing a country's gross domestic product by the total supply of money. This calculation can use either the M1 money supply, which includes physical currency, checkable deposits, and certain other figures, or the M2 supply, which also includes savings deposits and money market funds.

Why Is the Velocity of Money So Low?

The velocity of money in the United States fell sharply during the first and second quarters of 2020, as calculated by the St. Louis Federal Reserve Bank. While there is no definitive explanation, the fall is likely due to the diminished activity incurred during the COVID-19 pandemic, as well as an increase in consumer savings due to economic uncertainty. https://www.investopedia.com/terms/v/velocity.asp

The Velocity of Money Explained in One Minute (youtube)

Quantity Theory of Money (youtube)

Quantity theory of money (Khan academy)

Steve Hanke says we’re going to have one ‘whopper’ of a recession in 2023

PUBLISHED MON, AUG 29 202210:28 PM EDT,Abigail Ng

https://www.cnbc.com/2022/08/30/steve-hanke-were-going-to-have-one-whopper-of-a-recession-in-2023.html?__source=google%7Ceditorspicks%7C&par=google

KEY POINTS

• The U.S. economy is going to fall into a recession next year, according to Steve Hanke, a professor of applied economics at Johns Hopkins University, and that’s not necessarily because of higher interest rates.

• “We will have a recession because we’ve had five months of zero M2 growth, money supply growth, and the Fed isn’t even looking at it,” he told CNBC’s “Street Signs Asia” on Monday.

• Meanwhile, inflation is going to remain high because of “unprecedented growth” in money supply in the United States, Hanke said.

The U.S. economy is going to fall into a recession next year, according to Steve Hanke, a professor of applied economics at Johns Hopkins University, and that’s not necessarily because of higher interest rates.

“We will have a recession because we’ve had five months of zero M2 growth, money supply growth, and the Fed isn’t even looking at it,” he told CNBC’s “Street Signs Asia” on Monday.

Market watchers use the broad M2 measure as an indicator of total money supply and future inflation. M2 includes cash, checking and savings deposits and money market securities.

In recent months, money supply has stagnated and that’s likely to lead to an economic slowdown, Hanke warned.

“We’re going to have one whopper of a recession in 2023,” he said.

Meanwhile, inflation is going to remain high because of “unprecedented growth” in money supply in the United States, Hanke said.

Historically, there has never been “sustained inflation” that isn’t the result of excess growth in money supply, and pointed out that money supply in the U.S. saw “unprecedented growth” when Covid began two years ago, he said.

“That is why we are having inflation now, and that’s why, by the way, we will continue to have inflation through 2023 going into probably 2024,” he added.

In 2020, CNBC reported that the growth in money supply could lead to high inflation.

“The bottom line is we’re going to have stagflation — we’re going to have the inflation because of this excess that’s now coming into the system,” he added.

“The problem we have is that the [Fed Chair Jerome Powell] does not understand, even at this point, what the causes of inflation are and were,” Hanke said.

“He’s still going on about supply-side glitches,” he said, adding that “he has failed to tell us that inflation is always caused by excess growth in the money supply, turning the printing presses on.”

Powell, in his policy speech at the annual Jackson Hole economic symposium on Friday, said he views the high inflation in the U.S. as a “product of strong demand and constrained supply, and that the Fed’s tools work principally on aggregate demand.”

‘Sacrificial lamb’

David Rosenberg, president of Rosenberg Research, also expressed skepticism over the Fed’s direction, but in other respects. He said the Fed is now “more than happy” to overtighten to get inflation down quickly.

“Overtighten means that if the economy slips into a recession, you know — so be it,” he told CNBC’s “Squawk Box Asia” on Monday, adding that Powell said this is short-term pain for long-term gain.

He said he’s “a little disappointed” that the central bank is chasing lagging indicators like the unemployment rate and inflation, but that the Fed is “not going to take any chances” after being “thoroughly embarrassed” for calling inflation transitory.

″[Powell] basically said the economy will be, near term, a sacrificial lamb,” Rosenberg said.

“I think this Fed, after being on the wrong side of the call for the past say 12 to 15 months, are going to need to see probably at least six months of intense disinflation in the price data before they call it quits,” he added.

Jerome Powell Is Wrong. Printing Money Causes Inflation.

The Fed chairman insists the growth of M2 doesn’t ‘have important implications.’ The math shows otherwise.

By Steve H. Hanke and Nicholas Hanlon, Feb. 23, 2022 1:07 pm ET

https://www.wsj.com/articles/powell-printing-money-supply-m2-raises-prices-level-inflation-demand-prediction-wage-stagnation-stagflation-federal-reserve-monetary-policy-11645630424

Main Street (11/15/21): "Inflation is just like alcoholism," said economist Milton Friedman. "In both cases...the good effects come first, the bad effects only come later." Could there be a lesson here for Joe Biden?

Federal Reserve Chairman Jerome Powell still believes that inflation and the money supply are unconnected. He first made this remarkable assertion in his Semiannual Monetary Policy Report to Congress last February, saying that “the growth of M2 . . . doesn’t really have important implications for the economic outlook.” Since then, the U.S. annual inflation rate has climbed to 7.5% from 1.7%, but Mr. Powell hasn’t changed his mind. He doubled down during congressional testimony in December, arguing that the connection between money and inflation ended about 40 years ago. The nearby chart shows otherwise.

By turning a blind eye to money, the Fed has allowed the printing presses to run in overdrive. The money supply as measured by M2, which is the Fed’s broadest measure of money in the economy, has been growing at record rates—with 39.9% cumulative growth since February 2020. M2 is still growing at an elevated, inflationary rate of 12.6% a year. Before the pandemic, you’d have to go back to the early 1980s to find a monetary growth rate this high.

One of us, Mr. Hanke, predicted in these pages last July that year-end inflation for 2021 would “be at least 6% and possibly as high as 9%.” That was based on the quantity theory of money, which economic thinkers have used since the Renaissance. The theory rests on a simple identity, the equation of exchange, which demonstrates the link between the money supply and inflation: MV=Py, where M is the money supply, V is the velocity of money (the speed at which it circulates relative to total spending), P is the price level, and y is real gross domestic product. So, the quantity theory of money provides the link between money and inflation.

If Mr. Powell is right and all that is outdated thinking, then when looking back through economic data, the equation of exchange shouldn’t be able to predict prices. But look at the chart. When we took the past 60 years of economic data and the rate-of-change form of the identity we explained above, it predicted price changes almost perfectly. Our estimate deviated from actual inflation only during 2020, as the money supply grew at unprecedented rates and lockdowns stanched real growth. By June 2021, our estimate for inflation based on the quantity theory of money had reverted back to its conjunction with actual inflation.

Money Velocity Is At An All-Time Low. Why Does It Matter?

Forbes Finance Council, Ivan IllanForbes Councils Member

Forbes Finance CouncilCOUNCIL POST| Membership (Fee-Based), Apr 25, 2022,07:00am EDT

https://www.forbes.com/sites/forbesfinancecouncil/2022/04/25/money-velocity-is-at-an-all-time-low-why-does-it-matter/?sh=3100496c3dfa

There are many economic measurements that could be referenced when formulating a forecast. You’re probably familiar with economic data like unemployment figures, Fed funds rate and the inflation rate. Those are important but don’t necessarily tell the whole story on the state of the economy, much less the direction to which things may be headed. In my and my team’s own research, as part of our investment committee decision-making discussions, we often like to seek out more obscure data. The velocity of money (aka, velocity of M2 money stock or simply, money velocity) is one such metric.

Money velocity (MV) isn’t a complicated concept. The Federal Reserve might describe it as the turnover rate of a dollar through the U.S. economy. A higher MV figure means a dollar is cycling through domestic transactions for goods and services more frequently. Conversely, a lower figure would mean the exact opposite, which could indicate a slowing economic backdrop.

Referencing data on MV from the Federal Reserve Bank of St. Louis, you can see something noteworthy. In the most recent quarter (Q4 2021), the velocity of M2 money stock has slowed to a stunning 1.123. Essentially, this means that one USD cycled through the U.S. economy in Q4 2021 about 1.123 times. During the Great Financial Crisis (GFC), MV went from a high of 1.989 at the GFC’s start in Q3 2007 to a low of 1.712 by end of the crisis in Q1 2009. Now surprisingly, MV is 34.4% lower than where it was at coming out of the GFC. This seems troubling.

It’s possible that a declining MV could have been directly attributed to record low interest rates, which resulted from record high growth of money supply. Afterall, the formula for MV is simple: GDP/money supply. Therefore, a huge increase in the denominator naturally results in a lower figure without the same corresponding increase in GDP. If not cycling through transactions, where did all that newly minted money go?

Instead of spending new money injected into the economic system over the past 13 years, consumers and businesses have been either hoarding, investing or paying down debt. Household savings rates spiked during the past couple of years, which resulted in cash hoarding in checking and savings accounts.

Since the GFC, and because of record low interest rates, investors allocated monies toward various asset classes, primarily corporate stock shares and real estate. Households took some of that new money and paid down debt, while corporations took advantage of the low rates and issued record amounts of new debt. U.S. corporations are now sitting atop the highest corporate debt mountain in U.S. history.

Part III What is Fractional Reserve Banking System?

The Money Multiplier (video)

Money creation in a fractional reserve system | Financial sector | AP Macroeconomics | Khan Academy

Fractional Reserve Banking

By JULIA KAGAN Updated August 10, 2022, Reviewed by SOMER ANDERSON

https://www.investopedia.com/terms/f/fractionalreservebanking.asp#:~:text=Fractional%20reserve%20banking%20is%20a,systems%20use%20fractional%20reserve%20banking.

What Is Fractional Reserve Banking?

Fractional reserve banking is a system in which only a fraction of bank deposits are backed by actual cash on hand and available for withdrawal. This is done to theoretically expand the economy by freeing capital for lending. Today, most economies' financial systems use fractional reserve banking.

KEY TAKEAWAYS

· Fractional reserve banking describes a system whereby banks can loan out a certain amount of the deposits that they have on their balance sheets.

· Banks are required to keep on hand a certain amount of the cash that depositors give them, but banks are not required to keep the entire amount on hand.

· Often, banks are required to keep some portion of deposits on hand, which is known as the bank's reserves.

· Some banks are exempt from holding reserves, but all banks are paid a rate of interest on reserves.

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.

Reserve requirements for banks under the Federal Reserve Act were set at 13%, 10%, and 7% (depending on what kind of bank) in 1917. In the 1950s and '60s, the Fed had set the reserve ratio as high as 17.5% for certain banks, and it remained between 8% to 10% throughout much of the 1970s through the 2010s.

During this period, banks with less than $16.3 million in assets were not required to hold reserves. Banks with assets of less than $124.2 million but more than $16.3 million had to have 3% reserves, and those banks with more than $124.2 million in assets had a 10% reserve requirement.

Beginning March 26, 2020, the 10% and 3% required reserve ratios against net transaction deposits was reduced to 0 percent for all banks, essentially removing the reserve requirements altogether.

Prior to the introduction of the Fed in the early 20th century, the National Bank Act of 1863 imposed 25% reserve requirements for U.S. banks under its charge.

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.

What Are the Pros of Fractional Reserve Banking?

Fractional reserve banking permits banks to use funds (i.e., the bulk of deposits) that would be otherwise unused and idle to generate returns in the form of interest rates on new loans—and to make more money available to grow the economy. It is thus able to better allocate capital to where it is most needed.

What Are the Cons of Fractional Reserve Banking?

Fractional reserve banking could catch a bank short of funds on hand in the self-perpetuating panic of a bank run. This occurs when too many depositors demand their cash at the same time, but the bank only has, say 10% of deposits in liquid cash available. 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.

Where Did Fractional Reserve Banking Originate?

Nobody knows for sure when fractional reserve banking originated, but it is certainly not a modern innovation. Goldsmiths during the Middle Ages were thought to issue demand receipts for gold on hand that exceeded the amount of physical gold they had under custody, knowing that on any given day only a small fraction of that gold would be demanded.

In 1668, Sweden's Riksbank introduced the first instance of modern fractional reserve banking.

Example: You deposited $1,000 in a local bank

Iteration #	Deposited	=	Reserves	+	Available to Lend	Bank
Iteration #	Deposited	=	Reserves	+	Available to Lend	Lends to
1. A	1,000.00	=	100	+	900	A
2. B	900	=	90	+	810	B
3. C	810	=	81	+	729	C
4. D	729	=	72.9	+	656.1	D
And the cycle continues…

Excel Template (FYI) – Fractional reserve banking

Iteration #	Deposited by	Amount Held	Amount	Total Amount that	Total Amount that	Total Amount	Total Amount that
	Customer	in Reserve	Currently	“Can” be	Has Been	Held in Reserve	Customers Believe
		from Deposit	Available to	Lent Out	Lent Out		They Have
			Lend Out
			from Deposit
1	1,000.00	100	900	900	0	100	1,000.00
2	900	90	810	1,710.00	900	190	1,900.00
3	810	81	729	2,439.00	1,710.00	271	2,710.00
4	729	72.9	656.1	3,095.10	2,439.00	343.9	3,439.00
5	656.1	65.61	590.49	3,685.59	3,095.10	409.51	4,095.10
6	590.49	59.05	531.44	4,217.03	3,685.59	468.56	4,685.59
7	531.44	53.14	478.3	4,695.33	4,217.03	521.7	5,217.03
8	478.3	47.83	430.47	5,125.80	4,695.33	569.53	5,695.33
9	430.47	43.05	387.42	5,513.22	5,125.80	612.58	6,125.80
10	387.42	38.74	348.68	5,861.89	5,513.22	651.32	6,513.22
….

Weaknesses of fractional reserve lending (khan academy)

Homework of chapter 2 (due with first mid term)

1. 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?

2. From Fed St. Louis website, find the most recent charts of M1 money stock and M2 money stock.

a. http://research.stlouisfed.org/fred2/categories/24

b. Compare the two charts and discuss the differences between the two charts.

3. What is fractional banking system?

4. 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? Template here FYI

5. What is Money velocity? Briefly explain the relationship between money velocity and inflation?

6. Briefly explain the relationship between money supply and inflation?

Money Multiplier and Reserve Ratio

19 June 2018 by Tejvan Pettinger

https://www.economicshelp.org/blog/67/money/money-multiplier-and-reserve-ratio-in-us/

money-multiplier-definition

The Money Multiplier refers to how an initial deposit can lead to a bigger final increase in the total money supply.

For example, if the commercial banks gain deposits of £1 million and this leads to a final money supply of £10 million. The money multiplier is 10.

The money multiplier is a key element of the fractional banking system.

There is an initial increase in bank deposits (monetary base)
The bank holds a fraction of this deposit in reserves and then lends out the rest.
This bank loan will, in turn, be re-deposited in banks allowing a further increase in bank lending and a further increase in the money supply.

The Reserve Ratio

The reserve ratio is the % of deposits that banks keep in liquid reserves.

For example 10% or 20%

Formula for money multiplier

money-multiplier-formula

In theory, we can predict the size of the money multiplier by knowing the reserve ratio.

If you had a reserve ratio of 5%. You would expect a money multiplier of 1/0.05 = 20
This is because if you have deposits of £1 million and a reserve ratio of 5%. You can effectively lend out £20 million.

Example of money multiplier

Suppose banks keep a reserve ratio of 10%. (0.1)
Therefore, if someone deposits $100, the bank will keep $10 as reserves and lend out $90.
However, because $90 has been lent out – other banks will see future deposits of $90.
Therefore, the process of lending out deposits can start again.

Note: This example stops at stage 10. In theory, the process can continue for a long time until deposits are fractionally very small.

money-multiplier-graph

If allowed to repeat for an infinite number of times, the final total deposits would be $1,000
Money multiplier = 1/0.1 = 10.
Final increase in money supply = 10 x $100 = $1,000

Using the Reserve ratio to influence monetary policy

In theory, if a Central Bank demands a higher reserve ratio – it should have the effect of acting like deflationary monetary policy. A higher reserve ratio should reduce bank lending and therefore reduce the money supply.

Money Multiplier in the real world

In a simple theory of the money multiplier, it is assumed that if the bank lends $90 – all of this will return. However, in the real world, there are many reasons why the actual money multiplier is significantly smaller than the theoretically possible money multiplier.

Import spending. If consumers buy imports the money leaves the economy
Taxes. A percentage of income will be taken in taxes.
Savings. Not all money is spent and circulated, a significant percentage will be saved
Currency Drain Ratio. This is the % of banknotes that individual consumers keep in cash, rather than depositing in banks. If consumers deposited all their cash in banks, there would be a bigger money multiplier. But, if people keep funds in cash then the banks cannot lend more
Bad loans. A bank may lend out $90 but the company goes bankrupt and so this is never deposited bank into the banking system.
Safety reserve ratio. This is the % of deposits a bank may like to keep above the statutory reserve ratio. i.e. the required reserve ratio may be 5%, but banks may like to keep 5.2%.
It might not be possible to lend more money out. Just because banks could lend 95% of their deposits doesn’t mean they can, even if they wanted to. In a recession, people may not want to borrow, but they prefer to save.
Banks may not want to lend Also, at various times, the banks may not want to lend, e.g. during a recession they feel firms and individuals more likely to default. Therefore, the banks end up with a higher reserve ratio.

Therefore, due to these factors, the reserve ratio and money multiplier are theoretical.

Loan first multiplier

The money multiplier model suggests banks wait for deposit and then lend out a fraction. However, in the real world, banks may take it upon themselves to issue a loan, and then seek out reserves from other financial institutions/Central Bank or private individuals.

For example, in the credit bubble of 2000-2007, many banks were lending mortgages by borrowing on short-term money markets. They were lending money that wasn’t related to saving deposit accounts.

Money multiplier and quantitative easing

monetary-base-cpi

In 2009-12 Central Banks pursued quantitative easing. This involves increasing the monetary base. – Buying bonds off banks gave them greater cash reserves. In theory, this increase in the money multiplier should increase the overall money supply by a large amount due to the money multiplier

m4-money-supply-since-05

However, in practice, this didn’t occur. The money supply didn’t increase because banks were not keen to lend any extra money. Also, banks were trying to improve their reserves following the credit crunch and their previous over-extension of loans.

Chapter 3 Financial Instruments, Financial Markets, and Financial Institutions

Ppt

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

A financial instrument is a real or virtual document representing a legal agreement involving any kind of monetary value.
Financial instruments may be divided into two types: cash instruments and derivative instruments.
Financial instruments may also be divided according to an asset class, which depends on whether they are debt-based or equity-based.
Foreign exchange instruments comprise a third, unique type of financial instrument.

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 (supplement materials)

Understanding order types by wall street survivor (youtube)

Order types (market, limit, stop), video

For discussion:

1. Why did the other seller reduce the asking price after she posted her selling order?

2. Why did she hide her purchasing orders of 20,000 shares?

Understanding Stock Orders that you can try

1. Market order: A market order instructs your broker to buy or sell the stock immediately at the prevailing price, whatever that may be.

2. Limit order: Limit orders instruct your broker to buy or sell a stock at a particular price. The purchase or sale will not happen unless you get your price.

(www.investorpedia.com)

For example, our example portfolio purchased shares of Wal-Mart for $70.35 per share. Now we plan to sell our WMT shares after they realize a $10, or roughly 20%, increase. However, rather than constantly checking the market several times in a single day, with the intent of entering a market sell order once WMT reaches at least $80.35 per share, we can submit a simple limit sell order to do that for us.

Click on Sell for the Transaction type and enter 100 for the Quantity. For the order price, you need to select the button corresponding to Limit and then enter 80.35 as the limit price - this will ensure your order to sell WMT shares will not occur unless you can get at least $80.35 per share for your position of WMT shares. We keep the order's Term set at "Good Till Cancelled", which means the order will stay active and be processed once WMT shares reach or exceed your limit price. (*Note: We could have set Term to be "Day Order", which means the order would expire at the end of the current trading day if the order does not execute).

As you can see, the use of limit sell orders is very useful if you wish to sell a stock at a specific target price, but are unwilling or unable to regularly check intraday or daily closing prices of the stock. Also, an added advantage of using limit sell orders is that they remove the emotional component of making trading decisions. Too often, investors will be tempted to hold on to a winning stock even once it becomes overpriced. Submitting a limit sell order immediately after you buy the stock is a good time to avoid any emotional complications, allowing you to better maintain your strategy and realize superior long-term returns.

Similarly, limit buy orders are equally useful. You can enter a limit buy order with a certain limit price, which allows you to buy a set number of shares only if the stock's market price equal to, or lower than, the maximum limit price you entered. In our example portfolio we purchased WMT for $70.35/share with a market buy order. But perhaps we thought WMT was a bit overpriced at the time, so we could have used a limit buy order to purchase 100 shares only if WMT fell to $65.00/share or less. That way, we only buy at a price we believe is fair. If WMT does not fall to $65, the order will not be processed.

3. Stop loss order: A stop loss order gives your broker a price trigger that protects you from a big drop in a stock.

(www.investorpedia.com)

Essentially, a stop order is "dormant" until a stock's price falls to the specified "stop price". In other words, a stop order is an instruction to your brokerage to buy (or sell) a specified number of shares of a company when the prevailing market price is equal or higher than (or, in the case of a sell stop order, equal or lower than) the specified price that you submitted. In our example portfolio, we purchased shares of Google Inc (Nasdaq: GOOG) for $463.18 per share. Many investors use a sell stop order to limit their losses, meaning that they'll automatically sell if a stock goes down a certain percentage.

Entering a stop order is an efficient and cost-effective means of limiting losses by avoiding the agony of regularly checking your stock and deciding whether to hold or sell it. For instance, if a so-called growth stock has headed south, an investor may choose to hold, hoping the share price might rebound, but if it doesn't, losses can quickly mount.

4. Short selling:

video

For class discussion: Pro and cons of short selling?

(www.investorpedia.com)

As you can see, short selling follows the conventional investing principle of “buying low” and “selling high” but with one critical difference – the sequence of the buy and sell transactions. While the buy transaction precedes the sell transaction in conventional “long only” investing, in short selling, the sell transaction precedes the buy transaction.

When you short sell, you create a short position or a shortfall. A short position represents a binding obligation that must be closed or covered at some point. This “short covering” obligation gives rise to one of the biggest risks of short selling, as discussed later in this tutorial.

Short selling is also known as "shorting," "selling short" or "going short." To be short a security or asset implies that one is bearish on it and expects the price to decline. Short selling has also spawned some of the most colorful terms in the investment lexicon.

Short selling can be used for speculation or hedging. Speculators use short selling to capitalize on a potential decline in a specific security or the broad market. Hedgers use the strategy to protect gains or mitigate losses in a security or portfolio. Note that institutional investors and savvy individuals frequently engage in short selling strategies simultaneously for both speculation and hedging. Hedge funds are among the most active short sellers, and often use short positions in select stocks or sectors to hedge their long positions in other stocks.

Short sellers are often portrayed as cynical, hardened individuals who are bent on making profits by driving the companies that are their “short” targets to failure and bankruptcy. The reality, however, is that short sellers facilitate smooth functioning of the markets by providing liquidity, and also act as a restraining influence on investors who may be prone to chase overhyped stocks, especially during periods of irrational exuberance.

Short selling is viewed by many investors as an inordinately dangerous strategy, since the long-term trend of the equity market is generally upward and there is theoretically no upper limit to how high a stock can rise. But under the right circumstances, short selling can be a viable and profitable investment strategy for experienced traders and investors who have an adequate degree of risk tolerance and are familiar with the risks involved in shorting.

Example:

Let's say XYZ's current ask price is 53. You place an order to buy at a limit price of 50. If the price of the security falls to 50, your order may be executed. If you had placed a limit order to buy at 53 or above, your order would have been "marketable" and executed right away.

In Class Exercise part I

Multiple Choices

1. A trading order that immediately purchases stock at the prevailing price is called a:

a. stop-loss order

b. limit order.

c. market order.

(DEFINITION of 'Stop-Loss Order': An order placed with a broker to sell a security when it reaches a certain price. A stop-loss order is designed to limit an investor’s loss on a position in a security. Although most investors associate a stop-loss order only with a long position, it can also be used for a short position, in which case the security would be bought if it trades above a defined price. A stop-loss order takes the emotion out of trading decisions and can be especially handy when one is on vacation or cannot watch his/her position. Also known as a “stop order” or “stop-market order.”) video: http://www.investopedia.com/terms/s/stop-lossorder.asp )

2. A trading order that immediately purchases stock or is completely cancelled is called a:

a. stop-loss order.

b. fill-or-kill limit order.

c. market order.

d. open order.

(DEFINITION of 'Fill Or Kill - FOK': A type of time-in-force designation used in securities trading that instructs a brokerage to execute a transaction immediately and completely or not at all. This type of order is most likely to be used by active traders and is usually for a large quantity of stock. The order must be filled in its entirety or canceled (killed). The purpose of a fill or kill order is to ensure that a position is entered at a desired price.)

(Definition of ‘Open Order’: A type of order to buy or sell a security that remains in effect until it is either canceled by the customer, until it is executed or until it expires. Open orders commonly occur when investors place restrictions on their buy and sell transactions. A lack of liquidity in the market or for a particular security can also cause an order to remain open. )

3. A trading order that is canceled unless executed within a designated time period is called a

a. stop-loss order.

b. limit order.

c. market order.

d. fill or kill order.

4. Limit orders:

a. specify a certain price at which a market order takes effect.

b. specify a particular price to be met or bettered.

c. are executed at the best price available.

d. are orders entered for a particular day.

5. A market order is an instruction to:

a) immediately buy a security at the current bid price. ----- (wrong, because buy at the ask price, and sell at the bid price)

b) buy if the market price at least reaches the specified price target.

c) sell at or above a specified price target.

d) none of these.

Part III: IPO, SEO, Primary Market and Secondary Market

What is an IPO | by Wall Street Survivor (video)

What is an IPO? | CNBC Explains (video)

A lesson from Facebook -- avoid IPOs - MoneyWeek Investment Tutorials

IPO market’s drastic 2022 slowdown: What it means for banks (CNBC, video)

Only 22% of new public companies became profitable in 2021 as the IPO market stalls (CNBC, video)

Porsche’s $84 billion IPO valuation is double Ferrari’s market cap (CNBC, video)

For class discussion:

1. What is IPO? SEO? Who are the major participants?

2. What is the primary market? What is the secondary market? Who are the major participants in these markets?

3. Shall a company go public? What is your opinion?

4. Is investing in an IPO a good idea in 2022? In 2023?

IPO Calendar

This Week (http://www.marketwatch.com/tools/ipo-calendar)

In Class Exercise part II

Multiple Choices

1. The market for equities is predominantly a:

a. primary market.

b. market dominated by individual investors.

c. secondary market.

d. market dominated by foreign investors.

2. Primary markets:

a. involve the organized trading of outstanding securities on exchanges.

b. involve the organized trading of outstanding securities in the over-the-counter market.

c. involve the organized trading of outstanding securities on exchanges and over-the-counter markets.

d. are where new issues (IPOs) are sold by corporations to raise new capital.

Part IV: NASDAQ vs. NYSE

Top 7 Differences Traders Should Know

What is the difference between NYSE and NASDAQ? (video)

NYSE vs NASDAQ - who has more "mega cap" listings? (video)

Dec 10, 2018 6:47 AM -05:00, Ben Lobel, Markets Writer

https://www.dailyfx.com/nas-100/NASDAQ-vs-NYSE.html

NASDAQ and the New York Stock Exchange (NYSE) are the two largest stock exchanges in the world, providing a platform for trading securities. But while they share similarities in their considerable size and purpose, they are very different markets.

Understanding the differences between Nasdaq and NYSE can shed light on how stock market trading works.

NYSE and NASDAQ are the biggest stock exchanges in the world

WHAT ARE THE DIFFERENCES BETWEEN NASDAQ AND NYSE?

The main difference between Nasdaq and NYSE is their markets. Nasdaq is a dealer’s market, with participants trading through a dealer rather than directly with each other, while NYSE is an auction market, which enables individuals to transact between each other on an auction basis.

Other differences include the location of the transactions, how traffic is controlled, and the types of companies listed – all of which are explored in more depth in the sections below.

The formats that Nasdaq and NYSE take – dealer’s market and auction market respectively – represent a fundamental difference between the way they operate. An auction market, as run by NYSE, is a system based on buyers and sellers entering competitive bids at the same time. The price at which a stock is traded reflects the highest price that a buyer is willing to pay, and the lowest price a seller is willing to accept. Matching bids and offers are then paired together with the orders executed by the ‘specialist’ (see ‘Traffic Control’ below).

However, a dealer’s market, as run by Nasdaq, is a type of market where multiple dealers post prices at which they will buy or sell a specific stock. In a dealer’s market, a dealer is designated as a market maker – a member firm or market participant such as a brokerage company or bank – that actively buys and sells stocks on behalf of traders. Market makers can enable the process of matching up buyers and sellers to be a lot quicker, maintaining liquidity and ensuring an efficient trading process.

Location of Transactions

While both institutions are based in New York City, the location of transactions for trading on Nasdaq and on the NYSE are very different. NYSE retains a physical trading floor, although many of the transactions occur at its data center in Mawah, New Jersey.

However, as an electronic exchange, Nasdaq does not have a physical trading floor and operates through direct trading between investors and the market makers. While Nasdaq trading originally took place over a computer bulletin board system, now automated trading systems offer the benefit of daily trading volumes and full reports on trades.

Traffic Control

Traffic controllers, in essence, connect buyers and sellers, but their role differs between Nasdaq and NYSE. At each exchange, they are responsible for dealing with traffic problems and ensuring their markets run effectively. However, Nasdaq’s traffic controller, known as the ‘market maker’, actively buys and sells stocks on behalf of traders, while the NYSE’s traffic controller, known as the ‘specialist’, facilitates the market for buyers and sellers through setting opening prices for stocks, accepting limit orders, and moderating interest for particular stocks.

The two roles are, on paper, different in that Nasdaq’s market maker effectively creates a market, while NYSE’s specialist simply facilitates it. However, both roles have the same goal of enabling a smooth and orderly market for clients.

It is worth noting that approximately 40% of the volume traded on the Nasdaq is done through an electronic communications network (ECN), which is an automatic system for directly matching buyers and sellers. On the NYSE, only 7% of the volume is done via an ECN, but that could change with evolution towards a hybrid system of humans and machines.

Types of Companies Listed

When it comes to the listings on Nasdaq and NYSE, the NYSE trades stocks for around 2,800 companies, while Nasdaq has more than 3,300 listings.

The NASDAQ-100 features 100 of the largest publicly-traded businesses, based on market capitalization, but Nasdaq’s wider exchange features many small and micro-capitalization stocks also.

Listing Requirements

Listing requirements differ between Nasdaq and NYSE. Nasdaq listing requirements mean that companies must have at least 1,250,000 shares available for the public to trade, while companies listing on NYSE must have issued a minimum of 1,100,000 to at least 400 shareholders. Other differences include fees; for companies looking to list on the NYSE the entry fee goes up to $500,000, while for Nasdaq, the entry fee ranges from $50,000 to $75,000, with a yearly fee of around $27,000.

Additionally, there is a minimum share price of $4 for NYSE-listed companies and the market value of the company’s public shares must be at least $40 million. For a listing on Nasdaq, companies must have a minimum of three dealers for its stocks.

Perception of Stocks

The general perception of the stocks on Nasdaq and NYSE is that the more volatile trades are to be found on Nasdaq. This is because long-established, stable companies are more often found on the NYSE, with examples ranging from Coca Cola to Citigroup, IBM and Walmart. The Nasdaq, on the other hand, has more of a reputation for listing fast-growth tech businesses with potentially more scope for dramatic price movement. Stocks to be found on Nasdaq include Facebook, Apple, Google and Amazon.

Private vs Public

The ownership structure of each exchange used to be different to how it is today. Formerly, Nasdaq was listed as a publicly-traded corporation, while the NYSE was private. However, in March 2006, the NYSE went public, making its shares available to traders on an exchange. Traders can bet on Nasdaq and NYSE through the Nasdaq and NYSE platforms respectively.

HOW TRADERS CAN USE THE DIFFERENCES BETWEEN NASDAQ AND NYSE TO THEIR ADVANTAGE

In summary, when choosing which stock markets to go for as a trader, you might consider the following:

Volatility: If you’re looking for stocks with the potential for rapid price movements, you may find more opportunities on Nasdaq. On the other hand, NYSE offers shares that are generally more established and stable.
Nature of trading: If you want to trade through floor brokers, you will have that option with NYSE, while Nasdaq offers electronic trading. Products offered by both can be traded via third-parties, ECNs, and derivatives.

Indices

· NASDAQ indices include the NASDAQ Composite, NASDAQ-100, and NASDAQ Biotechnology.

· Indices on the NYSE include the Dow Jones Industrial Average and NYSE Composite.

· Other indices, like the S&P 500 and Russell 1000, include stocks listed on both exchanges.

https://www.diffen.com/difference/NASDAQ_vs_NYSE

Experience Wall Street Stock Trading In The 1980s (optional)

Homework ( DUE with first midterm exam)

1) What are the differences between market order and limit order?

2) What is short selling stock? How to short sell a stock?

3) Check three stocks listed above in the IPO table.

· Follow these stocks and report their performances one month after the IPO.

· Summarize your findings.

4) What are the major differences between NYSE and NASDAQ?

Robinhood will give retail investors access to IPO shares https://www.cnbc.com/2021/05/20/robinhood-will-give-retail-investors-access-to-ipo-shares-a-longstanding-wall-street-dominion.html

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?

IPO Market Faces Worst Year in Two Decades. ‘Really Hard Pill to Swallow.’

Inflation, rising interest rates and Russia’s invasion of Ukraine sent shock waves through the stock market, putting a freeze on the IPO pipeline

By Corrie Driebusch Aug. 22, 2022 11:19 am ET

https://www.wsj.com/articles/ipo-market-faces-worst-year-in-two-decades-startups-11661181427

The IPO market is on pace for its worst year in decades, leaving fledgling companies with few options but to burn through cash while they wait for the stock market to calm.

Late last year, hundreds of companies were in the final stages of preparing to go public, encouraged by the best 18 months ever for U.S. initial public offerings. Then a combination of factors—sky-high inflation, rising interest rates and Russia’s invasion of Ukraine—sent shock waves through the stock market.

The IPO pipeline froze. So far this year, traditional IPOs have raised only $5.1 billion all told, Dealogic data show. Typically at this point in the year, traditional IPOs have raised around $33 billion, according to Dealogic data that goes back

The last time levels were this low was 2009, when the U.S. was recovering from the depths of the financial crisis and the IPO market reopened near the end of the year.

IPO advisers say they don’t expect 2022 to follow that pattern, meaning it could end up being the worst year for raising money in IPOs since Dealogic, a research firm, started tracking it in 1995.

Fintech firm Klarna Bank AB was a highly anticipated 2022 IPO, but instead of making a splashy debut, the Sweden-based company laid off hundreds of workers to cut costs and was forced to seek funding in private markets. Klarna, which specializes in buy-now-pay-later services, managed to raise $800 million this summer—but only after cutting its valuation by 85% to $6.7 billion.

That valuation is still three times the level Klarna was valued three years ago, a Klarna spokeswoman said.

StockX, an online marketplace that sells sneakers, streetwear and other items, had planned to go public as early as the second half of 2021, people familiar with the matter told The Wall Street Journal last year. But StockX has yet to file IPO paperwork. In June, the company laid off 8% of its workforce. The company declined to comment.

Fewer companies going public is typically viewed as bad news for the economy and investors.

An IPO, especially when a company is younger with more room to grow, can allow more small investors to benefit from future gains. Publicly traded firms must register with regulators and provide more transparency around their finances. Big-name IPOs are typically the kinds of high-growth companies that helped the stock market rise for a decade after the financial crisis.

Bankers and lawyers who work on IPOs said companies that decide to brave a fall or early winter stock-market debut this year may need to halve their valuations after two years of roaring markets where private investors plowed cash into money-losing companies at sky-high valuations.

Top IPO lawyers say they are “pencils down” for almost all their expected deals this year, and that some companies looking to 2023 IPOs are pushing off hiring bankers.

Denny Fish, a portfolio manager at Janus Henderson Investors, typically buys shares of growth companies in their IPOs. He said he doesn’t plan to participate in any IPOs until 2023 at the earliest. “It might feel a little better because the market has bounced in July, but there’s still so much uncertainty,” Mr. Fish said. “There’s just not a market for companies coming public right now.”

As of Friday, the tech-heavy Nasdaq Composite was down 19% in 2022. That’s up from its mid-June trough, when the index was trading off more than 30% for the year.

Notable cryptocurrency startups, food-delivery companies and financial-technology firms are among the companies that had planned 2022 IPOs. As time passes and their cash reserves diminish, companies may need to tighten their belts as financing gets tougher.

Some, such as rapid-delivery startup Gopuff, are cutting costs by laying off workers. Grocery-delivery company Instacart Inc. and payments company Stripe Inc. have slashed their private valuations. Others have had to raise new money at steep discounts to prior financing rounds.

Many fund managers agree with Mr. Fish. Those who bought stock in the blockbuster IPOs in 2020 and 2021, including trading platform Robinhood Markets Inc., HOOD 2.93%▲ electric-vehicle maker Rivian Automotive Inc. and restaurant-software provider Toast Inc., TOST 3.92%▲ are saddled with big losses.

Even though the IPO market isn’t healthy right now, many companies still have a burning desire to go public, bankers say. Some need the cash. Others are running against a ticking clock for restricted stock units issued to employees through vesting plans. And some are eyeing acquisitions but need stock or money to complete offers.

“I don’t think a lot of companies that are private right now expected they’d be private by now,” said Barrett Daniels, U.S. IPO co-leader at accounting firm Deloitte LLP.

He said companies that need money, especially founder-led firms, may struggle with the lower valuations their companies might now command. “It’s a really, really hard pill to swallow. Going backwards is hard to compute,” he said.

There are a handful of companies determined to go public in 2022, people familiar with the matter said, including Intel Corp.’s INTC 0.96%▲ self-driving car unit Mobileye, Instacart, and American International Group AIG 2.56%▲ spinoff Corebridge Financial.

Other offerings, including SoftBank Group Corp.’s Arm, a chip-design specialist, following its failed sale to Nvidia Corp., are expected within the first few months of 2023, people familiar with the matter say.

There are many reasons for the IPO drought. Late last year, fears of inflation and subsequent Federal Reserve rate increases spooked investors who put money into companies that promised big growth but have little or no current profits. High-growth companies sold off and inflation fears accelerated, with many analysts warning of a coming recession, driving shares of profitable companies lower, too. The economy contracted at an annualized rate in two consecutive quarters, a common definition of a recession, and volatility climbed.

Meanwhile, IPO advisers and investors agree the IPO playbook is changing: They say the first companies to go public after the markets calm down should be profitable, fairly large, and “must own” names—companies that are well-known and leaders in their specific industry.

Many private companies are taking note. Thanks in part to cost-cutting, Instacart, for example, was profitable in the second quarter of this year under generally accepted accounting principles, according to a person familiar with the matter. Revenue for Instacart during the three months ended in June climbed 39% from the year-earlier period to $621 million, investors told The Wall Street Journal, the highest quarterly revenue in Instacart’s history.

Though some companies including Klarna were forced to face a sharp valuation cut because they needed to raise more money, many others aren’t hurting for cash yet, because they raised a lot in 2021 before the market turned. Last year, U.S. venture-backed companies raised nearly $330 billion, almost double the previous record raised in 2020, according to research company PitchBook.

Although the stock market is bouncing back and some secondary stock offerings have performed well, bankers fear what a poor showing by a new issue could do to the IPO market.

In May, Bausch + Lomb Corp. went public when virtually no one else was doing so, and investors were largely uninterested. The eye-care company priced its stock at $18 a share, far below its expectations. It commanded a valuation of about $6.3 billion, less than half of what the company had been hoping to reach just months earlier, people familiar with the matter said. A company spokeswoman declined to comment. Now the stock trades around $15.50 a share.

American Stock Exchange (AMEX)

By JAMES CHEN Updated October 13, 2020, Reviewed by GORDON SCOTT

https://www.investopedia.com/terms/a/amex.asp

Quick Guide To The AMEX: American Stock Exchange [Episode 182]

What Is the American Stock Exchange (AMEX)?

The American Stock Exchange (AMEX) was once the third-largest stock exchange in the United States, as measured by trading volume. The exchange, at its height, handled about 10% of all securities traded in the U.S.

Today, the AMEX is known as the NYSE American. In 2008, NYSE Euronext acquired the AMEX. In the subsequent years, it also became known as NYSE Amex Equities and NYSE MKT.

KEY TAKEAWAYS

· The American Stock Exchange (AMEX) was once the third-largest stock exchange in the U.S.

· NYSE Euronext acquired the AMEX in 2008 and today it is known as the NYSE American.

· The majority of trading on the NYSE American is in small cap stocks.

· The NYSE American uses market makers to ensure liquidity and an orderly marketplace for its listed securities.

Understanding the American Stock Exchange (AMEX)

The AMEX developed a reputation over time as an exchange that introduced and traded new products and asset classes. For example, it launched its options market in 1975. Options are a type of derivative security. They are contracts that grant the holder the right to buy or sell an asset at a set price on or before a certain date, without the obligation to do so. When the AMEX launched its options market, it also distributed educational materials to help educate investors as to the potential benefits and risks.

The AMEX used to be a larger competitor of the New York Stock Exchange (NYSE), but over time the Nasdaq filled that role.

In 1993, the AMEX introduced the first exchange traded fund (ETF). The ETF, now a popular investment, is a type of security that tracks an index or a basket of assets. They are much like mutual funds but differ in that they trade like stocks on an exchange.

Over time, the AMEX gained the reputation of listing companies that could not meet the strict requirements of the NYSE. Today, a good portion of trading on the NYSE American is in small cap stocks. It operates as a fully electronic exchange.

History of the American Stock Exchange (AMEX)

The AMEX dates back to the late 18th century when the American trading market was still developing. At that time, without a formalized exchange, stockbrokers would meet in coffeehouses and on the street to trade securities. For this reason, the AMEX became known at one time as the New York Curb Exchange.

The traders who originally met in the streets of New York became known as curbstone brokers. They specialized in trading stocks of emerging companies. At the time, many of these emerging businesses were in industries such as railroads, oil, and textiles, while those industries were still getting off the ground.

In the 19th century, this type of curbside trading was informal and quite disorganized. In 1908, the New York Curb Market Agency was established in order to bring rules and regulations to trading practices.

In 1929, the New York Curb Market became the New York Curb Exchange. It had a formalized trading floor and a set of rules and regulations. In the 1950s, more and more emerging businesses began trading their stocks on the New York Curb Exchange. The value of companies listed on the exchange almost doubled between 1950 and 1960, going from $12 billion to $23 billion during that time. The New York Curb Exchange changed its name to the American Stock Exchange in 1953.

Special Considerations

Over the years, the NYSE American has become an attractive listing place for younger, entrepreneurial companies, some of whom are in the early stages of their growth and certainly not as well-known as blue chip companies. Compared to the NYSE and Nasdaq, the NYSE American trades at much smaller volumes.

Because of these factors, there could be concerns that investors would not be able to quickly buy and sell some securities in the market. To ensure market liquidity—which is the ease at which a security can be converted to cash without impacting its market price—the NYSE American offers electronic designated market makers.

Market makers are individuals or firms that are available to buy and sell a particular security as needed throughout the trading session. These designated market makers have quoting obligations for specific NYSE American-listed companies. In return for making a market for a security, market makers earn money through the bid-ask spread and from fees and commissions. So, despite the fact that the NYSE American is a smaller-volume exchange specializing in listing smaller companies, its use of market makers enables it to maintain liquidity and an orderly market.

Chapter 4: Future value, Present Value, and Interest Rate

Ppt

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

First Mid Term Exam – close book, close notes, 9/20, in class

Study Guide (Truel and False, multiple choice questions)

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 NFT? What is metaverse? What is blockchain?

7. What is bitcoin? What is Dogecoin? In your view, could bitcoin become a major global currency?

8. Could cryptocurrency put banks out of business?

9. What is CBDC?

10. What could happen if we increase money supply? What about decrease money supply? What is QE?

11. What is M0? MB? M1? M2? M3?

12. Why M2 is >> M0? Why M2>>M1?

13. What is money multiplier?

14. What is money velocity?

15. “In a fractional reserve banking system, banks create money when they make loans.

16. Bank reserves have a multiplier effect on the money supply.” This sentence is right or wrong? Please provide your rational

17. 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?

18. As an investor, besides market order, what other types of orders can use choose from? Show definitions and examples.

19. 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?

20. What is IPO? Why shall you buy stocks pre-IPO shares?

21. Compare primary market vs. secondary market.

22. Time value of money questions – show math equations only. No need of excel or calculator.

23. In your view, what might trigger the next financial crisis? Why?

24. Compare NYSE with NASDAQ.

25. What is AMEX?

26. What is QE?

27. Order type: limit order, market order, short sell, stop loss

28. What is money market?

Chapter 6 Bond Market

Chapter 6 PPT

1. Cash flow of bonds

The above graph shows the cash flow of a five year 5% coupon bond.

Where can you find bond information?

http://finra-markets.morningstar.com/BondCenter/Default.jsp

For example: a 3 year bond 10% coupon rate, draw its cash flow.

How Bonds Work (video)

2. Risk of Bonds

Class discussion: Is bond market risky?

Bond risk (video)

Bond risk – credit risk (video)

Bond risk – interest rate risk (video)

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 (What are Municipal Bonds? | Fidelity (youtube))

International Bond

Bond Mutual Fund (Individual Bonds vs. Bond Funds: What’s the Difference? (video))

TIPs (What are TIPS - Treasury Inflation Protected Securities (video))

Class discussion Topic I: TIPS

· 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?

Treasury Inflation Protected Securities (TIPS)

Brian O'Connell, reviewed By Benjamin Curry, May 24, 2022

https://www.forbes.com/advisor/investing/treasury-inflation-protected-securities-tips/

Treasury Inflation Protected Securities (TIPS) are bonds issued by the U.S. government that offer protection against inflation, in addition to modest interest payments.

“For investors who prioritize preserving the purchasing power of their cash, TIPS can help mitigate the impact of unexpectedly high inflation,” says Wes Crill, head of investment strategists at Dimensional Fund Advisors in Austin, Texas.

How Do TIPS Work?

TIPS are fixed income securities that work similarly to other treasury bonds. When you buy TIPS, you’re purchasing debt issued by the U.S. government. You get regular interest payments on the par value of the securities, and you get your principal back when the TIPS reach maturity.

What’s special is that TIPS include a special mechanism that provides inflation protection. Each year, the U.S. Treasury adjusts the par value of TIPS based on the Consumer Price Index (CPI), a measure of inflation.

This TIPS feature helps preserve the purchasing power of your investment. The value of ordinary bonds, which typically feature fixed par values, may be eroded over time by gains in inflation.

“Indexing the bond’s value to inflation helps protect investors from an erosion in purchasing power,” says Crill. Regardless of how much prices change over the term of your TIPS investment, you maintain the purchasing power of the cash you invested—plus interest payments.

What’s more, interest payments are also adjusted for inflation each year. While the interest rate remains constant over the duration of your TIPS, the interest payment you receive every six months is based on your TIPS’ current par value, meaning they effectively increase with CPI inflation.

Note that deflation will reduce the par value of TIPS. It’s a very rare phenomenon, but the value and interest payments of your TIPS could be adjusted downward to reflect negative CPI rates. That said, you never receive less than the original par value of the TIPS upon maturity.

TIPS and Taxes

As with most investments, TIPS earnings are subject to taxes, at least on the federal level. Earnings are generally exempt from state and local taxes. However, you have to be careful with TIPS because their earnings encompass their interest payments and any inflation adjustments that increase their par value.

“In any year when the principal value of a TIPS bond increases due to the inflation adjustment, that gain is considered reportable income for the year, even though the investor won’t receive the inflation-adjusted principal until the security matures,” says Robert Johnson, professor of finance at Heider College of Business at Creighton University.

If you don’t plan for this in advance, this may create a small unexpected tax burden, as you won’t have received the updated par value back yet but are still expected to pay income taxes on it.

In the event that deflation occurs, reducing the par value of TIPS, you may be able to use it to offset other income gains. You generally will only be able to do this if the adjustment exceeds the amount of TIPS interest you earned that year. Speak with a tax professional to determine how TIPS may affect your taxes.

Advantages of TIPS

For inflation-conscious investors, TIPS have some big advantages.

Easy Inflation Insurance

TIPS can provide an easy way to engineer an inflation hedge in your portfolio. “This is particularly important for more conservative or income-focused investors,” like those in retirement often are, says Matt Dmytryszyn, director of investments at Telemus, an investment advisory firm in Southfield, Mich.

In high-inflation environments, TIPS performance may greatly exceed that of traditional government bonds, whose fixed interest payments effectively become smaller over time.

Backed by the Full Faith and Credit of Uncle Sam

While many investments may outperform inflation over time, TIPS are the only one guaranteed to do this that also have all of the benefits of standard Treasury bonds.

“They’re supported by the full faith and credit of the U.S. government and are traded in a deep and very liquid market,” says Frederick Miller, founder of Sensible Financial Planning and Management, LLC, in Waltham, Mass.

In other words, it’s highly unlikely the U.S. government will fail to pay you back—that hasn’t happened yet in U.S. history—and, should you need to sell your TIPS before their term ends, you should be able to do so relatively easily. This makes TIPS great low-risk investments.

Disadvantages of TIPS

TIPS aren’t without their disadvantages. Here are a few of the risks you might encounter if you invest in TIPS.

Poor performance during deflation or low inflation.

While TIPS have an edge over traditional bonds when inflation runs hot, they perform poorly when deflation strikes or there is low inflations. That’s because deflation or low inflation drags down their par value, shrinking interest payments. In these conditions, TIPS fail to keep up with market interest rates.

Unpredictable cash flow.
Because their payments are dependent on inflation, it’s hard to estimate in advance what your income might be. This may not be a huge deal if payments end up being more than expected, but during periods of lower inflation or deflation, you could end up with less money coming in than you need.

Anticipatory taxes.

Because you must pay income taxes on any increases to par value, you could end up owing “phantom taxes” on money you haven’t actually earned until your TIPS mature. You can combat this by holding your TIPS in tax-advantaged retirement accounts.

Liquidity.

In general, it’s pretty easy to cash out or resell your U.S. Treasuries before their maturity date. TIPS don’t trade as much as other bonds in secondary markets, which may make it harder to sell yours quickly. During periods of unstable inflation, you also may end up selling your TIPS at a loss, especially if their par value has been adjusted to lower than what you paid.

CPI may not match your personal inflation rate.

TIPS are tied to CPI, and if your spending habits don’t completely align with the averages used to measure CPI, inflation adjustments may not compensate you for your spending patterns. “The CPI is a basket of goods and the composition of each of our baskets of goods will vary in some way from the composition CPI basket,” says Dmytryszyn. TIPS may not keep up with your personal rate of inflation.

How to Buy TIPS

You can buy TIPS through your online brokerage account or directly from the U.S. Treasury at TreasuryDirect.

If you choose to buy TIPS on the secondary market, be sure to compare how much the current inflation-adjusted par value differs from the original par value. Remember: You are only guaranteed to receive payment up to the original face value of a TIPS. If its price is above the issue price, you could lose money if deflation drags the par value to less than you paid.

That means you’ll probably only want to buy TIPS on a secondary market if the current par value is less than the issued par value. Otherwise, your safest bet may be purchasing TIPS directly from the Treasury.

You can also buy shares of mutual funds and exchange-traded funds (ETFs) that contain diversified mixes of TIPS. While buying into a TIPS fund may make certain aspects of TIPS ownership easier, such as allowing you to reinvest earnings or buy odd-dollar amounts of shares, keep in mind you’ll be paying expense ratio fees, which can negatively impact your returns.

Should You Buy TIPS?

If you’re a safety-minded investor who wants some government-backed protection against inflation, TIPS can make good sense.

“TIPS matter to Main Street investors because they can help you protect your buying power from rising inflation,” says Tom Preston, who spent 30 years as a Wall Street trader and is a market strategist for Tastytrade, a Chicago-based digital finance and investment marketplace. “When inflation increases the price of things you need to buy, the extra return from a TIPS can offset that.”

Before buying your TIPS, though, be sure to compare current bond yields to expected inflation rates. Because they adjust for inflation, TIPS interest rates tend to be much smaller than non-TIPS bonds. For instance, if bonds are yielding 3%, inflation is only 2%, and TIPS interest is 0.5%, you would only expect to earn the equivalent of 2.5% on your TIPS each year. This could make it an inferior choice to the non-TIPS Treasury. Conversely, if non-TIPS bonds were only yielding 2%, TIPS would give you an extra half a percent over traditional bonds.

According to Raymond James, the average breakeven point has been around 2.5% since the mid-1990s, meaning a non-TIPS bond must yield at least that much to hypothetically outperform a TIPS.

Class discussion Topics II: Junk Bond

· 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?

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 BondsEverything You Need to Know About Junk Bonds

By THE INVESTOPEDIA TEAM Updated May 17, 2022 Reviewed by CIERRA MURRY

https://www.investopedia.com/articles/02/052202.asp

The term "junk bond" can evoke memories of investment scams such as those perpetrated by Ivan Boesky and Michael Milken, the junk-bond kings of the 1980s. But if you own a bond fund today, some of this so-called junk may have already found its way into your portfolio. And that's not necessarily a bad thing.

Here's what you need to know about junk bonds.

Like any bond, a junk bond is an investment in debt. A company or a government raises a sum of money by issuing IOUs stating the amount it is borrowing (the principal), the date it will return your money (maturity date), and the interest rate (coupon) it will pay you on the borrowed money. The interest rate is the profit the investor will make for lending the money.

KEY TAKEAWAYS

· Junk bonds have a lower credit rating than investment-grade bonds, and therefore have to offer higher interest rates to attract investors.

· Junk bonds are generally rated BB[+] or lower by Standard & Poor's and Ba[1] or lower by Moody's.

· The rating indicates the likelihood that the bond issuer will default on the debt.

· A high-yield bond fund is one option for an investor interested in junk bonds but wary of picking them individually.

Before it is issued, every bond is rated by Standard & Poor's or Moody's, the major rating agencies that are tasked with determining the financial ability of the issuer to repay the debt it is taking on. The ratings range from AAA (the best) to D (the company is in default).

The two agencies have slightly different labeling conventions. AAA from Standard & Poor's, for example, is Aaa from Moody's.

Broadly speaking, all bonds can be placed in one of two categories:

Investment-grade bonds are issued by low-risk to medium-risk lenders. A bond rating on investment-grade debt can range from AAA to BBB. These highly-rated bonds pay relatively low interest because their issuers don't have to pay more. Investors looking for an absolutely sound place to put their money will buy them.

Junk bonds are riskier. They will be rated BB or lower by Standard & Poor's and Ba or lower by Moody's. These lower-rated bonds pay a higher yield to investors. Their buyers are getting a bigger reward for taking a greater risk.

Think of a bond rating as the report card for a company's credit rating. Blue-chip firms with solid financials and steady income will get a high rating for their bonds. Riskier companies and government bodies with rocky financial histories will get a lower rating.

The chart below shows the bond-rating scales from the two major rating agencies.

Historically, average yields on junk bonds have been 4% to 6% above those for comparable U.S. Treasuries. U.S. bonds are generally considered the standard for investment-grade bonds because the nation has never defaulted on a debt.

Bond investors break down junk bonds into two broad categories:

Fallen angels are bonds that were once rated investment grade but have since been reduced to junk-bond status because concerns have emerged about the financial health of the issuers.

Rising stars are the opposite. The companies that issue these bonds are showing financial improvement. Their bonds are still junk, but they've been upgraded to a higher level of junk and, if all goes well, they could be on their way to investment quality.

Who Buys Junk Bonds?

The obvious caveat is that junk bonds are a high-risk investment. There's a risk that the issuer will file for bankruptcy and you'll never get your money back.

There is a market for junk bonds, but it is overwhelmingly dominated by institutional investors who can hire analysts with knowledge of specialized credit.

This does not mean that junk-bond investing is strictly for the wealthy.

The High-Yield Bond Fund

For individual investors who are interested in junk bonds, investing in a high-yield bond fund can make sense.

You're dabbling in a higher-risk investment, but you're relying on the skills of professional money managers to make the picks.

High-yield bond funds also lower the overall risk to the investor by diversifying their portfolios across asset types. The Vanguard High-Yield Corporate Fund Investor Shares (VWEHX), for example, keeps 4.5% of its money in U.S. bonds and 3% in cash while spreading the rest among bonds rated from Baa3 to C. The Fidelity Capital and Income Fund (FAGIX) keeps nearly 20% of its money in stocks.

One important note: You need to know how long you can commit your cash before you decide to buy a junk bond fund. Many do not allow investors to cash out for at least one or two years.

Also, there is a point at which the rewards of junk bonds don't justify the risks. You can determine this by looking at the yield spread between junk bonds and U.S. Treasuries. The yield on junk is historically 4% to 6% above U.S. Treasuries. If you see the yield spread shrinking below 4%, it's probably not worth the added risk. to invest in junk bonds.

One more thing to look for is the default rate on junk bonds. This can be tracked on Moody's website.

One final warning: Junk bonds follow boom and bust cycles, just like stocks. In the early 1990s, many bond funds earned upwards of 30% annual returns. A flood of defaults can cause these funds to produce stunning negative returns.

https://fred.stlouisfed.org/series/BAMLH0A0HYM2EY

Units: Percent, Not Seasonally Adjusted

Frequency: Daily, Close

FYI only https://fred.stlouisfed.org/series/BAMLH0A0HYM2EY

This data represents the effective yield of the ICE BofA US High Yield Index, which tracks the performance of US dollar denominated below investment grade rated corporate debt publicly issued in the US domestic market. To qualify for inclusion in the index, securities must have a below investment grade rating (based on an average of Moody's, S&P, and Fitch) and an investment grade rated country of risk (based on an average of Moody's, S&P, and Fitch foreign currency long term sovereign debt ratings). Each security must have greater than 1 year of remaining maturity, a fixed coupon schedule, and a minimum amount outstanding of $100 million.

ICE BofA Explains the Construction Methodology of this series as:

Index constituents are capitalization-weighted based on their current amount outstanding. With the exception of U.S. mortgage pass-throughs and U.S. structured products (ABS, CMBS and CMOs), accrued interest is calculated assuming next-day settlement. Accrued interest for U.S. mortgage pass-through and U.S. structured products is calculated assuming same-day settlement. Cash flows from bond payments that are received during the month are retained in the index until the end of the month and then are removed as part of the rebalancing. Cash does not earn any reinvestment income while it is held in the Index. The Index is rebalanced on the last calendar day of the month, based on information available up to and including the third business day before the last business day of the month. Issues that meet the qualifying criteria are included in the Index for the following month. Issues that no longer meet the criteria during the course of the month remain in the Index until the next month-end rebalancing at which point they are removed from the Index.

The index data referenced herein is the property of ICE Data Indices, LLC, its affiliates, ("ICE") and/or its Third Party Suppliers and has been licensed for use by the Federal Reserve Bank of St. Louis. ICE, its affiliates and Third Party Suppliers accept no liability in connection with its use.

Suggested Citation:

Ice Data Indices, LLC, ICE BofA US High Yield Index Effective Yield [BAMLH0A0HYM2EY], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/BAMLH0A0HYM2EY, September 21, 2022.

Part III: International Bond

For discussion:

Should you invest in foreign bonds?

Rising Italy bond yields to test an ECB set to pull rate hike trigger again

By Dhara Ranasinghe, Tommy Wilkes and Yoruk Bahceli

https://www.reuters.com/markets/europe/rising-italy-bond-yields-test-an-ecb-set-pull-rate-hike-trigger-again-2022-09-02/

LONDON, Sept 2 (Reuters) - Rising borrowing costs in highly-indebted Italy are again testing the European Central Bank's resolve to contain bond market strain.

Just days before the ECB is tipped to deliver a second big interest rate hike to curb record-high inflation, worries about a more aggressive move have unnerved investors.

Italy's 10-year bond yield on Thursday topped 4% for the first time since mid-June, when a sharp move above that level pushed the closely-watched spread to German debt to around 250 bps and prompted the ECB to hold an emergency meeting to discuss how to contain bond stress as it withdraws stimulus.

Alert to the dangers of tightening policy against a backdrop of sharp rises in borrowing costs, the ECB unveiled its Transmission Protection Instrument (TPI) in July. It is a new bond purchase scheme to help more indebted euro zone states and prevent a divergence of borrowing costs from benchmark issuer Germany it sees as happening through no fault of their own.

"Everyone in the market knows that 4% is tricky for debt sustainability in Italy and the growth outlook has deteriorated," said Pictet Wealth Management fixed income strategist Laureline Renaud-Chatelain.

Yet, analysts suspect the new tool was unlikely to be used soon - especially as a snap Italian election looms on Sept. 25.

"The yield level is going to be a problem. But I don't think the ECB will activate the new tool before an election," Renaud-Chatelain said.

Renewed Italian political instability has contributed to the bond sell-off, while the recent yield surge is in line with peers. Italian and German 10-year yields rose around 70 bps each in August as fears about higher inflation and rates took hold.

The risk premium over Germany, at around 235 bps, has widened but is below recent peaks, supported perhaps by the ECB skewing reinvestments from maturing bonds it bought for its pandemic purchase scheme at Italy.

"The spread remains orderly and more than the level it is the behaviour of the spread (and more generally the periphery) that the ECB would be concerned about," said Peter Schaffrik, global macro strategist at RBC Capital Markets.

PAIN THRESHOLD?

Still, markets were expected to keep pushing yields higher to test just where the ECB's tolerance level for pain in Italian bond markets lies.

In the past, analysts have viewed the 250-300 bps area in the spread as a danger zone for the ECB and some analysts expect the spread to reach this area in coming months.

UBS, for instance, reckons the spread could test 300 bps.

Italian borrowing costs meanwhile climbed to new multi-year highs at a Tuesday auction.

"No one knows when the ECB will start intervening and they obviously won't tell us," said Mike Riddell, senior fixed income portfolio manager at Allianz Global Investors.

"My assumption since the announcements of potential support for the periphery and namely Italy, is that markets will test (the ECB) given the trajectory for economic growth and rates."

Battered by soaring energy prices, many economists expect the euro zone economy to slip into a recession - a challenging backdrop for the ECB as inflation nears double digits.

On the plus side, Italy's election noise so far hasn't alarmed investors.

The Italian rightist alliance's ambitious spending plans will respect European Union budget rules and not blow a hole in Italy's finances, according to Giorgia Meloni, who heads the Brothers of Italy party topping the polls. read more

"The worrying thing for the market was that you'd have Italy's yields rising and a considerably worse growth outlook after (former Prime Minister Mario) Draghi left," said Mizuho rates strategist Peter McCallum. "It now seems like politics isn't going to be so much as a shock as some people have been fearing."

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), what is the rating of War-Mart bond? Is it better than MSFT’s or are they the same? Explain why Wal-Mart bond is more risky than the Treasury bond with the same condition.

3. Compare municipal bond, TIPS, corporate bond and Treasury bond in terms of issuers, pro and cons (risk).

4. Do you recommend TIPS to your grandparents? Why or why not? Please refer to both articles on TIPS posted in this chapter.

5. As a bond investor, do you plan to invest in junk bond? Why or why not?

6. In “Rising Italy bond yields to test an ECB set to pull rate hike trigger again”, it states that “Italy's 10-year bond yield on Thursday topped 4% for the first time since mid-June, when a sharp move above that level pushed the closely-watched spread to German debt to around 250 bps and prompted the ECB to hold an emergency meeting to discuss how to contain bond stress as it withdraws stimulus”. Why does a 4% yield on the Italy’s 10 year bond imply a serious economic problem to the ECB? Do you have any suggestions to the ECB in terms of how to fix this problem?

FYI: Italy's debt-to-GDP ratio is the second-highest in the euro zone (CNBC, youtube)

7. According to “Investors are piling into high yield bonds. What to know before adding ‘junk’ to your portfolio” and “Junk Bonds Stage a Comeback as Investors Regain Risk Appetite”, do you think that junk bonds are a good investment right now? Why or why not?

FYI: This under-the-radar trend suggests junk-loan default rates are entering a danger zone (CNBC, youtube)

Optional: go to https://www.treasurydirect.gov/indiv/products/prod_tips_glance.htm and learn about how to purchase TIPS on TreasruyDirect

Protection for Inflation, With Some Leaks

A TIPS fund can shield investors from inflation to some extent, but so can other choices, like real estate, dividend-paying stocks and commodities.

Credit...Ben Konkol, By Tim Gray, Jan. 14, 2022

https://www.nytimes.com/2022/01/14/business/mutual-funds/inflation-tips-fund-etf.html

Judged by their name alone, Treasury Inflation-Protected Securities would seem a cure for one of today’s main investor anxieties: inflation.

Alas, that name doesn’t tell all you need to know.

A mutual fund or exchange-traded fund that invests in TIPS can help prevent rising prices from eroding the value of your investment portfolio. And inflation is a worry today: It’s running at an annual rate of 7 percent, a level not seen since 1982. That’s when “E.T.” landed in movie theaters and Michael Jackson’s “Thriller” thrummed on radios.

But TIPS funds and E.T.F.s aren’t the best inflation fighters for every investor, and TIPS, a kind of bond issued by the U.S. Treasury, have complexities that belie their plain-as-boiled-potatoes label.

People assume “just because inflation goes up, you’ll do well” with TIPS, said Lynn K. Opp, a financial adviser with Raymond James in Walnut Creek, Calif. But other factors, like rising interest rates, can sap TIPS’s returns, she said.

Plus, TIPS are expensive when compared with standard Treasuries in that they pay less interest, Ms. Opp said. In the first week of January, a five-year TIPS was yielding minus 1.7 percent, while a five-year Treasury was yielding 1.4 percent. In effect, TIPS investors were paying the Treasury to hold their money.

In 2020, net new flows of about $22 billion gushed into them, according to Morningstar. In just the first 10 months of 2021, those flows nearly tripled, to $61 billion.

Performance may have been the draw: The average TIPS fund tracked by Morningstar returned 5.5 percent in 2021, compared with a loss of 1.5 percent for the Bloomberg Barclays Aggregate Bond Index, a well-known bond index.

To understand TIPS funds or E.T.F.s, it helps to understand the underlying inflation-protected securities.

The U.S. Treasury adjusts the principal of a TIPS twice a year based on the most recent reading of the Consumer Price Index, a government measure of inflation. When the C.P.I. climbs, the principal ratchets up. And when the index falls — because prices are falling — it ratchets down.

“The interest payments can change,” said Gargi Chaudhuri, head of iShares investment strategy, Americas, for BlackRock, because those payments are based on principal that can change with inflation.

“If you look back a decade, inflation expectations sat above where inflation rolled in year after year,” said Steve A. Rodosky, a co-manager of PIMCO’s Real Return Fund. “So people would’ve been better off owning nominal Treasuries.” (“Nominal” is professionals’ term for noninflation-protected bonds.)

Perhaps TIPS’s most confusing quality is the nature of their inflation protection.

It might seem that a TIPS fund would work like hiking pants that zip off into shorts: right for whatever (inflationary) conditions arise. But what sets TIPS apart is the protection they afford against unexpected inflation, said Roger Aliaga-Diaz, chief economist for Vanguard.

Market prices for all assets adjust, to some extent, to reflect anticipated inflation. Prices for standard bonds, for example, fall to compensate for the fact that inflation has purloined part of their original yields. Prices for TIPS fall, too, though the crucial difference is that their inflation adjustments help compensate for that. (Bond prices and yields move in opposite directions.)

Whether you opt for a TIPS fund in your portfolio will probably turn on your age and expectations about inflation.

Retirees and people approaching retirement might choose one because its value should be less volatile than that of other assets that can help buffer inflation, like stocks and commodities, said Mr. Aliaga-Diaz. Vanguard’s Target Retirement 2015 Fund, a so-called target-date fund, allocates 16 percent of its asset value to TIPS.

Jennifer Ellison, a financial adviser in Redwood City, Calif., said her firm, Cerity Partners, currently recommends that clients keep 15 percent to 20 percent of the bond portion of their portfolios in TIPS funds. “But we have been as low as 10 percent at times,” she said.

A young person might not want any allocation to a TIPS fund, preferring stock funds as inflation insurance instead.

“Over the longer term, there’s been no better way to protect oneself from inflation than to have an allocation to stocks, because corporate earnings tend to grow at a rate that outpaces inflation, and stocks have appreciated at a rate that well outpaces inflation,” said Ben Johnson, director of global E.T.F. research for Morningstar.

Even for retirees, a less volatile sort of stock fund, like one that invests in dividend payers, might blunt inflation better than a TIPS fund, Mr. Johnson said.

“Among our favorites is the Vanguard Dividend Appreciation E.T.F.,” he said. “It owns stocks that have grown their dividends for at least 10 years running. That’s a way to dial down a bit of risk while maintaining some equity exposure.”

Another stock option is Fidelity’s Stocks for Inflation E.T.F., which holds shares of companies in industries that tend to outperform during inflationary times.

If you go for a TIPS fund, pick one with low costs, Mr. Johnson said. Costs always matter in investing, but they’re especially important here because all these funds, in the main, do the same thing: They buy a single sort of Treasury security.

“In the TIPS market itself, it’s exceedingly difficult to add value,” he said. Portfolio managers are thus often allowed to add in a slug of other sorts of bonds, as well as derivative securities. “But you do add risk by doing that.”

Among the cheaper TIPS offerings are the iShares 0-5 Year TIPS Bond E.T.F., the Vanguard Short-Term Inflation-Protected Securities E.T.F. and the Schwab U.S. TIPS E.T.F. All three have expense ratios of 0.05 percent or less.

Inflation expectations present a harder puzzle for investors than your expected retirement date. In theory, if you think inflation will exceed the market’s expectations, a TIPS fund would be a good bet.

Investment pros make this assessment by checking the break-even inflation rate — the difference between the yields on TIPS and nominal Treasuries.

“It’s the rate of inflation you need to average for TIPS to outperform nominal Treasuries over the period for which you’re investing,” said Kathy Jones, chief fixed income strategist at the Schwab Center for Financial Research. In the first week of January, that rate was about 3 percent for five-year Treasuries versus five-year TIPS.

People who think inflation will exceed that level for the next five years might want a TIPS fund. (They also might want to ask themselves why their inflation intuition is better than the market’s.)

Another vexation is how TIPS funds state their yields.

The U.S. Securities and Exchange Commission mandates a standard formula for computing yields — the 30-day yield. That formula doesn’t work well for TIPS offerings because the regular principal adjustments to the underlying securities can distort its result.

Some fund companies calculate the 30-day yield including the principal adjustments; some don’t.

State Street Global Advisors, which sponsors the SPDR Portfolio TIPS E.T.F., is one that doesn’t.

“In our view, it’s more conservative to not include the inflation adjustment,” said Matthew Bartolini, head of SPDR Americas research for State Street. “Including it can lead to a misleading statistic — it’s likely to overstate the eventual yield of the fund.”

Perhaps the crucial fact to know about TIPS funds is the most basic one: They’re bond offerings, buffeted by the same macrofactors that buffet other bonds.

“If interest rates go up, the price is going to go down, pretty much irrespective of what happens to inflation,” said Ms. Jones of the Schwab Center.

She cautioned, too, that “there’s no guaranteed way to beat inflation.”

A TIPS fund might help. So might an appropriate stock fund. “Having some allocation to things like real-estate investment trusts and precious metals makes sense, too, but that’s not necessarily going to beat inflation, either,” she said.

Junk Bonds Stage a Comeback as Investors Regain Risk Appetite

Borrowing by the riskiest companies was higher this week than in all of July, but some warn that the window may not be open for long.

By Joe Rennison Aug. 19, 2022

https://www.nytimes.com/2022/08/19/business/junk-bonds.html

As the Federal Reserve raised interest rates, trying to cool the economy by increasing borrowing costs, companies that are considered risky have found it harder to raise debt. But firms with low credit ratings, whose debt is often referred to as “junk,” are now taking advantage of a window of opportunity to borrow more cash.

Junk-rated companies, which tend to pay higher rates, have sold $4.1 billion in bonds in the United States this week, according to Refinitiv. Already, issuance of junk bonds has reached the highest weekly amount since early June, just before investor confidence cratered, the stock market reached its nadir and lenders backed away from junk bonds, which are also known as high-yield debt.

A batch of better-than-expected corporate earnings reports and positive economic data has recently lifted stock markets, eased volatility and softened some investors’ forecasts for the Fed’s rate-raising campaign. The junk bond market has also begun to thaw: This week’s issuance topped the total for all of July.

Yet bankers and investors warn that the time for these riskier borrowers to raise fresh funds may be short. Companies with debt and payments to lenders soon coming due have jumped at the chance to refinance.

“Depending on your view of the overall economy, this might be a really good opportunity to tap the market,” said John Gregory, the head of leveraged syndicate at Wells Fargo, who works with companies to sell high-yield bonds to investors.

The embattled cruise operator Royal Caribbean raised $1.25 billion on Monday, paying a hefty interest rate of 11.63 percent. The company will use the cash in part to pay back investors that lent it $650 million in 2012, which comes due in November. When it borrowed that money, before the pandemic ground the cruise industry to a halt, the company paid an interest rate of 5.25 percent.

The recent rise in issuance has been aided by four consecutive weeks of cash flowing into funds that buy U.S. high-yield bonds, the longest streak in nearly a year.

“The fear of the market going lower turned into a fear of missing out,” said John McClain, a portfolio manager at Brandywine Global Investment Management.

However, the market has remained closed to the very riskiest issuers. Credit ratings for junk issuers range from BB to CCC, the lowest rung on the scale. (The safest, “investment grade” borrowers are rated BBB up to AAA.) There has only been one CCC-rated deal since the end of April, a $400 million bond from packaging manufacturer Intertape Polymer in June.

On Thursday, S&P Global Ratings said that it expected 3.5 percent of junk issuers to default on their debt in the 12 months through June 2023, more than double the 1.4 percent rate in the year through June 2022. Roughly $90 billion, or 6 percent of the junk bond market, remains in distress — defined as trading at a yield above Treasuries, or “spread,” of more than 10 percentage points — according to ICE Data Services.

Both high-yield bonds and the stock market ended the week somewhat lower than where they started, as a rally that has lifted company valuations and debt prices over the past two months paused.

Investors are split on how aggressive the Federal Reserve will be as it raises interest rates in an attempt to cool the economy by enough to tame inflation but not so much to trigger a severe downturn. Market moves will be driven by investors’ assumptions about “whether we get to a soft landing or whether we see a deeper recession,” said Mr. McClain.

Investors are piling into high-yield bonds. What to know before adding ‘junk’ to your portfolio

PUBLISHED FRI, AUG 12 20222:15 PM EDT, Kate Dore, CFP®

https://www.cnbc.com/2022/08/12/investors-are-piling-into-junk-bonds-what-to-know-before-buying.html

KEY POINTS

· With a recent influx of money pouring into high-yield bonds, financial experts urge caution before piling in.

· High-yield bonds typically have greater default risk than investment-grade bonds because issuers may be less likely to cover interest payments and loans by the maturity date.

After a rocky start to 2022, U.S. high-yield bond funds received an estimated $6.8 billion in net money in July, according to data from Morningstar Direct.

A DAY AGO

While yields have recently dipped to 7.29% as of Aug. 10, interest is still higher than the 4.42% received in early January, according to the ICE Bank of America U.S. High-Yield Index.

However, junk bonds typically have greater default risk than their investment-grade counterparts because issuers may be less likely to cover interest payments and loans by the maturity date.

“It’s a shiny metal on the ground, but all shiny metals are not gold,” said certified financial planner Charles Sachs, chief investment officer at Kaufman Rossin Wealth in Miami.

While some say default risk is built into junk bonds’ higher yields, Sach warns these assets may act more like stocks on the downside.

If an investor feels strongly about buying high-yield bonds, he may suggest a smaller allocation — 3% to 5%, for example. “Don’t think of it as a major food group within your portfolio,” he added.

Neuberger: We’re closer to the end of peak uncertainty, leading investors to get back into the high-yield market

Since March, the Federal Reserve has taken aggressive action to fight inflation, including the second consecutive 0.75 percentage point interest rate hike in July. And these rate hikes may continue with annual inflation still at 8.5%.

At the margin, rising interest rates may make it more difficult for some bond issuers to cover their debt, especially those with maturing bonds that need to refinance, said Matthew Gelfand, a CFP and executive director of Tricolor Capital Advisors in Bethesda, Maryland.

“I think that investors and lenders will demand somewhat higher rates as a result,” he said, noting that rising interest rates may continue for a while.

Coupon rate ‘spread’ is slightly smaller than usual

When assessing high-yield bonds, advisors may compare the “spread” in coupon rates between a junk bond and a less risky asset, such as U.S. Treasurys. Generally, the wider the spread, the more attractive high-yield bonds become.

With high-yield bonds paying 7.29% as of Aug. 10, an investor may receive $72.90 per year on a $1,000 face value bond, whereas the 7-year Treasury, offering about 2.86%, provides $28.60 annually for the same $1,000 bond.

U.S. 7-year Treasury yield year-to-date

In this example, the yield spread is roughly 4.43 percentage points, offering a so-called income premium of $44.30, which is $72.90 from the high-yield bond minus $28.60 from the Treasury.

Over the past 40 years, the average spread between these assets has been about 4.8 percentage points, according to Gelfand, making the slightly narrower spread less attractive.

However, “there are a lot of moving parts in the high-yield bond market,” he added.

FYI: I bond

I Bond: What It Is, How It Works, Where to Buy

By ADAM HAYES Updated September 18, 2022, Reviewed by ROGER WOHLNER, Fact checked by SUZANNE KVILHAUG

https://www.investopedia.com/terms/s/seriesibond.asp

What Is a Series I Bond?

A series I bond is a non-marketable, interest-bearing U.S. government savings bond that earns a combined fixed interest rate and variable inflation rate (adjusted semiannually). Series I bonds are meant to give investors a return plus protection from inflation.

Most Series I bonds are issued electronically, but it is possible to purchase paper certificates with a minimum of $50 using your income tax refund, according to Treasury Direct.

KEY TAKEAWAYS

· A series I bond is a non-marketable, interest-bearing U.S. government savings bond.

· Series I bonds give investors a return plus inflation protection on their purchasing power and are considered a low-risk investment.

· The bonds cannot be bought or sold in the secondary markets.

· Series I bonds earn a fixed interest rate for the life of the bond and a variable inflation rate that is adjusted each May and November.

· These bonds have a 20-year initial maturity with a 10-year extended period for a total of 30 years.

How Do I Bonds Work?

I bonds are issued at a fixed interest rate for up to 30 years, plus a variable inflation rate that is adjusted each May and November. This gives the bondholder some protection from the effects of inflation.

Understanding Series I Bonds

Series I bonds are non-marketable bonds that are part of the U.S. Treasury savings bond program designed to offer low-risk investments. Their non-marketable feature means they cannot be bought or sold in the secondary markets. The two types of interest that a Series I bond earns are an interest rate that is fixed for the life of the bond and an inflation rate that is adjusted each May and November based on changes in the non-seasonally adjusted consumer price index for all urban consumers (CPI-U).

The fixed-rate component of the Series I bond is determined by the Secretary of the Treasury and is announced every six months on the first business day in May and the first business day in November. That fixed rate is then applied to all Series I bonds issued during the next six months is compounded semiannually and does not change throughout the life of the bond.

Like the fixed interest rate, the inflation rate is announced twice a year in May and November and is determined by changes to the Consumer Price Index (CPI), which is used to gauge inflation in the U.S. economy. The change in the inflation rate is applied to the bond every six months from the bond's issue date.

Where Can I Buy Series I Savings Bonds?

U.S. savings bonds, including Series I bonds, can only be purchased online from the U.S. Treasury, using the TreasuryDirect website. You can also use your federal tax refund to purchase Series I bonds.

Credit Suisse in market spotlight despite moves to calm concerns (FYI)

By Oliver Hirt and Michael Shields

https://www.reuters.com/business/finance/credit-suisse-fall-around-10-early-trading-2022-10-03/

Summary

· Credit Suisse caught in market turbulence ahead of revamp

· Shares fell as much as 11.5% before recouping losses

· Bank's euro-denominated bonds reach record lows

· Swiss bank says its capital, liquidity are strong

ZURICH, Oct 3 (Reuters) - Credit Suisse Group AG (CSGN.S) saw its shares slide by as much as 11.5% and its bonds hit record lows on Monday before clawing back some of the losses amid concerns about the lender’s ability to restructure its business without asking for more money.

The situation prompted Swiss regulator FINMA and the Bank of England in London, where the lender has a major hub, to monitor what was happening and work closely together, one source familiar with the matter said.

Some analysts and industry sources said the bank had enough capital and cash to deal with any crises. One analyst said investors feared the bank's ability to execute on a turnaround strategy, which it is due to reveal on Oct. 27.

Broader market malaise is also likely adding to investor worries, they said. Global financial markets have been particularly fragile of late, where rapidly rising interest rates, policy inconsistencies, recession fears and the war in Ukraine have unnerved investors.

"The key issue is the viability of the bank following its upcoming strategic review," wrote ABN AMRO analyst Joost Beaumont, who added that adverse market conditions have raised the "execution risk of any strategic review."

The Bank of England, FINMA and the Swiss finance ministry declined to comment.

Analysts at Citi said that widening credit spreads could exacerbate market fears and damage counterparty confidence, as well as drive funding costs higher.

"In the long-term the further the share price falls the more dilutive any capital raise becomes (and vice versa), which constrains the magnitude of any investment banking restructuring that CS can undertake," the analysts said.

Credit Suisse, one of the largest in Europe and one of Switzerland's global systemically important banks, has had to raise capital, halt share buybacks, cut its dividend and revamp management after losing more than $5 billion from the collapse of investment firm Archegos in March 2021, when it also had to suspend client funds linked to failed financier Greensill.

In July, Credit Suisse announced its second strategy review in a year and replaced its chief executive, bringing in restructuring expert Ulrich Koerner to scale back investment banking and cut more than $1 billion in costs. read more

The bank is considering measures to scale back its investment bank into a "capital-light, advisory-led" business, and is evaluating strategic options for the securitised products business, Credit Suisse has said.

Citing people familiar with the situation, Reuters reported last month that Credit Suisse was sounding out investors for fresh cash as it attempts its overhaul. read more

Credit Suisse shares fell as much as 11.5% before coming off early lows to end down just 1%. Its international bonds also showed the strain, with euro-denominated bonds dropping to record lows before clawing back some losses in the afternoon.

Spreads on Credit Suisse's U.S. dollar bonds were quoted on Monday morning about 40 to 90 basis points wider across their outstanding bonds. Their bonds maturing 2027 were about 365 bps over Treasuries vs 290 bps bid on Friday while the Credit Suisse 6.537% bond maturing August 2033 was bid at 460 bps over Treasuries vs 420 bps on Friday, one syndicate banker said.

"It is pretty ugly for CS bonds," said the banker.

Credit Suisse credit default swaps soared higher on Monday, adding 105 basis points from Friday's close to trade at 355 bps, their highest level in at least more than two decades. The bank's CDS, which measure the cost to insure its bonds, stood at 57 bps at the start of the year.

Bank executives spent the weekend reassuring large clients, counterparties and investors about its liquidity and capital, the Financial Times reported on Sunday. read more

That followed Chief Executive Koerner’s telling staff last week that the bank, whose market capitalisation dropped to a record low of 9.73 billion Swiss francs ($9.85 billion) on Monday, has solid capital and liquidity.

Some investors said they were not panicking.

"They’ll be recapitalised by the public markets if the environment is good in a month or two, or they’ll be backstopped by the Swiss government if the environment is bad," said Thomas Hayes, chairman and managing member of New York-based Great Hill Capital.

LIQUIDITY 'HEALTHY'

JPMorgan analysts said in a research note on Monday that, based on its financials at the end of the second quarter, they view Credit Suisse's capital and liquidity as "healthy".

Given the bank has indicated a near-term intention to keep its CET1 capital ratio at 13% to 14%, the second-quarter end ratio is well within that range and the liquidity coverage ratio is well above requirements, the analysts added.

Credit Suisse had total assets of 727 billion Swiss francs ($735.68 billion) at the end of the second quarter, of which 159 billion francs was cash and due from banks, while 101 billion francs was trading assets, it noted.

Still, investors are questioning how much capital the bank may need to raise to fund the cost of a restructuring, analysts at Jefferies wrote in a note to clients on Monday. Also, the bank is now potentially a forced seller of assets, they said.

Deutsche Bank analysts in August estimated a capital shortfall of at least 4 billion francs.

Credit Suisse seeks to reassure investors of financial strength amid rising concerns

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)

Moody’s sovereign rating list

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.

Category	Definition
AAA	An obligation rated 'AAA' has the highest rating assigned by Standard & Poor's. The obligor's capacity to meet its financial commitment on the obligation is extremely strong.
AA	An obligation rated 'AA' differs from the highest-rated obligations only to a small degree. The obligor's capacity to meet its financial commitment on the obligation is very strong.
A	An obligation rated 'A' is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligations in higher-rated categories. However, the obligor's capacity to meet its financial commitment on the obligation is still strong.
BBB	An obligation rated 'BBB' exhibits adequate protection parameters. However, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity of the obligor to meet its financial commitment on the obligation.
	Obligations rated 'BB', 'B', 'CCC', 'CC', and 'C' are regarded as having significant speculative characteristics. 'BB' indicates the least degree of speculation and 'C' the highest. While such obligations will likely have some quality and protective characteristics, these may be outweighed by large uncertainties or major exposures to adverse conditions.

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

How the credits are assigned?

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:

$ζ$ =1.2A+1.4B+3.3C+0.6D+1.0E

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.
When Altman Z-Score >= 3, it is in Safe Zones.
When Altman Z-Score is between 1.8 and 3, it is in Grey Zones.

https://www.gurufocus.com/term/zscore/DAL/Altman-Z-Score/Delta-Air-Lines-Inc

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)****************** Delta Air Lines 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.

Delta Air Lines'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*-0.1205 + 1.4*-0.0047 + 3.3*0.028 + 0.6*0.2756 + 1.0*0.5587

· = 0.67

Trailing Twelve Months (TTM) ended in Jun. 2022:

· Total Assets was $74,805 Mil.

· Total Current Assets was $17,313 Mil.

· Total Current Liabilities was $26,324 Mil.

· Retained Earnings was $-353 Mil.

· Pre-Tax Income was 1033 + -1200 + -395 + 1532 = $970 Mil.

· Interest Expense was -269 + -274 + -265 + -314 = $-1,122 Mil.

· Revenue was 13824 + 9348 + 9470 + 9154 = $41,796 Mil.

· Market Cap (Today) was $19,569 Mil.

Total Liabilities was $70,994 Mil.

· X1 = Working Capital / Total Assets = (Total Current Assets - Total Current Liabilities) / Total Assets = (17313 - 26324) / 74805 = -0.1205

· X2 = Retained Earnings/ Total Assets = -353 / 74805 = -0.0047

· X3 = Earnings Before Interest and Taxes / Total Assets = (Pre-Tax Income - Interest Expense) / Total Assets = (970 - -1122) / 74805 = 0.028

· X4 = Market Value Equity / Book Value of Total Liabilities = Market Cap / Total Liabilities = 19569.360 / 70994 = 0.2756

· X5 = Revenue / Total Assets = 41796 / 74805 = 0.5587

The zones of discrimination were as such:

· Distress Zones - 1.81 < Grey Zones < 2.99 - Safe Zones

· Delta Air Lines has a Altman Z-Score of 0.67 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.

Delta Air Lines (NYSE:DAL) 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 gene

Let’s see how the Z score affects Delta’s bond rating: https://finra-markets.morningstar.com/BondCenter/Default.jsp

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? Do you think that the repurchase plan helps Ford to improve its credit rating? Please refer to the articles posted in this session.

Ford announces buyback of up to $5 billion in debt (CNBC, youtube)

Refer to the z score posted on gurufocus.com

2. What is Z score? Refer to the Z scores of American airlines, Jet Blue Airlines, and Delta Airlines. Do you think that Delta airline is more likely to default than the other two airlines based on z score? Why or why not?

Hint: search for z scores of the three airlines and compare for z scores.

CCC

An obligation rated 'CCC' is currently vulnerable to nonpayment, and is dependent upon favorable business, financial, and economic conditions for the obligor to meet its financial commitment on the obligation. In the event of adverse business, financial, or economic conditions, the obligor is not likely to have the capacity to meet its financial commitment on the obligation.

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."

Ford to repurchase up to $5 billion in junk bonds as it restructures its balance sheet in hopes of restoring credit rating

PUBLISHED THU, NOV 4 20218:30 AM EDTUPDATED THU, NOV 4 20211:47 PM EDT Michael Wayland

https://www.cnbc.com/2021/11/04/ford-to-repurchase-up-to-5-billion-in-junk-bonds-as-it-restructures-its-balance-sheet.html

Ford is buying back much of the $8 billion in bonds the company issued at the start the coronavirus pandemic at lofty yields of between 8.5% and 9.625%, according to Ford Treasurer Dave Webb. It’s also repurchasing some older bonds at similarly high yields in hopes of upgrading its credit rating, which lost its investment-grade status in March 2020.

Ford expects to fund the buyback with cash on hand, which totaled about $31 billion to end the third quarter. Webb said a $1 billion or more “green” bond could follow as part of a wider effort to “aggressively restructure” its balance sheet under its Ford+ turnaround plan. He said the company is looking to issue 10-year bonds that pay between 3.5% and 4.5%.

“We think it’s the time to aggressively restructure the balance sheet, lower our interest costs, and really clear the decks for 2022 and beyond. That’s really what we’re looking to accomplish here,” Webb told reporters during a call.

The repurchase was announced as part of Ford’s new “sustainable financing framework,” which the automaker is calling a first of its kind for the North American automotive industry. It will focus on vehicle electrification and other environmental and social areas such as clean manufacturing and community revitalization.

It’s a shift for Ford, including its Ford Credit financial subsidiary, as environmental, social and governance, or ESG, investing becomes more popular and a consideration of investors.

The bond repurchase and new framework are aimed at helping to finance the Ford+ plan, including investing tens of billions of dollars into electric and autonomous vehicle technologies.

Webb declined to speculate on when the automaker expects to return to investment grade. He said the company is “intense on getting there as quickly as we possibly can.”

“The actions that we’re taking here on the balance sheet further support that effort and intent. We think they, certainly, should be viewed as a credit positive,” Webb said.

Is Ford's Junk Bond Buyback Good News For Investors?

By Rhian Hunt – Nov 8, 2021 at 8:16AM

https://www.fool.com/investing/2021/11/08/is-fords-junk-bond-buyback-good-news-for-investors/

KEY POINTS

· Ford added $8 billion of what it calls “COVID bonds” during 2020’s lockdown crisis.

· The company was rated as “speculative,” cutting it off from institutional investment.

· It is now buying back its high-yield “junk bonds” and issuing green bonds in their place.

The company is working to regain an investment grade rating and its benefits.

After taking on billions in debt to weather the 2020 economic storms of COVID-19, Ford (F 1.21%) announced on Nov. 4 that it's freeing itself from approximately $5 billion worth of junk bonds through an upcoming buyback. The bonds helped save Ford's bacon when the U.S. government enforced shutdowns last year, but those bonds also pushed it below investment-grade rating.

Now, the company aims to win back that rating -- a step potentially helpful in supporting its aggressive electric vehicle (EV) expansion, and likely bullish for investors much sooner. Let's take a closer look at what's happening.

Striking off the junk bond shackles

Early last year, when the coronavirus arrived on America's shores and lockdowns began crushing the economy, Ford issued $8 billion in bonds, giving itself a substantial cash reserve to survive the crisis. The bond issue served its purpose in this way, but it also caused corporate credit rating agency Standard & Poor's (S&P) to cut Ford's rating to BB+, a "speculative grade" rating rather than "investment grade."

Moody's had already dropped the automaker's rating below the "investment" threshold in September 2020, citing declining new car sales simultaneous with a multi-billion-dollar Ford restructuring.

Fitch Ratings, the third agency, also downgraded the Blue Oval to BB+ in May, specifically noting that the $8 billion bond issue "will leave the company with higher leverage over the longer term, along with a substantial maturity wall in 2023 when the first $3.5 billion [...] comes due." With all three main rating agencies cutting Ford's rating to "speculative" (or, colloquially, "junk"), obtaining additional credit became more difficult and more expensive. Additionally, large institutional investors such as mutual funds, insurance companies, hedge funds, and so on, are typically barred from investing in junk rated companies.

The automotive giant already had a checkered rating history, spending seven years with a junk rating between 2005 and 2012. Its latest move, however, is likely a crucial step in putting the past behind it, adding strength to its Ford+ turnaround strategy and initiatives.

Ford, which currently has $31 billion in cash available, is spending up to $5 billion of that repurchasing junk bonds with yields between 6.375% and 9.98%, according to its press release. Speaking to reporters on Nov. 4, the Blue Oval's treasurer David Webb said that "it's the time to aggressively restructure the balance sheet, lower our interest costs, and really clear the decks for 2022 and beyond," CNBC reports. Webb also stated the company plans to issue 3.5% to 4.5% yield bonds with a 10-year maturity in place of the retired junk bonds. This includes an initial $1 billion in "green" bonds that will enable Ford Credit to give lower-credit car buyers financing.

Feeding into a bigger winning strategy

Crucially, escaping the fetters of its junk bonds and associated junk rating will again open Ford up to cash inflows from major institutional investors. A return to investment-grade rating will therefore likely help ordinary investors in at least two major bullish ways. Most immediately, institutional money flowing back into Ford stock should cause share value to rise, making existing shareholders' holdings more valuable.

In a big-picture sense, though, the move is even more positive for Fools with the Blue Oval in their portfolios. Ford explicitly states that the initiative will help it fund its massive expansion into electric vehicles, with $30 billion earmarked for EV production investment by 2030 and $7 billion going into its six-mile-square "Blue Oval City" factory in Tennessee and several battery-making facilities immediately.

Eschewing the half-hearted approach of some traditional automakers to the electric vehicle revolution, Ford aims to have a fifty-fifty split between EVs and gasoline vehicles in its vehicle lineup by the end of the decade. In addition to already producing some EVs, Ford says it now has more than 160,000 reservations for its Ford F-150 Lightning all-electric pickup truck. For comparison, Tesla (TSLA -3.46%) delivered 101,312 vehicles in total in 2017, and 145,846 Model 3 vehicles (out of a total 245,240 EVs) in 2018.

Ford's electrification push is arguably its most important current strategy, with Tesla's more than $1 trillion valuation highlighting the immense potential of EV sales. Ford is taking decisive large-scale action to be one of the leading electric car stocks once the mass transition from gasoline autos to EVs occurs.

Since its return to investment grade will provide a powerful boost to this electrification strategy (and, likely, share value), the answer to the question "Is Ford's junk bond buyback good news for investors?" appears to be a decisive "Yes."

Ford announces buyback of up to $5 billion in debt (CNBC, youtube)

Part III: Yield curve (or Term structure)

· What is yield curve?

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 have the spreads between UK interest rates and US interest rates widened?

· Why do we need yield curve?

· What can yield curve tell us?

What is yield curve, video

Yield Curve http://finra-markets.morningstar.com/BondCenter/Default.jsp

· For class discussion: How do you describe the shape of the current yield curve as of 10/11/2022?

· Why is the current yield curve not upward slopping?

· What can well tell from the current yield curve about the future economy?

Humped Yield Curve

By JAMES CHEN Updated July 27, 2021, Reviewed by GORDON SCOTT

https://www.investopedia.com/terms/h/humped-yield-curve.asp#:~:text=A%20humped%20yield%20curve%20is,humped%20yield%20curve%20will%20ensue.

What Is a Humped Yield Curve?

A humped yield curve is a relatively rare type of yield curve that results when the interest rates on medium-term fixed income securities are higher than the rates of both long and short-term instruments. Also, if short-term interest rates are expected to rise and then fall, then a humped yield curve will ensue. Humped yield curves are also known as bell-shaped curves.

KEY TAKEAWAYS

· A humped yield curve occurs when medium-term interest rates are higher than both short- and long-term rates.

· A humped curve is uncommon, but may form as the result of a negative butterfly, or a non-parallel shift in the yield curve where long and short-term yields fall more than intermediate one.

· Most often yield curves feature the lowest rates in the short-term, steadily rising over time; while an inverted yield curve describes the opposite. A humped curve is instead bell-shaped.

Humped Yield Curves Explained

The yield curve, also known as the term structure of interest rates, is a graph that plots the yields of similar-quality bonds against their time to maturity, ranging from 3 months to 30 years. The yield curve, thus, enables investors to have a quick glance at the yields offered by short-term, medium-term, and long-term bonds. The short end of the yield curve based on short-term interest rates is determined by expectations for the Federal Reserve policy; it rises when the Fed is expected to raise rates and falls when interest rates are expected to be cut. The long end of the yield curve is influenced by factors such as the outlook on inflation, investor demand and supply, economic growth, institutional investors trading large blocks of fixed-income securities, etc.

The shape of the curve provides the analyst-investor with insights into the future expectations for interest rates, as well as a possible increase or decrease in macroeconomic activity. The shape of the yield curve can take on various forms, one of which is a humped curve.

When the yield on intermediate-term bonds is higher than the yield on both short-term and long-term bonds, the shape of the curve becomes humped. A humped yield curve at shorter maturities has a positive slope, and then a negative slope as maturities lengthen, resulting in a bell-shaped curve. In effect, a market with a humped yield curve could see rates of bonds with maturities of one to 10 years trumping those with maturities of less than one year or more than 10 years.

Humped vs. Regular Yield Curves

As opposed to a regularly shaped yield curve, in which investors receive a higher yield for purchasing longer-term bonds, a humped yield curve does not compensate investors for the risks of holding longer-term debt securities.

For example, if the yield on a 7-year Treasury note was higher than the yield on a 1-year Treasury bill and that of a 20-year Treasury bond, investors would flock to the mid-term notes, eventually driving up the price and driving down the rate. Since the long-term bond has a rate that is not as competitive as the intermediate-term bond, investors will shy away from a long-term investment. This will eventually lead to a decrease in the value of the 20-year bond and an increase in its yield.

Types of Humps

The humped yield curve does not happen very often, but it is an indication that some period of uncertainty or volatility may be expected in the economy. When the curve is bell-shaped, it reflects investor uncertainty about specific economic policies or conditions, or it may reflect a transition of the yield curve from a normal to inverted curve or from an inverted to normal curve. Although a humped yield curve is often an indicator of slowing economic growth, it should not be confused with an inverted yield curve. An inverted yield curve occurs when short-term rates are higher than long-term rates or, to put it another way, when long-term rates fall below short-term rates. An inverted yield curve indicates that investors expect the economy to slow or decline in the future, and this slower growth may lead to lower inflation and lower interest rates for all maturities.

When short-term and long-term interest rates decrease by a greater degree than intermediate-term rates, a humped yield curve known as a negative butterfly results. The connotation of a butterfly is given because the intermediate maturity sector is likened to the body of the butterfly and the short maturity and long maturity sectors are viewed as the wings of the butterfly.

Introduction to the yield curve (Khan academy)

What is the Yield Curve, and Why is it Flattening? (video)

Summary of Yield Curve Shapes and Explanations

Normal Yield Curve
When bond investors expect the economy to hum along at normal rates of growth without significant changes in inflation rates or available capital, the yield curve slopes gently upward. In the absence of economic disruptions, investors who risk their money for longer periods expect to get a bigger reward — in the form of higher interest — than those who risk their money for shorter time periods. Thus, as maturities lengthen, interest rates get progressively higher and the curve goes up.

Steep Curve – Economy is improving
Typically the yield on 30-year Treasury bonds is three percentage points above the yield on three-month Treasury bills. When it gets wider than that — and the slope of the yield curve increases sharply — long-term bond holders are sending a message that they think the economy will improve quickly in the future.

Inverted Curve – Recession is coming
At first glance an inverted yield curve seems like a paradox. Why would long-term investors settle for lower yields while short-term investors take so much less risk? The answer is that long-term investors will settle for lower yields now if they think rates — and the economy — are going even lower in the future. They're betting that this is their last chance to lock in rates before the bottom falls out.

Flat or Humped Curve

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)

Animated yield curve 1965 – 2022 (video, FYI)

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?

· ……

YieldCurve.com	Yield Curve figures updated weekly since October 2003 For historical animated yield curve data use drop-down menu
UK Gilt	6 Month	1 Year	2 Year	5 Year	10 Year	30 Year
October 14, 2019	0.74	0.66	0.53	0.48	0.69	1.16
October 7, 2019	0.74	0.46	0.35	0.26	0.45	0.95
US Treasury	3 Month	6 Month	2 Year	5 Year	10 Year	30 Year
October 14, 2019	1.69	1.68	1.60	1.56	1.73	2.20
October 7, 2019	1.70	1.65	1.41	1.35	1.53	2.01

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.

What The Heck Is An Inverted Yield Curve? And Why Does It Predict A Recession?

Q.ai - Powering a Personal Wealth MovementContributor, Sep 26, 2022,11:12am EDT

https://www.forbes.com/sites/qai/2022/09/26/what-the-heck-is-an-inverted-yield-curve-and-why-does-it-predict-a-recession/?sh=15ea6cd93eb6

Key takeaways

· A yield curve sheds light on what many people view as the economy's current state and may be used to forecast changing business dynamics, particularly a downturn.

· Always be aware that the yield curve is an indicator, not a forecast. Using the yield curve as the only point of data will not paint a complete picture.

· That said, an inverted yield curve has accurately predicted the ten most recent recessions.

· There has been so much emphasis on interest rates lately. The truth, however, is far more complicated, with rates on individual bonds frequently behaving very differently based on their maturity dates. This article will explain a yield curve's importance and whether an inverted yield curve means a recession is coming.

What is a yield curve?

A yield curve can be drawn for any type of bond, from corporate bonds to municipal bonds. Let's go over the fundamentals of yield curves, using the U.S. Treasury yield curve as an example.

Whenever people buy Treasury securities, they effectively provide the government with funds. Simply stated, this is a loan. In return, the Treasury pledges to repay its investors after a certain amount of time (known as maturity) and offers investors a predetermined rate of loan interest, known as the coupon.

While the coupon on a U.S. Treasury bond doesn't fluctuate with time, the yield on the bond will. This is because yield accounts for the continually fluctuating values of Treasurys in the secondary market.

The yield to maturity is the rate of return of all the cashflow earned from a bond, including coupon and principal repayment. The yield to maturity is inversely proportional to the bond price. If the bond price decreases, its yield to maturity increases.

On an X/Y graph, the horizontal X axis measures maturity. In the particular instance of the U.S. Treasury yield curve, the X axis begins on the left with short-term Treasury notes of maturities ranging from a few days up to a year, then moves to Treasury notes with maturities ranging from one to 10 years, and settles down on the right with bond maturities ranging from 20 to 30 years.

The current yield for every maturity is on the vertical Y axis, with the lowest yield at the bottom and higher yields at the top. A normal yield curve is upwards sloping. This is because investors need to be paid more for investing their money over a longer term. There is more risk in these investments, so the yield has to be higher.

What does a yield curve tell investors?

A yield curve sheds light on what many people view as the economy's current state and may be used to forecast changing business dynamics. The yield curve effectively represents the view of most market players, so it provides a reasonably accurate picture of what is happening within the economy.

If the market players are worried about potential economic growth, short-term yields will rise as investors look to invest in longer-term bonds. Additionally, short-term yields will rise if the Federal Reserve increases interest rates, as the federal funds rate highly impacts shorter maturity bonds.

During normal economic expansion, short-term yields will be lower, and long-term yields will head higher. Seems simple enough?

What happens when the yield curve inverts?

An inverted yield graph illustrates that long-term interest rates are less than short-term lending rates. Instead of the rate increasing as you move the maturity date further out, the yield actually decreases. Economists interpret this as a warning sign for a recession in the economy.

We are currently observing a major inversion of the yield curve with the 1-year treasury now 50 bps above the 10-year treasury yield.

A true inverted yield curve is not common. More common is a flattening of the yield curve. This means there is uncertainty as to which way the economy is headed, towards expansion or recession.

Does an inverted yield curve mean there is a recession?

Does an inverted yield curve indicate that a stock market drop and economic strife is coming? Very honestly, there is merit to this idea. In fact, an inverted yield curve has accurately predicted the ten most recent recessions.

With that said, the yield curve doesn't cause downturns. Instead, it represents how investors see the trajectory of the U.S. economy. If people believe a slump is imminent, they will rush to buy long-term U.S. bonds.

When there are many buyers of long-term treasuries in a short time, the yield drops. Since there is less demand for shorter-term treasuries, the yield increases. The Federal Reserve also plays a part here. Short-term bonds will increase their yields if they begin to raise interest rates. This will naturally flatten the yield curve as the yield on longer-term bonds stays the same.

Rising interest rates and the yield curve

If long-term interest rates drop past short-term interest rates, the yield curve inverts and slides downwards. Long-term investors invest in longer-term bonds because of the uncertainty and risk surrounding the stock market in the near term. They would rather invest in a long-term bond and lock in a yield than risk losing money investing in more volatile stocks.

The shrinking yield spread between short- and long-term lending rates is a flattened yield curve. Whenever this occurs, the price of the bonds fluctuates accordingly. If the bond has a three-year maturity, and the three-year yield falls, the bond's price will rise. The bonds price changes to keep parity with changing rates and existing bonds in the secondary market.

A flattened yield curve might indicate economic weakening because interest rates and inflation will remain low for some time. Investors anticipate modest growth in the economy, and bank lending slows.

When the yield curve steepens, the difference between short-term and long-term bond interest rates increases. This means that long-term bond yields are going up faster than short-term bond rates, or short-term bond yields are declining while long-term bond yields increase. As a result, long-term bond prices will fall compared to short-term bond prices.

A steepening graph upward usually signals more economic growth and inflationary expectations, which results in increased lending rates. A 2-year note with a 1.5% yield and a 20-year note with a 3.5% yield is one example of a steepening yield curve.

The bottom line

The yield curve is an indicator, not a forecast. Using the yield curve as the only point of data will not paint a complete picture. You need to look at the economy as a whole, along with the trend of inflation, the creation of new jobs, wage growth and what the Federal Reserve says. Only then can you make educated guesses about the economy's future direction.

As we said above, the yield curve is a key economic indicator tied closely to recessions, but it’s still only one piece of the puzzle. There are many strategies and tactics available to investors looking for ways to beat the market during times of high inflation, or even a recession. For instance, Q.ai takes the guesswork out of investing.

Our artificial intelligence scours the markets for the best investments for all manner of risk tolerances and economic situations. Then, it bundles them up in handy Investment Kits that make investing simple and – dare we say it – fun.

Best of all, you can activate Portfolio Protection at any time to protect your gains and reduce your losses, no matter what industry you invest in.

********* 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

· https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/treasury-yield-curve-steepens-to-4-year-high-as-investors-bet-on-growth-rebound-62067561

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. SNL Image

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.

SNL Image

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."

SNL Image

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."

SNL Image

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 “What The Heck Is An Inverted Yield Curve? And Why Does It Predict A Recession?” and other articles posted in this chapter, 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)

2. "Inverting yield curves, rising inflation, weakening housing data, and slumping surveys have all driven the increase (in recession probability) in the US," wrote Credit Suisse analysts in a research note on Tuesday, forecasting that the probability of the United States being in recession 6 and 12 months ahead is approximately 25%.

· What is your prediction about the likelihood of a mild recession in 2023?

3. Goto https://www.treasury.gov/resource-center/data-chart-center/interest-rates/pages/textview.aspx?data=yield

Based on the rates on Treasury securities provided by the Fed, draw a yield curve of any day in October 2022.

And discuss: the shape of the yield curve, its implication on future economy.

4. What is the Steepen Yield Curve? Under what state of the economy will a steepen yield curve occur? Can the steepen yield curve appear in the rest of 2022? What about 2023? Why or why not?

Explainer: U.S. yield curve inverts again: What is it telling us?

By David Randall and Davide Barbuscia

https://www.reuters.com/markets/us/us-yield-curve-inverts-again-what-is-it-telling-us-2022-07-05/

NEW YORK, July 5 (Reuters) - A closely watched part of the U.S. Treasury yield curve inverted again on Tuesday, as investors continue to price in the chance that the Federal Reserve's aggressive move to bring down inflation will push the economy into recession.

Yields on two-year Treasuries briefly rose above those of 10-year Treasuries for the third time this year, a phenomenon known as a yield curve inversion that has in the past preceded U.S. recessions.

It comes amid a chorus of growth warnings on Wall Street, as a Fed intent on bringing inflation down from more than 40-year highs sets the course for aggressive monetary policy tightening that investors fear will also hurt U.S. growth.

Here is a quick primer on what a steep, flat or inverted yield curve means, how it has predicted recession, and what it might be signaling now.

WHAT SHOULD THE CURVE LOOK LIKE?

The U.S. Treasury finances federal government budget obligations by issuing various forms of debt. The $23 trillion Treasury market includes bills that mature in one month to one year, two- to 10-year notes, and 20- and 30-year bonds.

The yield curve, which plots the return on all Treasury securities, typically slopes upward as the payout increases with the duration. Yields move inversely to prices.

A steepening curve typically signals expectations for stronger economic activity, higher inflation, and higher interest rates. A flattening curve can mean investors expect near-term rate hikes and are pessimistic about economic growth.

WHAT DOES AN INVERTED CURVE MEAN?

Investors watch parts of the yield curve as recession indicators, primarily the spread between three-month Treasury bills and 10-year notes , and the two- to 10-year (2/10) segment .

On Tuesday, yields on two-year Treasuries rose as high as 2.95%, while the 10-year stood at 2.94%. The two-year, five-year part of the curve also inverted for the first time since February 2020.

The inversions suggest that while investors expect higher short-term rates, they may be growing nervous about the Fed’s ability to control inflation without hurting growth, even though policymakers say they are confident in achieving a so-called "soft landing" for the economy

The Fed has already raised rates by 150 basis points this year, including a jumbo-sized, 75 basis point increase last month.

The two- to 10-year segment of the yield curve inverted in late March for the first time since 2019 and again in June.

The U.S. curve has inverted before each recession since 1955, with a recession following between six and 24 months, according to a 2018 report by researchers at the San Francisco Fed. It offered a false signal just once in that time. That research focused on a slightly different part of the curve, between one- and 10-year yields.

Anu Gaggar, Global Investment Strategist for Commonwealth Financial Network, found that the 2/10 spread has inverted 28 times since 1900. In 22 of these instances, a recession followed, she said in June.

For the last six recessions, a recession on average began six to 36 months after the curve inverted, she said.

Before March, the last time the 2/10 part of the curve inverted was in 2019. The following year, the United States entered a recession, which was caused by the pandemic.

WHAT DOES THIS MEAN FOR THE REAL WORLD?

While rate increases can be a weapon against inflation, they can also slow economic growth by raising borrowing costs for everything from mortgages to car loans.

The yield curve also affects consumers and business.

When short-term rates increase, U.S. banks raise benchmark rates for a wide range of consumer and commercial loans, including small business loans and credit cards, making borrowing more costly for consumers. Mortgage rates also rise.

When the yield curve steepens, banks can borrow at lower rates and lend at higher rates. When the curve is flatter their margins are squeezed, which may deter lending.

Analysis: U.S. yield curve flashing more warning signs of recession risks ahead

By Davide Barbuscia, 7/28/2022

https://www.reuters.com/world/us/us-yield-curve-flashing-more-warning-signs-recession-risks-ahead-2022-07-27/

NEW YORK, July 27 (Reuters) - The U.S. government bond market is sending a fresh batch of signals that investors are increasingly convinced the Federal Reserve's aggressive actions to tame inflation will result in recession.

The shape of the yield curve, which plots the return on all Treasury securities, is seen as an indicator of the future state of health of the economy, as inversions of the curve have been a reliable sign of looming recession.

While Fed Chair Jerome Powell on Wednesday said that he does not see the economy currently in a recession, spreads between different pairings of Treasury securities - and derivatives tied to them - have in past weeks moved into or toward an "inversion" when the shorter dated of the pair yields more than the longer one. These join another widely followed yield spread relationship - between 2- and 10-year notes - that has been in inversion for most of this month. read more

"Curves are flattening and some are negative. They're ultimately all telling you the same thing," said Eric Theoret, global macro strategist at Manulife Investment Management.

A steepening curve typically reflects expectations of stronger economic activity, higher inflation and interest rates. A flattening curve can signal expectations of rate hikes in the near term and a weaker economic outlook.

The Fed is aiming to achieve a so-called "soft landing" that does not entail an outright contraction in U.S. economic output and the rise in joblessness that typically accompanies that. But the moves in the bond market over the past week show waning confidence in the Fed's ability to achieve so benign an outcome.

Some of those moves reversed slightly on Wednesday, with rates at the short end of the curve turning lower on expectations of the Fed being less likely to continue with super-sized hikes.

On Wednesday the Fed raised its benchmark overnight interest rate by 0.75% to a range of between 2.25% and 2.50% as it flagged weakening economic data. Powell said on Wednesday that achieving a soft landing for the economy was challenging.

The curve is indicating that the Fed will have to start cutting rates after hiking.

The part of the U.S. Treasury yield curve that compares yields on two-year Treasuries with yields on 10-year government bonds has been inverted for most of the past month and is around the most negative its been since 2000 on a closing price basis.

Powell, however, has in recent months said that the short-end of the yield curve was a more reliable warning of an upcoming recession.

"The first 18 months of the yield curve has 100% of the explanatory power of the yield curve, and it makes sense ... because if it's inverted that means the Fed is going to cut which means the economy is weak", he said in March.

Some analysts pointed to another measure, the differential between what money markets expect the three-month federal funds rate to be in 18 months and the current three-month federal funds rate. That went briefly into negative territory on Tuesday, said George Goncalves, head of U.S. Macro Strategy at MUFG.

That spread - measured through overnight indexed swap (OIS) rates, which reflect traders' expectations on the federal funds rate - was about 230 basis points in March.

"It's very similar to looking at the Treasury curve, these are all curves that trade with tiny spreads with each other," said Subadra Rajappa head of U.S. rates strategy at Societe Generale.

Another measurement of the curve, the 2-year forward rate for 3-month bills , is around the flattest since June 2021.

Fed economists have said that near-term forward yield spreads - namely the differential between the three-month Treasury yield and what the market expects that yield to be in 18 months - are more reliable predictors of a recession than the differential between long-maturity Treasury yields and their short-maturity counterparts.

That spread has not gone negative, though it has narrowed significantly from over 250 basis points in March to about 70 basis points this week, said MUFG's Goncalves.

Another part of the curve that compares the yield on three-month Treasury bills and 10-year notes has flattened dramatically over the past few weeks, from nearly 220 basis points in May to around 15 basis points this week although it steepened after Powell's remarks.

Separately, futures contracts tied to the Fed's policy rate showed this week that benchmark U.S. interest rates will peak in January 2023, earlier than the February reading they gave last week. read more

"Inverting yield curves, rising inflation, weakening housing data, and slumping surveys have all driven the increase (in recession probability) in the US," wrote Credit Suisse analysts in a research note on Tuesday, forecasting that the probability of the United States being in recession 6 and 12 months ahead is approximately 25%.

"It is likely recession probabilities rise further in the coming months if policy rate hikes cause further curve inversion and cyclical data continue to deteriorate," they added.

Benchmark bond yields are ‘bad news’ for investors as the Fed hikes rates by 0.75%. What it means for your portfolio

PUBLISHED WED, SEP 21 20222:00 PM EDTUPDATED WED, SEP 21 20223:32 PM EDT, Kate Dore, CFP®

https://www.cnbc.com/2022/09/21/what-the-inverted-yield-curve-means-for-your-portfolio-.html

KEY POINTS

· Ahead of news from the Federal Reserve on Wednesday, the 2-year Treasury yield climbed to 4.006%, the highest level since October 2007, and the 10-year Treasury reached 3.561% after hitting an 11-year high this week.

· When shorter-term government bonds have higher yields than long-term, which is known as yield curve inversions, it’s viewed as a warning sign for a future recession.

· “Higher bond yields are bad news for the stock market and its investors,” said certified financial planner Paul Winter, owner of Five Seasons Financial Planning.

· Young woman analyzing bills while writing in diary.

“Higher bond yields are bad news for the stock market and its investors,” said certified financial planner Paul Winter, owner of Five Seasons Financial Planning in Salt Lake City.

Higher bond yields create more competition for funds that may otherwise go into the stock market, Winter said, and with higher Treasury yields used in the calculation to assess stocks, analysts may reduce future expected cash flows.

What’s more, it may be less attractive for companies to issue bonds for stock buybacks, a way for profitable companies to return cash to shareholders, Winter said.

How Federal Reserve rate hikes affect bond yields

Market interest rates and bond prices typically move in opposite directions, which means higher rates cause bond values to fall. There’s also an inverse relationship between bond prices and yields, which rise as bond values drop.

Fed rate hikes have somewhat contributed to higher bond yields, Winter said, with the impact varying across the Treasury yield curve.

Markets will see higher 10-year treasury yields, says Komal Sri-Kumar

“The farther you move out on the yield curve and the more you go down in credit quality, the less Fed rate hikes affect interest rates,” he said.

That’s a big reason for the inverted yield curve this year, with 2-year yields rising more dramatically than 10-year or 30-year yields, he said.

Consider these smart moves for your portfolio

It’s a good time to revisit your portfolio’s diversification to see if changes are needed, such as realigning assets to match your risk tolerance, said Jon Ulin, a CFP and CEO of Ulin & Co. Wealth Management in Boca Raton, Florida.

On the bond side, advisors watch so-called duration, measuring bonds’ sensitivity to interest rate changes. Expressed in years, duration factors in the coupon, time to maturity and yield paid through the term.

Above all, investors must remain disciplined and patient, as always, but more specifically if they believe rates will continue to rise.

While clients welcome higher bond yields, Ulin suggests keeping durations short and minimizing exposure to long-term bonds as rates climb. “Duration risk may take a bite out of your savings over the next year regardless of the sector or credit quality,” he said.

Winter suggests tilting stock allocations toward “value and quality,” typically trading for less than the asset is worth, over growth stocks, that may be expected to provide above-average returns. Often, value investors are seeking undervalued companies expected to appreciate over time.

“Above all, investors must remain disciplined and patient, as always, but more specifically if they believe rates will continue to rise,” he added.

Chapter 5 Diversification – Part I Diversification, S&P500 Index

ppt

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. Joe McNay Investment Story - Financial Markets by Yale University #6 (youtube)

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? (please refer to the following paper)

S&P 500 Companies by Weight

The S&P 500 component weights are listed from largest to smallest. Data for each company in the list is updated after each trading day. The S&P 500 index consists of most but not all of the largest companies in the United States. The S&P market cap is 70 to 80% of the total US stock market capitalization. It is a commonly used benchmark for stock portfolio performance in America and abroad. Beating the performance of the S&P with less risk is the goal of nearly every portfolio manager, hedge fund and private investor.

=========================================================================

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?

Ticker	Company Name	6/30/2019	12/31/2018	12/31/2017	12/31/2016	12/31/2015	12/31/2014
MSFT	Microsoft Corp.	4.20%	3.73%	2.89%	2.51%	2.48%	2.10%
AAPL	Apple Inc.	3.54%	3.38%	3.81%	3.21%	3.28%	3.55%
AMZN	Amazon.com Inc.	3.20%	2.93%	2.05%	1.54%	1.45%	0.65%
FB	Facebook Inc.	1.90%	1.50%	1.85%	1.40%	1.33%	0.72%
BRK.B	Berkshire Hathaway Inc	1.69%	1.89%	1.67%	1.61%	1.38%	1.51%
JNJ	Johnson & Johnson	1.51%	1.65%	1.65%	1.63%	1.59%	1.61%
GOOG	Alphabet Inc. Class C	1.36%	1.52%	1.39%	1.19%	1.26%	0.85%
GOOGL	Alphabet Inc. Class A	1.33%	1.49%	1.38%	1.22%	1.27%	0.84%
XOM	Exxon Mobil Corp.	1.33%	1.37%	1.55%	1.94%	1.81%	2.16%
JPM	JPMorgan Chase & Co.	1.48%	1.54%	1.63%	1.60%	1.36%	1.29%
V	Visa Inc.	1.23%	1.10%	0.91%	0.76%	0.84%	0.56%
PG	Procter & Gamble Co	1.13%	1.09%	1.03%	1.17%	1.21%	1.36%
BAC	Bank of America Corp.	1.05%	1.07%	1.26%	1.16%	0.98%	1.04%
VZ	Verizon Communications Inc	0.97%	1.11%	0.95%	1.13%	1.05%	1.07%
INTC	Intel Corp.	0.88%	1.02%	0.95%	0.89%	0.91%	0.95%
CSCO	Cisco Systems Inc	0.96%	0.93%	0.83%	0.79%	0.77%	0.78%
UNH	UnitedHealth Group Inc	0.95%	1.14%	0.94%	0.79%	0.63%	0.53%
PFE	Pfizer Inc.	0.98%	1.20%	0.95%	1.02%	1.11%	1.08%
CVX	Chevron Corp.	0.97%	0.99%	1.04%	1.15%	0.95%	1.17%
T	AT&T Inc.	1.00%	0.99%	1.05%	1.36%	1.18%	0.96%
HD	Home Depot Inc	0.94%	0.92%	0.97%	0.85%	0.94%	0.76%
MRK	Merck & Co Inc	0.88%	0.95%	0.67%	0.84%	0.82%	0.89%
MA	Mastercard Inc.	0.97%	0.82%	0.62%	0.51%	0.54%	0.45%
BA	Boeing Co.	0.78%	0.81%	0.72%	0.46%	0.51%	0.48%
WFC	Wells Fargo & Co	0.78%	0.93%	1.18%	1.29%	1.41%	1.43%

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
Basically, to determine the weights of each of your stocks, you'll need two pieces of information. First, you'll need the cash values of each of the individual stocks you want to find the weight of.

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
These weights tell you how dependent your portfolio's performance is on each of your individual stocks. For example, your portfolio's day-to-day fluctuations will depend much more on a stock that makes up 20% of the total than one that only makes up 5%.

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
Let's say that you own the following stock investments: $2,000 of Microsoft, $3,000 of Wal-Mart, $2,500 of Wells Fargo, and $4,000 of Johnson & Johnson. A quick calculation shows that your total portfolio value is $11,500, and using the formula mentioned earlier, you can calculate the weights of each of your four stocks:

Stock	Cash Value	Weight
Microsoft	$2,000	17.4%
Wal-Mart	$3,000	26.1%
Wells Fargo	$2,500	21.7%
Johnson & Johnson	$4,000	34.8%

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.

Best stocks by year-to-date performance 10/17/2022

Symbol	Company Name	Price Performance (This Yr)
OXY	Occidental Petroleum Corp.	111.97%
EQT	EQT Corp.	86.84%
MPC	Marathon Petroleum Corp.	55.23%
ENPH	Enphase Energy Inc.	51.67%
HES	Hess Corp.	47.22%
XOM	Exxon Mobil Corp.	42.69%
VLO	Valero Energy Corp.	42.26%
COP	Conocophillips	41.78%
MRO	Marathon Oil Corp.	37.52%
CTRA	Coterra Energy Inc.	37.47%
MCK	McKesson Corp.	36.73%
DVN	Devon Energy Corp.	36.50%

https://www.nerdwallet.com/article/investing/best-performing-stocks

Worst stocks by year-to-date performance 10/17/2022

https://www.statmuse.com/money/ask/worst+performing+stocks+in+the+s%26p+500+in+2022

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, respectively)

· 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 19^th, 2017” and “Oct 19^th, 2022”, 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 2017 – Sept 2022)

2. Calculate the most recent weight of Apple in SP500. Also calculate the weight of GOOGLE, Amazon, Netflix.

Hint: please use 30.079 trillion (30,079,000,000,000) as of October 17, 2022 for SP500 market cap. The website for this information is here: https://www.slickcharts.com/sp500/marketcap (Hint collect stock price, total shares outstanding. Market value = stock price * shares outstanding. Market value of each stock / 30.079 trillion = weight of the stock in S&P500 index)

3. Do you agree with the author of “The S&P 500 is down over 20% this year—here’s why it’s smart to keep investing anyway”. Do you think that it is a good opportunity to invest in the stock market?

FYI: Invest Now or Wait for the Stock Market to CRASH MORE (youtubve)

4. Optional question - Compare the above top 8 best and worst stocks in 2022 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 (optional)

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.

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?

The S&P 500 is down over 20% this year—here’s why it’s smart to keep investing anyway

Published Tue, Oct 4 20222:59 PM EDT, Ryan Ermey

https://www.cnbc.com/2022/10/04/why-its-smart-to-keep-investing-during-a-garden-variety-bear-market.html

This year is currently looking like one of the roughest ever for the stock market.

Through the first nine months of 2022, the S&P 500 index lost 23.9%. Only five full calendar years have produced worse returns: three years from the Great Depression, 2008 and 1974.

But if market history paints a dire picture for what’s gone on so far this year, it also offers a silver lining for long-term investors. Bear markets like the current one tend to be short, and investors who keep their cool tend to make out alright.

That’s what Charles Rotblut, vice president at the American Association of Individual Investors, pointed out in a recent tweet. “Not only is the current bear market well within the typical range of past bears, those who stick w/ their allocations get rewarded for doing so,” he wrote.

The data he’s referencing is from CFRA chief investment strategist Sam Stovall, who analyzed 13 bear markets — defined as a decline of 20% or more from market peaks — dating back to 1945.

The current bear falls under what Stovall calls “garden variety” bear markets — those that feature a stock market slide between 20% and 40%. The others he calls “mega-meltdown” bears, which saw drawdowns of more than 40%.

The latter sort are especially tough for investors, lasting for just short of two years on average, with an average decline of 51%.

The garden-variety bear is somewhat less intimidating. The average drawdown during these periods is 27%, and they tend to last for 13 months on average. And importantly for investors, it took only 27 months for stocks to return to their peaks after these down periods, on average. That compares with an average recovery time of nearly five years for the harsher bears.

Two years may seem like a long time to stare down red numbers in your portfolio, and five may seem like an eternity. But if you’re invested for decades, a period of a few years is a blip.

More importantly, you’d be wise to add to your portfolio during down markets, rather than selling, says Rotblut.

“Have you ever looked at the chart and thought, ‘I wish I bought that stock when it was down at this price?’ Then why aren’t you buying now?” he says. “No one knows where the bottom is, but we do know stocks are on sale right now.”

The bottom of the market could be well into the future, and selling now before things get worse could, in the long run, boost your returns. But it would most likely be a mistake, experts say, for two reasons.

One: Even if you’re right about the market going down further, selling now would require you to peg the right time to get back in in order to turn a profit. “If you’re going to cash, what is your rule for getting back into the market? What are you going to use as your marker? And what happens if you don’t act then?” says Rotblut.

Timing the market is extraordinarily difficult, and getting it wrong could cripple your returns. A $10,000 investment in a fund tracking the S&P 500 at the end of 2006 would have grown to nearly $46,000 by the end of 2021, according to Putnam Investments.

But subtract the 10 best days from that 15-year period, and the total declines to about $21,000. “Time, not timing, is the best way to capitalize on stock market gains,” Putnam researchers say.

The other reason: Although past returns are no guarantee of future results, markets have historically rewarded investors for buying into the market after it’s had the kind of slide investors have seen so far this year.

As measured by the Wilshire 5000 — a broad U.S. stock market index — the first nine months of 2022 rank among the worst 20 nine-month periods of the last half century, according to data from Compound Capital Advisors.

In all but one of those instances, the index logged a positive return in the one-year period following the nine-month decline, with an average return of 12%. Over the next three years, the index was positive each time, with an average gain of 41%.

Simply put in a tweet from Compound CEO Charlie Bilello: “Has selling AFTER large 9-month declines been a good strategy for long-term investors in the past? No.”

Chapter 5 Part II – Mutual Funds and ETF

Mutual fund ppt

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.

Investment risk tolerant test

Discussion: Based on your risk tolerant score, which of the follow shall you choose? Why?

Example: Optimally diversified portfolio

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 (Exchange Traded Fund)

Discussion: What is the difference between the two? Pro and con of each?

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?

For class discussion:

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?

ETF trading (Video)

Exchange traded funds (ETFs) (Khan academy)

Ponzi schemes (Khan academy)

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?

QQQ is rebalanced quarterly and reconstituted annually

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

SPY vs. QQQ: Which ETF Wins in 2022?

Since the bull-market friendly QQQ has beat SPY more often than not over the last 20 years, it should never be counted out.

By MarketBeat Staff, September 6, 2022

https://www.entrepreneur.com/finance/spy-vs-qqq-which-etf-wins-in-2022/434753

Barring a miraculous late year run, the major indices will finish in the red for the first time since 2018. That means the ETFs that track them, will drag down many investment account values after three years of double-digit gains.

Over the next four months, two of the most popular ETFs, the SPDR S&P 500 ETF Trust (NYSEARCA:SPY) and the Invesco QQQ Trust (NASDAQ:QQQ) will be battling it out for the dubious honor of 2022 ‘winner’. Together the funds hold more than $500 billion in investor assets.

Last year’s race came down to the wire with SPY sticking its nose out for a 28.7% to 27.4% victory. It ended a four-year winning streak for QQQ including 2020’s 48.4% to 18.3% drubbing.

Despite their potential to produce dramatically different returns, SPY and QQQ do have a lot in common. Since 2000, the correlation of their annual returns is a remarkably high 0.92. That makes sense considering more than three-fourths of QQQ’s holdings are also in SPY—and the top holdings are very similar.

Yet there also some subtle differences that can account for major performance disparities. It is these differences that will determine if SPY (down 17.4% year-to-date) holds its lead on QQQ (down 25.8%) and notch its first back-to-back title since 2005-2006.

#1 Risk-On or Risk-Off?

If the economy fends off recessionary pressures and inflation shows signs of cooling this would likely be a welcomed development for equity investors. In turn, a less hawkish Fed would be icing on the cake. This could lead to improved consumer confidence and market sentiment. The opposite scenario of persistent inflation, deep recession, and aggressive Fed policy could make things worse.

In the bullish case, stocks would return to “risk-on” mode. The advantage would go to QQQ. Why? The Nasdaq-100 index tends to do better when markets head higher. This reflects the higher risk nature of its components and its 1.29 beta relative to the broad U.S. market. Under the bearish scenario, the less risky S&P 500 tracked by the SPY would probably outperform.

#2 Sector Performance

We often hear the Nasdaq called the ‘tech-heavy’ index and indeed it is. Almost half of its weight is in the technology sector. In the S&P 500, technology names account for around one-fourth of the benchmark.

In both cases technology is the largest sector weighting, but it is the double weighting in QQQ that accounts for much of its day-to-day return differences with SPY. Tech has been the worst performing sector so far this year and a big reason why QQQ is lagging. More of the same would all but clinch a W for SPY, while a fourth quarter tech rally is QQQ’s best hope for a dramatic comeback win.

The energy sector could also be a factor. By far the best performing economic group year-to-date, even SPY’s 4% energy weighting could contribute to outperformance. There are no energy names in QQQ.

Then there are financials. They are the third largest sector in SPY at a 13% weighting but represent less than 1% of QQQ. Strong bank earnings reports boosted by higher interest rates could really help SPY distance itself from QQQ.

#3 Big Stock Influencers

At the individual stock level, SPY and QQQ appear to be close cousins when comparing their respective top holdings. In fact, the top five are identical—Apple, Microsoft, Amazon, Tesla, and Alphabet. What isn’t identical though is how much the big five are weighted in each fund. They command more than 40% of the QQQ portfolio. In SPY their combined weighting is a more diluted 22%.

This means that the relative weighting of these lead horses can create some major return differences. Apple is the prime example. It has a 13.7% weight in QQQ and a 7.3% weight in SPY, a difference of 6.4%. So, when Apple shares outperform the S&P 500, the Nasdaq, and thereby QQQ, has a good chance to outperform.

The same goes for stocks like Microsoft, Amazon, and Tesla which have significantly larger weights in QQQ. Unfortunately for QQQ investors, all three have underperformed SPY year-to-date offsetting Apple’s modest outperformance.

Putting weights aside, 62 of QQQ’s 102 holdings are lagging SPY year-to-date. This in addition to the risk-off trade, tough year for tech, and certain mega cap underperformers has made it virtually impossible for QQQ to gain ground on SPY.

A summer run did help QQQ briefly close the gap on SPY before Fed Chairman Powell’s hawkish tone relinquished about half of its gains. Since the bull-market friendly QQQ has beat SPY more often than not over the last 20 years, it should never be counted out. But a lot will have to fall into place for the tech-dominated fund to win in 2022.

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?

Discussion: Return only? The higher the better? Or alpha?

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)

What is alpha? video

Value or Growth Stocks: Which Is Better?

By MARK P. CUSSEN Updated March 18, 2022, Reviewed by MARGUERITA CHENG, Fact checked by RYAN EICHLER

https://www.investopedia.com/articles/professionals/072415/value-or-growth-stocks-which-best.asp

Growth stocks are those companies that are considered to have the potential to outperform the overall market over time because of their future potential. Value stocks are classified as companies that are currently trading below what they are really worth and will thus provide a superior return. Which category is better? The comparative historical performance of these two sub-sectors yields some surprising results.

KEY TAKEAWAYS

· Growth stocks are expected to outperform the overall market over time because of their future potential.

· Value stocks are thought to trade below what they are really worth.

· The question of whether a growth or value stock strategy is better must be evaluated in the context of the investor's time horizon and risk.

What is Value Investing?

Growth Stocks vs. Value Stocks

The concept of a growth stock versus one that is considered to be undervalued generally comes from the fundamental stock analysis.

Growth

Growth stocks are considered by analysts to have the potential to outperform either the overall markets or else a specific subsegment of them for a period of time.

Growth stocks can be found in small-, mid-, and large-cap sectors and can only retain this status until analysts feel that they have achieved their potential. Growth companies are considered to have a good chance for considerable expansion over the next few years, either because they have a product or line of products that are expected to sell well or because they appear to be run better than many of their competitors and are thus predicted to gain an edge on them in their market.

Value

Value stocks are usually larger, more well-established companies that are trading below the price that analysts feel the stock is worth, depending upon the financial ratio or benchmark that it is being compared to. For example, the book value of a company’s stock may be $25 a share, based on the number of shares outstanding divided by the company’s capitalization. Therefore, if it is trading for $20 a share at the moment, then many analysts would consider this to be a good value play.

Stocks can become undervalued for many reasons. In some cases, public perception will push the price down, such as if a major figure in the company is caught in a personal scandal or the company is caught doing something unethical. But if the company’s financials are still relatively solid, then value-seekers may see this as an ideal entry point, because they figure that the public will soon forget about whatever happened and the price will rise to where it should be.

Value stocks will typically trade at a discount to either the price to earnings, book value, or cash flow ratios. Of course, neither outlook is always correct, and some stocks can be classified as a blend of these two categories, where they are considered to be undervalued but also have some potential above and beyond this. Morningstar Inc., therefore, classifies all of the equities and equity funds that it ranks into either a growth, value, or blended category.

Growth vs. Value: Performance

When it comes to comparing the historical performances of the two respective sub-sectors of stocks, any results that can be seen must be evaluated in terms of time horizon and the amount of volatility, and thus risk that was endured in order to achieve them.

Value stocks are at least theoretically considered to have a lower level of risk and volatility associated with them because they are usually found among larger, more established companies. And even if they don’t return to the target price that analysts or the investor predict, they may still offer some capital growth, and these stocks also often pay dividends as well.

Growth stocks, meanwhile, will usually refrain from paying out dividends and will instead reinvest retained earnings back into the company to expand. Growth stocks' probability of loss for investors can also be greater, particularly if the company is unable to keep up with growth expectations.

For example, a company with a highly touted new product may indeed see its stock price plummet if the product is a dud or if it has some design flaws that keep it from working properly. Growth stocks, in general, possess the highest potential reward, as well as risk, for investors.

Studies

Although the above paragraph suggests that growth stocks would post the best numbers over longer periods, the opposite has actually been true. Many studies point to value having outperformed growth style over long-term periods. However, looking at more recent data, value did outperform for the first 10 years of the 2000s, but growth has outperformed over the last 10 years. Take note that dividends likely play a key role in helping value outperform over longer-periods.

Going back to 1926, value has had numerous periods of outperformance relative to growth. Again, despite the long-term outperformance, growth has reigned supreme over the last decade. With that, the S&P 500 is made up of roughly 40% technology stocks.

What Percent of the S&P 500 Is Growth vs. Value?

The S&P 500 is not broken down into growth and value stocks. However, the two sectors that are often considered growth are technology and consumer discretionary, which make up 40% of the index. Meanwhile, value sectors—financials, industrials, energy, and consumer staples—make up roughly 29% of the index.

What Is an Example of a Value Stock vs. Growth Stock?

· An example of a value stock would be a bank, such as JPMorgan Chase (JPM). While key growth is often found in the technology space, such as Google (GOOG).

Are Growth or Value Funds Better for the Long-Term?

· Value has outperformed growth stocks over the longer-term, however, growth has been outperforming for the last 10 years.

The Bottom Line

The decision to invest in growth vs. value stocks is ultimately left to an individual investor’s preference, as well as their personal risk tolerance, investment goals, and time horizon. It should be noted that over shorter periods, the performance of either growth or value will also depend in large part upon the point in the cycle that the market happens to be in.

For example, value stocks tend to outperform during bear markets and economic recessions, while growth stocks tend to excel during bull markets or periods of economic expansion. This factor should, therefore, be taken into account by shorter-term investors or those seeking to time the markets.

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?

5. What is Value stock? Example? What is Growth stock? Example? Which is better: Growth stock vs. Value stock? Why?

FYI: How Value Index ETFs Are Outperforming Their Growth Counterparts (video)

Here are the 7 biggest investing mistakes you want to avoid, according to financial experts

Here are the common mistakes that the average investor makes with their money.

Updated Thu, Apr 7 2022, Elizabeth Gravier

https://www.cnbc.com/select/biggest-investing-mistakes/

It’s no secret that the pandemic brought a wave of new investors eager to give a shot at playing the market.

In fact, a Charles Schwab study found that 15% of all current U.S. stock market investors got their start in 2020 — giving rise to what Schwab calls the “Investor Generation.”

The pandemic prompted the perfect timing to begin investing: stocks became cheaper to buy as the market dipped, savings account interest rates got slashed in half and many young consumers were stranded at home with nothing much else to do.

Plus, now that many brokerage firms now offer accounts with no minimums and zero-commission trading, just about anyone can start investing, even with a small amount of money.

To help guide this new generation of investors, as well as their more experienced counterparts, Select spoke with a handful of certified financial planners about what to watch out for.

Here are the seven biggest investing mistakes they say are the most common.

· Constantly watching the markets

· Chasing the trends

· Following bad advice from social media

· Not giving your investments time to grow

· Investing money you’ll soon need

· Having unclear investing goals

· Delaying investing altogether

Mistake 1: Constantly watching the markets

Of all the mistakes we heard, this one came up the most.

“I have told many clients to turn off their TVs and stop watching the daily market news,” Danielle Harrison, a Missouri-based CFP at Harrison Financial Planning, tells Select.

While it’s normal (and generally advised) to keep an eye on what’s happening in the overall economy, it’s easy to get swept up in the excitement or doom and gloom of it all. The markets are constantly moving and trying to follow along in real-time can lead you to continuously checking or changing your investments when you’re better off leaving them alone for the long haul.

“You’re likely to perform worse than if you just stuck with your original strategy in the first place,” says Douglas Boneparth, a New York City-based CFP, president of Bone Fide Wealth and co-author of The Millennial Money Fix. Viewing negative performance without context can lead to rash decision making, while positive performance can instill overconfidence, explains Joe Lum, a California-based CFP and wealth advisor at Intersect Capital.

Lum agrees that it’s best for investors to avoid tracking their performance (both good and bad) too frequently. While it’s easier than ever to get instant information on your portfolio’s progress, it doesn’t mean it’s necessary.

“If we were running a marathon, it wouldn’t make sense to track our mileage in quarter-mile increments,” Lum says. “The same can be said about long-term investing, particularly in retirement accounts which traditionally have the longest time horizon.”

Before investing, Boneparth suggests asking yourself, “Can I hold these positions for a long period of time?”

“Investing should be boring,” Harrison says. Her advice? Look at your investments on a quarterly basis, which should be more than enough for most investors.

Mistake 2: Chasing the trends

Whether it be participating in a frenzy over GameStop stock, which we all saw back in January, or investing in the newest cryptocurrency, chasing the trends is a common mistake investors make.

Lauryn Williams, a Texas-based CFP and founder of Worth Winning, says she sees investors follow the next hot stock not knowing why they are choosing a particular investment other than the fact that “someone else says it is awesome.”

“A lot investors make the mistake of chasing trends or what’s cool because of FOMO,” Boneparth adds. He recommends always doing your due diligence before putting your money in the market. Or, as another option for a more hands-off approach, invest passively in the markets through index funds and watch your portfolio grow over time. By using your brokerage account to buy diversified mutual and index funds, you take on less risk than when you buy an individual company’s stock.

The best free stock trading platforms

Select reviewed over 12 online brokers that offer zero-commission trading and narrowed down the top six platforms for all sorts of investors: TD Ameritrade; Ally Invest; E*TRADE; Vanguard; Charles Schwab; and Fidelity.

These six offer the widest range of investment options, user-friendly technology, quality customer support and educational resources. You can read more about our methodology on selecting the best $0 commission trading platforms below.

Mistake 3: Following bad advice from social media

“I cringe at the misinformation out there surrounding investing and finances in general, especially on social media,” Harrison says.

The overall guidance from experts is simple: Don’t take investment advice from those who don’t know your personal financial situation. For example, you may feel pressured by someone on social media to start investing in a certain company, but they aren’t clued in to what other investment options you may have. You may be better off putting that money in your employer-sponsored retirement account, especially if your company matches contributions up to a certain percentage of your salary.

Make sure to do your own research when investing and read up on the person giving financial advice on TikTok or another social-media platform. Whether you are just starting out or you’re a more seasoned investor, a good place to begin is with FINRA’s free e-learning program for investors.

Mistake 4: Not giving your investments time to grow

When it comes to investing, time is important. Ideally, you should hold investments for as long as you can to maximize your returns. “Investing is something you do with the expectation of reasonable returns over a long-term period,” Harrison says.

A big mistake Williams sees is investors bailing out on an investment because they did not double their money in a certain period of time, which is usually days or weeks.

“If you need your money to grow urgently, you probably don’t have proper savings,” she says. “Quick growth comes with a lot of risk.” More about this in Mistake No. 5 below.

Mistake 5: Investing money you’ll soon need

People jumping into the markets before building themselves a strong financial foundation is the biggest mistake Boneparth sees investors make.

Prior to investing, you should feel in control of how you spend your money. A big part of that is building a cash reserve so you don’t need to rely on your investments when you run into an emergency or want to make a certain purchase.

“The stock market can be volatile, and you’d hate to lose the money you were saving for something like a down payment on a home you were wanting to purchase,” Harrison says.

A good way to know if you’re ready to invest is understanding if you have a healthy amount of cash in a savings account set aside for all your near-term goals. Harrison suggests that money needed within a relatively short time period, such as within three years, should not be invested in stocks.

Mistake 6: Having unclear investing goals

Once you have a separate savings net set aside that you can fall back on, make sure you have clear goals as you go into investing.

Harrison warns that investing to make more money is rarely the goal. Instead, people should see money as a tool for meeting their other goals. Making investing all about returns is a common mistake she sees.

“You don’t have to chase high returns that also correlate with higher risk, if you can adequately meet your goals with less risky investments,” Harrison says.

Many investors use the S&P 500 as a benchmark for their investment performance, but Lum points out that this index is often not a fair comparison against individuals’ actual portfolios.

“While the S&P 500 serves as an easy proxy for how ‘the market is doing,’ it is important to remember that the design of your portfolio and performance should be aligned to meet your goals — not an index that doesn’t know your financial situation, goals or time horizon,” Lum says.

Mistake 7: Delaying investing altogether

Lastly, choosing to never invest at all is a costly mistake. Keeping all your cash in a bank account means that money loses its purchasing power due to the rising rate of inflation.

“Some people are so scared of investing that they never even begin and lose out on the amazing compounding effect that can happen over the long term,” Harrison says.

Index funds are more popular than ever—here’s why they’re a smart investment (FYI only)

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.”

Index funds are one of the easiest ways to invest — here’s how they work (FYI only)

Index investing allows you to put money in the largest U.S. companies with low fees and minimal risk.

Updated Thu, Apr 7 2022, Elizabeth Gravier

Plenty of people shy away from investing because of fear.

In fact, a survey from Ally Invest found that 65% of adults say they find investing in the stock market to be scary and/or intimidating. Whether it’s the concern you’ll make a bad investment and lose money or a lack of access to quality investing advice, at the end of the day that fear is holding you back from really growing your net worth.

The good news is there are many easy ways to invest; you don’t have to worry about picking individual stocks, and hiring an expensive advisor isn’t always necessary. One of the easiest ways to get started investing is through index funds.

How index funds work

Index funds are investment funds that follow a benchmark index, such as the S&P 500 or the Nasdaq 100.

When you put money in an index fund, that cash is then used to invest in all the companies that make up the particular index, which gives you a more diverse portfolio than if you were buying individual stocks.

Let’s use the S&P 500 as an example. The S&P 500 is one of the major indexes that tracks the performance of the 500 largest companies in the U.S. Investing in an S&P 500 fund (one of the most popular) means your investments are tied to the performance of a wide range of companies.

Because the goal of index funds is to mirror the same holdings of whatever index they track, they are naturally diversified and thus hold a lower risk than individual stock holdings. Market indexes tend to have a good track record, too. Though the S&P 500 certainly fluctuates, it has historically generated nearly a 10% average annual return over time for investors. (Just remember that future returns are not guaranteed.)

Index investing is a form of passive investing

Index investors don’t need to actively manage the stocks and bonds investment as closely since the fund is just copying a particular index. This is why index funds are known as passive investing — and it’s what sets them apart from mutual funds.

Mutual funds are actively managed by fund managers who choose your investments. The goal with mutual funds is to beat the market, while the goal with index funds is simply to match the market’s performance. Since index funds don’t require daily human management, they have lower management costs (called “expense ratios”) than mutual funds. The money saved in fees by investing in an index fund over a mutual fund can save you lots of money in the long term and in turn help you make more money.

A common strategy for many investors who have a long investment timeline is to regularly invest money into an S&P 500 index fund (known as dollar-cost averaging) and watch their money grow over time.

Get started index investing with a brokerage account

Some of the top index funds are those that track the S&P 500 and have low costs. For example, Charles Schwab’s S&P 500 Index Fund (SWPPX) is a straightforward option with no investment minimum. Its expense ratio is 0.02%, meaning every $10,000 invested costs $2 annually. Passive, or index funds, generally have a 0.2% expense ratio, so this is notably low.

For an option with no expense ratio, consider the Fidelity ZERO Large Cap Index (FNILX). Though the fund doesn’t technically track the S&P 500, the Fidelity U.S. Large Cap Index tracks large capitalization stocks, which the website says, “are considered to be stocks of the largest 500 U.S. companies.”

To invest in an index fund, you’ll need to open a brokerage account, a traditional IRA or a Roth IRA (you can often choose to invest in index funds through your employer’s 401(k) too). Once your account is open and funded, you can choose from a number of different index funds, like an S&P 500 fund, a fund that tracks government bonds or a fund that tracks international stocks.

Also, consider using a robo-advisor like Wealthfront and Betterment (which Select rated highly on our list of the best robo-advisors), which will invest in a handful of index funds and ETFs based on your risk tolerance and investment timeline. Robo-advisors will automatically rebalance your portfolio based on market conditions and have much lower fees than traditional financial advisors.

Chapter 8 Stock Market

Part I: Stock Market Popular Websites

ppt

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

Stock charts

Simply the Web's Best Financial Charts

How to pick stocks

Capital Asset Pricing Model (CAPM)Explained

https://www.youtube.com/watch?v=-fCYZjNA7Ps

Fama French 3 Factor Model Explained

http://www.youtube.com/watch?v=zWrO3snZjuA

Ranking stocks using PEG ratio

https://www.youtube.com/watch?v=vY10cNAGJdM

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.

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:
Consider a series of 20 coin flips that have all landed with the "heads". A person might predict that the next coin flip is more likely to land with the "tails“.
Slot machines: Every losing pull will bring them that much closer to the jackpot. But that is wrong. All pulls are independent.

• 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

Second Mid-term exam (close book, close notes, in class exam, 11/1/2022)

Second Mid Term Exam Study Guide

Total 53 T/F and multiple choice questions (two points each questions. 3 questions will not be graded)

1. QQQ vs. SPY

2. Municipal bond? TIPS? Treasury bonds? Treasury bill? Series I bond?

3. High yield bond? Junk bond?

4. Money market fund?

5. Yield curve: normal, steep shaped, inverted, humped?

6. Altman Z-score? What is bond rating?

7. What is Alpha? What is Beta?

8. What are risks associated with bond market?

9. Performance of S&P500 stocks? Worst and the best.

10.Stock weight of the S&P500 stocks? Given S&P total value and the stock’s market value.

11.Value stocks vs. growth stocks

12.What is anchoring (behavior finance)

13.Mental Accounting? Herding? Confirmation Bias? (behavior finance)

14.What is overconfidence (behavior finance)

15.What is disposition effect (behavior finance)

16.gambler’s fallacy? (behavior finance)

Chapter 9 Options

PPT

Class discussion topics:

· Apple price will go up because of the holiday shopping season. Tesla price could fall based on the recent news. Anticipating big changes on stock prices of Apple and Tesla, how shall you react?

· You just bought Tesla stocks. You worried that Tesla 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.
Depending on the strategy, option trading can provide a variety of benefits including the security of limited risk and the advantage of leverage. Options can protect or enhance an investor’s portfolio in rising, falling and neutral markets. Regardless of the reasons for trading options or the strategy employed, it is important to understand the factors that determine the value of an option. (www.investopedia.com)

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.

What Is a Put Option?

A put option (or “put”) is a contract giving the option buyer the right, but not the obligation, to sell—or sell short—a specified amount of an underlying security at a predetermined price within a specified time frame. This predetermined price at which the buyer of the put option can sell the underlying security is called the strike price.

Put options are traded on various underlying assets, including stocks, currencies, bonds, commodities, futures, and indexes. A put option can be contrasted with a call option, which gives the holder the right to buy the underlying security at a specified price, either on or before the expiration date of the option contract.

KEY TAKEAWAYS

· Put options give holders of the option the right, but not the obligation, to sell a specified amount of an underlying security at a specified price within a specified time frame.

· Put options are available on a wide range of assets, including stocks, indexes, commodities, and currencies.

· Put option prices are impacted by changes in the price of the underlying asset, the option strike price, time decay, interest rates, and volatility.

· Put options increase in value as the underlying asset falls in price, as volatility of the underlying asset price increases, and as interest rates decline.

· Put options lose value as the underlying asset increases in price, as volatility of the underlying asset price decreases, as interest rates rise, and as the time to expiration nears.

https://www.investopedia.com/terms/p/putoption.asp

The five basic components of option pricing include the following:

1. Underlying Asset Price – The price of the underlying stock or index the option is written on.

2. Asset Volatility – Amount of uncertainty associated with the asset's expected return. In general, the higher the volatility, the more expensive the option will be. For example, if an asset's value is $100 today, and next month the price is estimated to be either $125 or $75, then the amount of uncertainty here is very high. Because of this, the option price will be high as well. After all, the more volatile the security, the greater chance that it will deliver large returns for the option holder. This uncertainty of return is one of the main drivers of option prices.

3. Time to Expiration – The amount of time left before the option expires. The price of an option decreases as it approaches its expiration date. Why is this? Well, as the expiration date approaches, the chances of the option gaining in value become lower and lower because the underlying security has less time in which to make a major up or down move.

4. Risk-Free Rate – For a variety of reasons that are beyond the scope of this report, the rate of return that may be earned without bearing any risk also comes into play when pricing options. Normally this is assumed to be the rate of interest earned by U.S. Treasury Bills.

5. Option Strike Price – This is the price at which the option can be exercised.

https://www.nasdaq.com/articles/the-5-factors-that-determine-options-prices-2019-11-08

Call Options & Put Options Explained Simply In 8 Minutes

Basic Options Calculator - Powered by IVolatility.com

https://www.optionseducation.org/toolsoptionquotes/optionscalculator (great tool to calculate option prices)

https://www.cboe.com/education/tools/options-calculator/ (CBOE option calculator)

Call and Put price of AAPL on Google Finance

Call and Put price of AAPL on Nasdaq

https://finance.yahoo.com/quote/AAPL/options?date=1674172800

https://www.nasdaq.com/market-activity/stocks/aapl/option-chain/call-put-options/aapl--230120c00135000

Learn THIS before Trading Options - The GREEKS explained for beginners & how options are priced (video, FYI)

o Home Work and class discussion questions (Due with final)

1. What is call option?

2. What is put option?

3. Between call option holders and put option holders, who will benefit from the falling of the stock price? Who is going to benefit from the rising of the stock prices?

4. (optional) Between call option holders and put option holders, who will benefit from the rising of interest rate? Who is going to benefit from the falling of interest rate?

How and Why Interest Rates Affect Options (FYI only)

By SHOBHIT SETH Updated June 08, 2022, Reviewed by CHARLES POTTERS

Fact checked by KIRSTEN ROHRS SCHMITT

https://www.investopedia.com/articles/active-trading/051415/how-why-interest-rates-affect-options.asp#:~:text=With%20an%20increase%20in%20interest,negatively%20by%20increasing%20interest%20rates.

Interest rate changes impact the overall economy, stock market, bond market, and other financial markets and can influence macroeconomic factors. A change in interest rates also impacts option valuation, which is a complex task with multiple factors, including the price of the underlying asset, exercise or strike price, time to expiry, risk-free rate of return (interest rate), volatility, and dividend yield. Barring the exercise price, all other factors are unknown variables that can change until the time of an option's expiry.

Which Interest Rate for Pricing Options?

It is important to understand the right maturity interest rates to be used in pricing options. Most option valuation models like Black-Scholes use annualized interest rates.

It is important to note that changes in interest rates are infrequent and in small magnitudes (usually in increments of 0.25%, or 25 basis points only). Other factors used in determining the option price (like the underlying asset price, time to expiry, volatility, and dividend yield) change more frequently and in larger magnitudes, which have a comparatively larger impact on option prices than changes in interest rates.

KEY TAKEAWAYS

· Changes in interest rate directly affect option pricing, whose calculation is made up of numerous complex factors.

· For standard option pricing models like Black-Scholes, the risk-free annualized Treasury interest rate is used.

· When interest rates increase, call options benefit while put option prices are impacted negatively.

Interest Advantage in Call Options

Purchasing 100 shares of a stock trading at $100 will require $10,000, which, assuming a trader borrows money for trading, will lead to interest payments on this capital. Purchasing the call option at $12 in a lot of 100 contracts will cost only $1,200. Yet the profit potential will remain the same as that with a long stock position.

Effectively, the differential of $8,800 will result in savings of outgoing interest payment on this loaned amount. Alternatively, the saved capital of $8,800 can be kept in an interest-bearing account and will result in interest income—a 5% interest will generate $440 in one year.

Thus, an increase in interest rates will lead to either saving in outgoing interest on the loaned amount or an increase in the receipt of interest income on the savings account. Both will be positive for this call position + savings. Effectively, a call option’s price increases to reflect this benefit from increased interest rates.

Interest Disadvantage in Put Options

Theoretically, shorting a stock with an aim to benefit from a price decline will bring in cash to the short seller. Buying a put has a similar benefit from price declines, but comes at a cost as the put option premium is to be paid. This case has two different scenarios: cash received by shorting a stock can earn interest for the trader, while cash spent in buying puts is interest payable (assuming the trader is borrowing money to buy puts).

With an increase in interest rates, shorting stock becomes more profitable than buying puts, as the former generates income and the latter does the opposite. Thus, put option prices are impacted negatively by increasing interest rates.

The Rho Greek

Rho is a standard Greek that measures the impact of a change in interest rates on an option price. It indicates the amount by which the option price will change for every 1% change in interest rates. Assume that a call option is currently priced at $5 and has a rho value of 0.25. If the interest rates increase by 1%, then the call option price will increase by $0.25 (to $5.25) or by the amount of its rho value. Similarly, the put option price will decrease by the amount of its rho value.

Since interest rate changes don’t happen that frequently, and usually are in increments of 0.25%, rho is not considered a primary Greek in that it does not have a major impact on option prices compared to other factors (or Greeks like delta, gamma, vega, or theta).

How a Change in Interest Rates Affects Call and Put Option Prices?

Taking the example of a European-style in-the-money (ITM) call option on underlying trading at $100, with an exercise price of $100, one year to expiry, a volatility of 25%, and an interest rate of 5%, the call price using Black-Scholes model comes to $12.3092 and call rho value comes to 0.5035. The price of a put option with similar parameters comes to $7.4828 and put rho value is -0.4482 (Case 1).

Rho Calculation using Black-Scholes Model

Source: Chicago Board Options Exchange (CBOE)

Now, let’s increase the interest rate from 5% to 6%, keeping other parameters the same.

Rho Calculation using Black-Scholes Model

The call price has increased to $12.7977 (a change of $0.4885) and put price has gone down to $7.0610 (change of $-0.4218). The call price and put price has changed by almost the same amount as the earlier computed call rho (0.5035) and put rho (-0.4482) values computed earlier. (The fractional difference is due to BS model calculation methodology, and is negligible.)

In reality, interest rates usually change only in increments of 0.25%. To take a realistic example, let’s change the interest rate from 5% to 5.25% only. The other numbers are the same as in Case 1.

Rho Calculation using Black-Scholes Model

The call price has increased to $12.4309 and put price reduced to $7.3753 (a small change of $0.1217 for call price and of -$0.1075 for put price).

As can be observed, the changes in both call and put option prices are negligible after a 0.25% interest rate change.

It is possible that interest rates may change four times (4 * 0.25% = 1% increase) in one year, i.e. until the expiry time. Still, the impact of such interest rate changes may be negligible (only around $0.5 on an ITM call option price of $12 and ITM put option price of $7). Over the course of the year, other factors can vary with much higher magnitudes and can significantly impact the option prices.

Similar computations for out-of-the-money (OTM) and ITM options yield similar results with only fractional changes observed in option prices after interest rate changes.

Arbitrage Opportunities

Is it possible to benefit from arbitrage on expected rate changes? Usually, markets are considered to be efficient and the prices of options contracts are already assumed to be inclusive of any such expected changes.

Also, a change in interest rates usually has an inverse impact on stock prices, which has a much larger impact on option prices. Overall, due to the small proportional change in option price due to interest rate changes, arbitrage benefits are difficult to capitalize upon.

The Bottom Line

Option pricing is a complex process and continues to evolve, despite popular models like Black-Scholes being used for decades. Multiple factors impact option valuation, which can lead to very high variations in option prices over the short term. Call option and put option premiums are impacted inversely as interest rates change. However, the impact on option prices is fractional; option pricing is more sensitive to changes in other input parameters, such as underlying price, volatility, time to expiry, and dividend yield.

Chapter 11 - 14: Commercial Banking and Investment Banking

Ppt 1 commercial banking I

PPT2 Commercial banking II (Balance sheet)

Wells Fargo’s Balance Sheet http://www.nasdaq.com/symbol/wfc/financials?query=balance-sheet

Period Ending:	12/31/2021	12/31/2020	12/31/2019	12/31/2018
Current Assets
Cash and Cash Equivalents	$910,870,000	$891,499,000	$808,756,000	$793,331,000
Short-Term Investments	--	--	--	--
Net Receivables	--	--	--	--
Inventory	--	--	--	--
Other Current Assets	--	--	--	--
Total Current Assets	--	--	--	--
Long-Term Assets
Long-Term Investments	$1,546,605,000	$1,500,003,000	$1,569,549,000	$1,525,758,000
Fixed Assets	$8,571,000	$8,895,000	$9,309,000	$8,920,000
Goodwill	$25,180,000	$26,392,000	$26,390,000	$26,418,000
Intangible Assets	--	--	--	--
Other Assets	$67,259,000	$87,337,000	$78,917,000	$81,293,000
Deferred Asset Charges	--	--	--	--
Total Assets	$1,948,068,000	$1,952,911,000	$1,927,555,000	$1,895,883,000
Current Liabilities
Accounts Payable	$70,957,000	$74,360,000	$75,163,000	$69,317,000
Short-Term Debt / Current Portion of Long-Term Debt	$34,409,000	$58,999,000	$104,512,000	$105,787,000
Other Current Liabilities	$1,482,479,000	$1,404,381,000	$1,322,626,000	$1,286,170,000
Total Current Liabilities	--	--	--	--
Long-Term Debt	$9,424,000	$16,509,000	$9,079,000	$8,499,000
Other Liabilities	--	--	--	--
Deferred Liability Charges	--	--	--	--
Misc. Stocks	$2,504,000	$1,032,000	$838,000	$900,000
Minority Interest	--	--	--	--
Total Liabilities	$1,760,462,000	$1,768,231,000	$1,740,409,000	$1,699,717,000
Stock Holders Equity
Common Stocks	$9,136,000	$9,136,000	$9,136,000	$9,136,000
Capital Surplus	$180,322,000	$162,683,000	$166,697,000	$158,163,000
Retained Earnings	-$79,757,000	-$67,791,000	-$68,831,000	-$47,194,000
Treasury Stock	$60,196,000	$60,197,000	$61,049,000	$60,685,000
Other Equity	-$2,348,000	-$681,000	-$2,454,000	-$7,838,000
Total Equity	$187,606,000	$184,680,000	$187,146,000	$196,166,000
Total Liabilities & Equity	$1,948,068,000	$1,952,911,000	$1,927,555,000	$1,895,883,000

Topics for class discussion

1. Anything wrong of the above balance sheet of Wells Fargo? Where do the loans and deposits go?

FRM: Bank Balance Sheet & Leverage Ratio (VIDEO)

2. What is bank run? It is rare. Why?

Bank Run Explained | History of Bank Runs (youtube)

3. 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.

Community

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.

Part II: Bank Failure

By JULIA KAGAN Updated November 17, 2021, Reviewed by SOMER ANDERSON, Fact checked by SUZANNE KVILHAUG

What Is Bank Failure?

A bank failure is the closing of an insolvent bank by a federal or state regulator. The comptroller of the currency has the power to close national banks; banking commissioners in the respective states close state-chartered banks. Banks close when they are unable to meet their obligations to depositors and others. When a bank fails, the Federal Deposit Insurance Corporation (FDIC) covers the insured portion of a depositor's balance, including money market accounts.

Understanding Bank Failures

A bank fails when it can’t meet its financial obligations to creditors and depositors. This could occur because the bank in question has become insolvent, or because it no longer has enough liquid assets to fulfill its payment obligations.

KEY TAKEAWAYS

· When a bank fails, assuming the FDIC insures its deposits and finds a bank to take it over, its customers will likely be able to continue using their accounts, debit cards, and online banking tools.

· Bank failures are often difficult to predict and the FDIC does not announce when a bank is set to be sold or is going under.

· It may take months or years to reclaim uninsured deposits from a failed bank.

· The most common cause of bank failure occurs when the value of the bank’s assets falls to below the market value of the bank’s liabilities, which are the bank's obligations to creditors and depositors. This might happen because the bank loses too much on its investments. It’s not always possible to predict when a bank will fail.

What Happens When a Bank Fails?

When a bank fails, it may try to borrow money from other solvent banks in order to pay its depositors. If the failing bank cannot pay its depositors, a bank panic might ensue in which depositors run on the bank in an attempt to get their money back. This can make the situation worse for the failing bank, by shrinking its liquid assets as depositors withdraw cash from the bank. Since the creation of the FDIC, the federal government has insured bank deposits up to $250,000 in the U.S.

When a bank fails, the FDIC takes the reins and will either sell the failed bank to a more solvent bank or take over the operation of the bank itself. Ideally, depositors who have money in the failed bank will experience no change in their experience of using the bank; they’ll still have access to their money and should be able to use their debit cards and checks as normal. In the event that a failed bank is sold to another bank, account holders automatically become customers of that bank and may receive new checks and debit cards.

When necessary, the FDIC has taken over failing banks in the U.S. in order to ensure that depositors maintain access to their funds, and prevent a bank panic.

Examples of Bank Failures

During the 2007-2008 financial crisis, the biggest bank failure in U.S. history occurred when Washington Mutual, with $307 billion in assets, closed its doors. Another large bank failure had occurred just a few months earlier when IndyMac was seized.

Special Considerations

The FDIC was created in 1933 by the Banking Act (often referred to as the Glass-Steagall Act). In the years immediately prior, which marked the beginning of the Great Depression, one-third of American banks had failed. During the 1920s, before the Black Tuesday crash of 1929, an average of about 70 banks had failed each year nationwide. During the first 10 months of the Great Depression, 744 banks failed, and during 1933 alone, about 4,000 American banks failed. By the time the FDIC was created, American depositors had lost $140 billion due to bank failures, and without federal deposit insurance protecting these deposits, bank customers had no way of getting their money back.

Bank Closing Summary – 2001 through 2020 - Detailed table below the graph

https://www.fdic.gov/bank/historical/bank/

Why the U.S. banking system could be on the verge of another crisis (youtube)

Homework (Due with final)

Question 1: 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 2: What are the pro and con for big banks?

Question 3: (optional) what is bank failure? Do you think that higher interest rates tend to help banks to thrive or tend to destroy them? Why?

Part III: 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?

Federal Reserve and Monetary Policy

Part I - Fed Introduction

In Plain Enlgish Fed St. Louise (Cool video about Fed)

For discussion:

1. What is FOMC? How many members? How many time does FOMC meet? What is determined at FOMC meeting?

2. What is reserve bank? For our area, where is the reserve bank located?

3. 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?

***** FRB – Federal Reserve Banks *******

Federal Reserve Bank of Atlanta

https://www.atlantafed.org/

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)

Part II: Monetary Policy

ppt

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: Oct 1, 2022

https://fred.stlouisfed.org/graph/?g=pbTc

What is the Fed Fund rate (youtube)

Part III: Open Market Operation

How Do Open Market Operations Affect the U.S. Money Supply?

By KESAVAN BALASUBRAMANIAM Updated April 08, 2022, Reviewed by MICHAEL J BOYLE, Fact checked by MARCUS REEVES

https://www.investopedia.com/ask/answers/06/openmarketoperations.asp

The U.S. Federal Reserve conducts open market operations by buying or selling bonds and other securities to control the money supply. With these transactions, the Fed can expand or contract the amount of money in the banking system and drive short-term interest rates lower or higher depending on the objectives of its monetary policy.

KEY TAKEAWAYS

· The Federal Reserve buys and sells government securities to control the money supply and interest rates. This activity is called open market operations.

· The Federal Open Market Committee (FOMC) sets monetary policy in the United States, and the Fed's New York trading desk uses open market operations to achieve that policy's objectives.

· To increase the money supply, the Fed will purchase bonds from banks, which injects money into the banking system.

· To decrease the money supply, the Fed will sell bonds to banks, removing capital from the banking system.

· Open market operations have played a key part in navigating recent economic downtowns including the 2008 Global Financial Crisis and the COVID-19 recession.

The Importance of Open Market Operations

Open market operations are one of three key tools the Federal Reserve uses to achieve its policy objectives. The objective of open market operations is to change the reserve balances of U.S. banks and cause reactionary changes to prevailing interest rates.

The Fed can increase the U.S. money supply by buying securities. Using newly created money, the Fed can go to the market, inject this capital into U.S. banks, and apply downward pressure on market interest rates as lenders now have more money to distribute as credit. The Fed can also decrease the U.S. money supply by doing the opposite. By selling securities it is holding on its balance sheet, the Fed can extract capital from bank reserves and decrease the amount of funds banks have available to lend.

Open market operations are important as it attempts to guide the direction of the economy. When the Fed is buying securities and increasing the money supply, the Fed is attempting to stimulate economic growth. This typically has a ripple effect of increased inflationary pressure, higher economic growth, higher employment, and generally greater economic prosperity for citizens and companies.

Open market operations also signal when the Fed believes inflationary pressure has gotten too high and the economy needs to contract. By selling securities, the Fed attempts to raise rates, slow economic growth, and stem inflation. Unfortunately, contractionary economic periods like this also traditionally cause increases in unemployment. It also makes obtaining credit more expensive for companies and citizens.

The Role of the Federal Open Market Committee

The Federal Open Market Committee (FOMC) sets monetary policy in the United States with a dual mandate of achieving full employment and controlling inflation. The committee holds eight regularly scheduled meetings each year, though emergency sessions may be called.

During these meetings, the FOMC determines whether to increase or decrease the money supply in the economy. This decision is driven by the FOMC's long-term goals of price stability, sustainable economic growth, and prevailing market conditions. The New York Fed's trading desk then conducts its market operations with the aim of achieving that policy, buying or selling securities in open market operations.

Expanding the Money Supply to Fuel Economic Growth

During a recession or economic downturn, the Fed will seek to expand the supply of money in the economy with a goal of lowering the federal funds rate—the rate at which banks lend to each other overnight.

To do this, the Fed trading desk will purchase bonds from banks and other financial institutions and deposit payment into the accounts of the buyers. This increases the amount of money that banks and financial institutions have on hand, and banks can use these funds to provide loans.

Contracting the Money Supply to Stabilize Prices

The Fed will undertake the opposite process when the economy is overheating and inflation is reaching the limit of its comfort zone. When the Fed sells bonds to the banks, it takes money out of the financial system, reducing the money supply.

Example of Monetary Contraction

By the end of 2021, the Federal Reserve was faced with rapidly escalating inflation and a booming economy. To try and preserve price stability, The Fed announced it would begin tapering its purchase of Treasury securities. Starting December 2021, the Fed began buying $10 billion less Treasury securities each month and $5 billion of agency mortgage-backed securities each month.

This will cause interest rates to rise, discouraging individuals and businesses from borrowing. In theory, consumers will spend, consumer, borrow, and invest less. It will also become more expensive for companies to expand. The impact of both outcomes is to slow inflation and economic growth, though the downside risk is an increase in unemployment.

Segment 406: Open Market Operations (youtube, by the Fed)

No Homework assignment. Please find time to work on term project which is due with final.

2022 FOMC Meetings (FYI)

January

25-26

Statement:
PDF | HTML
Implementation Note

Press Conference

Statement on Longer-Run Goals and Monetary Policy Strategy
Principles for Reducing the Size of the Federal Reserve's Balance Sheet

Minutes:
PDF | HTML
(Released February 16, 2022)

March

15-16*

Statement:
PDF | HTML
Implementation Note

Press Conference
Projection Materials
PDF | HTML

Minutes:
PDF | HTML
(Released April 06, 2022)

May

3-4

Statement:
PDF | HTML
Implementation Note

Press Conference

Plans for Reducing the Size of the Federal Reserve's Balance Sheet

Minutes:
PDF | HTML
(Released May 25, 2022)

June

14-15*

Statement:
PDF | HTML
Implementation Note

Press Conference
Projection Materials
PDF | HTML

Minutes:
PDF | HTML
(Released July 06, 2022)

July

26-27

Statement:
PDF | HTML
Implementation Note

Press Conference

Minutes:
PDF | HTML
(Released August 17, 2022)

September

20-21*

Statement:
PDF | HTML
Implementation Note

Press Conference
Projection Materials
PDF | HTML

Minutes:
PDF | HTML
(Released October 12, 2022)

November

1-2

Statement:
PDF | HTML
Implementation Note

Press Conference

December

13-14*

Study guide for Final (on Options, Banks, the Fed; 30 multiple choice questions)

11/17, 11:30 AM – 2 PM: Final Exam; Term project due

Chapter 9 Options

1. What is call option?

2. What is put option?

3. When interest rate increases (decrease), can call option holder benefit from it?

4. When interest rate increases (decrease), can put option holder benefit from it?

5. When the recession news just hit the market, between call and put option holders, who can benefit from this news?

6. What are the five factors that are associated with option pricing?

7. What is the most popular option pricing model? (https://www.investopedia.com/terms/b/blackscholes.asp#:~:text=The%20Black%2DScholes%20model%2C%20aka,free%20rate%2C%20and%20the%20volatility

Banks

1. What is bank run? It is rare. Why?

2. Why are banks reluctant to lend out to small business, but offer loans to homebuyers?

3. Too big too fail. What is your opinion on this statement? Should we worry about banks getting bigger and bigger? Why or why not?

4. How to explain the uniqueness of banks’ balance sheet. For example, banks are highly leveraged.

5. What are the differences between commercial bank and investment bank?

6. What are the pro and con for big banks?

The Fed

1. What is the purpose of the Fed? The structures of the Fed?

2. The three approaches to conduct Monetary policy.

3. Compare fed fund rate with discount rate. Which rate is targeted by Fed to implement monetary policy?

4. What is open market operation? When Fed plans to increase interest rate, how can Fed do so via open market operation?

5. 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?

6. What is easing monetary policy? What is contractary monetary policy?

Happy Holidays!