FIN 310 Class Web Page, Fall '16
Instructor: Maggie Foley
Weekly SCHEDULE, LINKS, FILES and Questions
Coverage, HW, Supplements
WSJ Papers for Discussion in class
Daily earning announcement: http://www.zacks.com/earnings/earnings-calendar
IPO schedule: http://www.marketwatch.com/tools/ipo-calendar
Chapter 1 Introduction
Flow of funds describes the financial assets flowing from various sectors through financial intermediaries for the purpose of buying physical or financial assets.
*** Household, non-financial business, and our government
Financial institutions facilitate exchanges of funds and financial products.
*** Building blocks of a financial system. Passing and transforming funds and risks during transactions.
*** Buy and sell, receive and deliver, and create and underwrite financial products.
*** The transferring of funds and risk is thus created. Capital utilization for individual and for the whole economy is thus enhanced.
For Class Discussion: During the financial crisis
1. the damage to investment bank < damage to banks?
2. Damage to insurance company = 0?
3. Damage to hedge fund < damage to pension fund?
4. Damage to corporation = 0?
Homework (due next Thursday):
Read the following paper and answer one question: Can we prevent the next financial crisis?
HW Question: what is it?
Fall of Lehman Brother part i
Fall of Lehman Brother part ii
Fall of Lehman Brother part iii
Fall of Lehman Brother part iv
Fall of Lehman Brother part v
Fall of Lehman Brother part vi
Chapter 1 An Introduction to Money and the Financial System
1. What are the six parts of the financial markets
2. What are the five core principals of finance
3. What is stock?
4. Why do we need stock exchanges?
Guarantee and settlement
5. What is high frequency trading? pros and cons
High frequency trading (https://www.youtube.com/watch?v=z4nCTdQlH8w)
Chapter 1 supplement I – Behavior Finance and Introduction of Trading
The following videos will help you to understand how your mind works
1. What is mental accounting.
2. What is gambler fallacy
3. What is prospect theory
4. What is herding
5. What is anchoring
Chapter 1 supplement II–Introduction of Trading
Stock screening tools
Reuters stock screener to help select stocks
Zack Recommendation of stocks (Daily)
Summary of stock screening rules from class discussion
PE<15 (? FB’s PE>100?)
Analyst ranking: strong buy only
Zacks average =1 (from Ranking stocks using PEG ratio)
You can find analyst rating from MSN money
Zacks average brokerage recommendation is Moderate Buy
Homework of the 2nd week (due on 9/15_):
1. What is high frequency trading (HFT)? Shall SEC ban HFT?
2. How are stock prices determined, in your opinion?
3. What is your trading strategy?
4. What is mental accounting, gambler fallacy, herding, anchoring?
Questions: (not HW, but potential mid term Qs)
1. Pro: reduce bid ask spread. Bid-ask spreads are down to around 3 basis points today—from 90 basis points 20 years ago. What is bid ask spread? Does it help investors?
2. Are HFT market makers or market takers? Why?
3. Shall we ban HFT?
4. What is spoofing?
Questions: (not HW, but potential mid term Qs)
1) How did it start?
2) Why trying in future market can cause flash crash in the stock market?
3) What is E-mini? What is spoofing attack?
4) What is your take away?
Questions: (not HW, but potential mid term Qs)
1. No doubt. He is guilty. Do you agree?
Chapter 2 What is Money
Part I What is Money?
· There is no single "correct" measure of the money supply: instead, there are several measures, classified along a spectrum or continuum between narrow and broad monetary aggregates.
• Narrow measures include only the most liquid assets, the ones most easily used to spend (currency, checkable deposits). Broader measures add less liquid types of assets (certificates of deposit, etc.)
· M0: In some countries, such as the United Kingdom, M0 includes bank reserves, so M0 is referred to as the monetary base, or narrow money.
· MB: is referred to as the monetary base or total currency. This is the base from which other forms of money (like checking deposits, listed below) are created and is traditionally the most liquid measure of the money supply.
· M1: Bank reserves are not included in M1. (M1 and Components @ Fed St. Louise website)
· M2: Represents M1 and "close substitutes" for M1. M2 is a broader classification of money than M1. M2 is a key economic indicator used to forecast inflation. (M2 and components @ Fed St. Louise website)
· M3: M2 plus large and long-term deposits. Since 2006, M3 is no longer published by the US central bank. However, there are still estimates produced by various private institutions. (M3 and components at Fed St. Louise website)
Questions for discussion:
Which measure of money is correct?
Why M2 is >> M0?
Part II What is Fractional Banking System?
In a fractional reserve banking system, banks create money when they make loans.
Bank reserves have a multiplier effect on the money supply.
Example: You deposited $1,000 in a local bank
Homework of chapter 2 (due on 9/22)
4. Imagine that you deposited $5,000 in Bank A. Imagine that the fractional banking system is fully functioning. After five cycles, what is the amount that has been deposited and what is the total amount that has been lent out?
9/15 (Thursday): Guest Speaker “How did I last so long in Wall Street?” by Mr. Peluso.
Mark your calendar:
Visit Fed Jax at 1:30pm on November 10th
9/20 (Tuesday): Watch “Money Monster”.
Homework (due 9/29):
1. What kind of algorithm was created by the programmer from Seoul?
2. What is human prints in this movie?
3. The market is getting more and more efficient. However, after watching this movie, do you still trust this system?
Chapter 3 Financial Instruments, Financial Markets, and Financial Institutions
Part I: Examples and characteristics of financial instruments
Discussion: You have some extra bucks. What will you do with the money?
With extra bucks è Find a proper financial instruments è find a financial institution è trade in the market
Part II: Order types (supplement materials)
Understanding Stock Orders that you can enter
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.
3. Stop loss order: A stop loss order gives your broker a price trigger that protects you from a big drop in a stock.
Let's say XYZ's current ask price is 53. You place an order to buy at a limit price of 50. If the price of the security falls to 50, your order may be executed. If you had placed a limit order to buy at 53 or above, your order would have been "marketable" and executed right away.
In Class Exercise part I
1. A trading order that immediately purchases stock at the prevailing price is called a:
a. stop-loss order
b. limit order.
c. market order.
(DEFINITION of 'Stop-Loss Order': An order placed with a broker to sell a security when it reaches a certain price. A stop-loss order is designed to limit an investor’s loss on a position in a security. Although most investors associate a stop-loss order only with a long position, it can also be used for a short position, in which case the security would be bought if it trades above a defined price. A stop-loss order takes the emotion out of trading decisions and can be especially handy when one is on vacation or cannot watch his/her position. Also known as a “stop order” or “stop-market order.”) video: http://www.investopedia.com/terms/s/stop-lossorder.asp )
a. stop-loss order.
b. fill-or-kill limit order.
c. market order.
d. open order.
(DEFINITION of 'Fill Or Kill - FOK': A type of time-in-force designation used in securities trading that instructs a brokerage to execute a transaction immediately and completely or not at all. This type of order is most likely to be used by active traders and is usually for a large quantity of stock. The order must be filled in its entirety or canceled (killed). The purpose of a fill or kill order is to ensure that a position is entered at a desired price.)
(Definition of ‘Open Order’: A type of order to buy or sell a security that remains in effect until it is either canceled by the customer, until it is executed or until it expires. Open orders commonly occur when investors place restrictions on their buy and sell transactions. A lack of liquidity in the market or for a particular security can also cause an order to remain open. )
a. stop-loss order.
b. limit order.
c. market order.
d. fill or kill order.
4. Limit orders:
a. specify a certain price at which a market order takes effect.
b. specify a particular price to be met or bettered.
c. are executed at the best price available.
d. are orders entered for a particular day.
5. A market order is an instruction to:
a) immediately buy a security at the current bid price.
b) buy if the market price at least reaches the specified price target.
c) sell at or above a specified price target.
d) none of these.
Part III: IPO, SEO, Primary Market and Secondary Market
1. What is IPO? SEO? Who are the participants? Who do firms pay for investment banks to do the IPO and SEO for them? Can they do the IPO and SEO by themselves?
2. What is primary market? What is secondary market? Who are the participants?
This Week (http://www.marketwatch.com/tools/ipo-calendar)
In Class Exercise part II
1. The market for equities is predominantly a:
a. primary market.
b. market dominated by individual investors.
c. secondary market.
d. market dominated by foreign investors.
2. Primary markets:
a. involve the organized trading of outstanding securities on exchanges.
b. involve the organized trading of outstanding securities in the over-the-counter market.
c. involve the organized trading of outstanding securities on exchanges and over-the-counter markets.
d. are where new issues (IPOs) are sold by corporations to raise new capital.
How 'Hide Not Slide' Orders Work
Sept. 18, 2012 10:40 p.m. ET
A basic principle of U.S. stock exchanges is that the first investor to place an order at the best current price generally should be the one whose order is filled first.
But critics say high-frequency traders can jump ahead in line via special order types, like "Hide Not Slide." Here's how it works.
Say an order to buy Microsoft Corp. for up to $30.01 a share is sent to electronic stock exchange Direct Edge Holdings LLC, with instructions to be filled only there and not routed elsewhere.
Meanwhile, though there is no matching sell order on Direct Edge, another market, such as Nasdaq, has an order to sell Microsoft at $30.01. It is also an order to be filled only on that exchange.
The SEC considers this a "locked market" and doesn't allow it. The fear is it could encourage manipulation such as buying and selling a stock merely to generate fees. The ban means an order to buy for $30.01 can't be displayed on Direct Edge. The order will "slide" to a lower price, $30.
Here's where Hide Not Slide orders can take advantage. They are hidden from other investors—not displayed on the exchange's order book.
The locked-markets ban applies only to displayed orders. So if a $30.01 Hide Not Slide order is placed now, it won't slide to a lower price.
When the market "unlocks"—such as if the sell order on Nasdaq is filled or canceled—the Hide Not Slide order is converted back to a displayed order at $30.01 and is eligible to trade against Microsoft shares posted for sale on Direct Edge at that price.
As for the first investor's order—the one that slid to $30—it converts back to the original $30.01 price, but is placed in line behind the Hide Not Slide order. If a $30.01 sell order for Microsoft enters Direct Edge, the Hide Not Slide order will get it first.
If not many Microsoft shares are offered for sale on Direct Edge at $30.01, the first investor may not get any.
The SEC, though it cleared this order type, is examining disclosures and whether, in practice, its use violates the rule that the first order placed at the best current price must be filled first.
Defenders of this order type—variations of which are provided by other exchanges—say that since the hidden order offered a better price during the locked market, it should get priority. Direct Edge declined to comment on the functioning of its order types or the investigation.
Exchanges generally say they make proper disclosures about order types and offer them to all investors. In practice, only those using computers and algorithms can use the arcane ones
HW (Due 10/6) Based on the above article, what is Hide not slide order?
Wall Street trader's NYSE Trading Floor Tour
NASDAQ on AWS - Customer Success Story
CBOT Trading Soybean market pit trading
MGEX - The final minute of trading in the pits, forever.
Ira, Fixed Income Capital Markets, BNP Paribas CIB, New York
Chapter 4: Future value, Present Value, and Interest Rate
Example1: A 5 year, 5% coupon bond, currently provides an annual return of 3%. Calculate the price of the bond.
Example 2: Your cousin is entering medical school next fall and asks you for financial help. He needs $65,000 each year for the first two years. After that, he is in residency for two years and will be able to pay you back $10,000 each year. Then he graduates and becomes a fully qualified doctor, and will be able to pay you $40,000 each year. He promises to pay you $40,000 for 5 years after he graduates. Are you taking a financial loss or gain by helping him out? Assume that the interest rate is 5% and that there is no risk.
Example 3: You are awarded $500,000 in a lawsuit, payable immediately. The defendant makes a counteroffer of $50,000 per year for the first three years, starting at the end of the first year, followed by $60,000 per year for the next 10 years. Should you accept the offer if the discount rate is 12%? How about if the discount rate is 8%?
Example 4: John is 30 years old at the beginning of the new millennium and is thinking about getting an MBA. John is currently making $40,000 per year and expects the same for the remainder of his working years (until age 65). I f he goes to a business school, he gives up his income for two years and, in addition, pays $20,000 per year for tuition. In return, John expects an increase in his salary after his MBA is completed. Suppose that the post-graduation salary increases at a 5% per year and that the discount rate is 8%. What is miminum expected starting salary after graduation that makes going to a business school a positive-NPV investment for John? For simplicity, assume that all cash flows occur at the end of each year
Homework (just write down the PV equations – Due 10/6):
1. The Thailand Co. is considering the purchase of some new equipment. The quote consists of a quarterly payment of $4,740 for 10 years at 6.5 percent interest. What is the purchase price of the equipment? ($138,617.88)
2. The condominium at the beach that you want to buy costs $249,500. You plan to make a cash down payment of 20 percent and finance the balance over 10 years at 6.75 percent. What will be the amount of your monthly mortgage payment? ($2,291.89)
3. Today, you are purchasing a 15-year, 8 percent annuity at a cost of $70,000. The annuity will pay annual payments. What is the amount of each payment? ($8,178.07)
4. Shannon wants to have $10,000 in an investment account three years from now. The account will pay 0.4 percent interest per month. If Shannon saves money every month, starting one month from now, how much will she have to save each month? ($258.81)
5. Trevor's Tires is offering a set of 4 premium tires on sale for $450. The credit terms are 24 months at $20 per month. What is the interest rate on this offer? (6.27 percent)
6. Top Quality Investments will pay you $2,000 a year for 25 years in exchange for $19,000 today. What interest rate are you earning on this annuity? (9.42 percent)
7. You have just won the lottery! You can receive $10,000 a year for 8 years or $57,000 as a lump sum payment today. What is the interest rate on the annuity? (8.22 percent)
Study Guide for the First Mid Term (Close book close notes)
1. Read “Section V. REAL AND FINANCIAL IMPLICATIONS OF CRISES” (Page 28-Page 31) of “Financial Crises: Explanations, Types, and Implications” and explain what are the “real effects of crisis” and “financial effects of crisis”, respectively.
2. What is high frequency trading? Who are the major players in high frequency trading? What can they gain from high frequency trading?
3. As an ordinary player, can you become a frequency trader? Why or why not?
4. SEC has banned investment banks from participating in any activities associated with high frequency trading via Dodd Frank Act. Do you agree with the SEC? Why or why not?
5. Using one example to explain what is mental accounting.
6. Using one example to explain what is gambler fallacy
7. Using one example to explain what is herding
8. Using one example to explain what anchoring
9. Using one example to explain what over confidence
10. In a fractional reserve banking system, banks create money when they make loans. Bank reserves have a multiplier effect on the money supply. Image you are going to deposit $300 in Wells Fargo. Explain how much money has been created after four cycles.
11. Explain what are M0, M1, M2, and M3.
12. Compare market order, limit order, and stop loss order.
13. What is IPO? What is SEO?
14. How does an IPO get valued?
15. What is primary market? What is secondary market?
16. Time value of money questions (similar to HWs and In Class Exercises)
17. Questions from WSJ papers assigned for reading (WSJ papers will be provided.)
First Mid term – 10/4
Chapter 6 Bond Market
1. Cash flow of bonds
For example: a 3 year bond 10% coupon rate, draw its cash flow.
How Bonds Work (video)
2. Risk of Bonds
Class discussion: Is bond market risky?
Bond risk (video)
Bond risk – credit risk (video)
Bond risk – interest rate risk (video)
3. Choices of investment in bonds
FINRA – Bond market information
Treasury Bond Auction and Market information
Bond Mutual Fund
Class discussion: As a college student, which type of bonds shall you buy? Why?
Class discussion Topics I
Is there a bond bubble? When will it burst?
We are in a bond bubble now (new video)
Class discussion Topics II
You can invest in junk bonds. Shall you? Or shall you not?
Definition: A high yield bond – also known as a junk bond – is a debt security issued by companies or private equity concerns, where the debt has lower than investment grade ratings. It is a major component – along with leveraged loans – of the leveraged finance market.(www.highyieldbond.com)
Home Work I (due 10/20):
1. Draw cash flow graph of a bond with 5 years left to maturity 5% coupon rate.
2. Find GOOGLE (Symbol: GOOG)’s 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 GOOGLE bond)
a. How to calculate the price?
b. Why GOOG’s bond yield is lower than MSFT’s?
c. What does “callable” mean?
d. Who are the three major rating agencies?
e. What is the rating of GOOG? Is it better than MSFT’s or are they the same?
3. Explain why Google bond is more risky than the Treasury bond with the same condition.
4. Why is there a concern for bond bubble? As a bond investor, how can you avoid losing money from the bond market?
5. As a bong investor, do you plan to invest in junk bond? Why or why not?
Stocks rise and fall, but bonds are starting to make people anxious no matter what they do.
Question (HW II due 10/20)):
How do you explain the following. “ On April 17, the yield on the bund plunged to an all-time low of 0.05%. Three weeks later, it spiked to 0.786%, without a major news event or apparent broad shift in investor sentiment.”
Question (HW III due 10/20)):
1. “In July, Germany became the second G7 nation to issue a 10-year bond with a negative yield. In fact, according to a recent report by Bloomberg, more than 80% of German government bonds have negative yields. In Japan, 20-year bonds are now below zero.”
------- How can the yields be negative?
2. “Low and negative rates are forcing legions of investors to seek higher yield, and in doing so, they are taking on more and more risk. Maybe it’s because they know that the central banks will maintain these policies despite potentially adverse consequences in the long term.”
----- under what circumstance, will the bond bubble pop?
Question: (Not HW)
1. “LMM's Bill Miller said he's shorting the 10-year, and Elliott Management's Paul Singer said the long end of the bond market was a bubble and Treasurys and other developed market bonds are not safe havens.” --- why is LMM’s Bill shorting the 10 year Treasury bond?
2. How is the bond performance in other developed countries?
Robert Shiller Interview: why one of the world’s smartest economists is worried about the bond market
Chapter 7 Rating, Term structure
Part I: Credit Rating Agency
The Big Short - Standard and Poors scene --- This is how they worked
1. Conflict of interest?
2. Who is doing the right thing, the lady representing the rating agency, or the Investment Banker?
Three Major Rating Agencies
University: Bond rating (video)
1. Who are they?
2. Are they private firms or government agencies?
3. How do they rank?
4. Do we need rating agencies and critiques.
Sovereigns Rating (http://countryeconomy.com/ratings/) – The lowest and the highest – Most recent
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?
Rating Conflicts (video) https://www.youtube.com/watch?v=-C5JW4I3nfU
Part II: Yield curve (or Term structure)
· What is yield curve? ( http://www.yieldcurve.com/MktYCgraph.htm)
Market watch on Wall Street Journal has daily yield curve and interest rate information.
Draw today’s yield curve yourself using the following information (5 extra points)
· Why do we need yield curve?
· What can yield curve tell us?
Daily Treasury Yield Curve Rates
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?
Summary of Yield Curve Shapes and Explanations
Normal Yield Curve
Steep Curve – Economy is improving
Inverted Curve – Recession is coming
To become inverted, the yield curve must pass through a period where long-term yields are the same as short-term rates. When that happens the shape will appear to be flat or, more commonly, a little raised in the middle.
Unfortunately, not all flat or humped curves turn into fully inverted curves. Otherwise we'd all get rich plunking our savings down on 30-year bonds the second we saw their yields start falling toward short-term levels.
On the other hand, you shouldn't discount a flat or humped curve just because it doesn't guarantee a coming recession. The odds are still pretty good that economic slowdown and lower interest rates will follow a period of flattening yields.
Pure expectation Theory
The pure expectations theory contends that the shape of the yield curve depends on investors’ expectations about future interest rates.
What is the 'Expectations Theory'
The Expectations Theory – also known as the Unbiased Expectations Theory – states that long-term interest rates hold a forecast for short-term interest rates in the future. The theory postulates that an investor earns the same amount of interest by investing in a one-year bond in the present and rolling the investment into a different one-year bond after one year as compared to purchasing a two-year bond in the present.
Consider that the present bond market provides investors with a two-year bond that has an interest rate of 20% and a one-year bond with an interest rate of 18%. The expectations theory can be utilized to forecast the interest rate for the one-year bond in one year. The first step of the calculation is to add one to the two-year bond’s interest rate. In this example, the result is 1.2, or 120%.
The next step is to square the result; 1.2 squared results in 1.44. This number is then divided by the current one-year interest rate plus one. This means that 1.44 is divided by 1.18 to equal 1.22. Subtracting one from that sum is the final step and results in a predicted one-year bond interest rate of 22% for the following year.
In this example, the investor, theoretically, is earning an equivalent return to the present interest rate of a two-year bond. If the investor chooses to invest in a one-year bond at 18%, he has to hope for the bond yield to increase to 22% for the following year’s one-year bond.
What is the interest rate expected to be one year from now for one year T-notes?
What is the interest rate expected to be two years from now for one year T-notes?
1. Find Moody’s rating of Venezuela, Ukraine, Germany, and Japan.
2. Go to