FIN 310 Class Web Page, Fall '16

Instructor: Maggie Foley

Jacksonville University

The Syllabus

Term Project 

  

Weekly SCHEDULE, LINKS, FILES and Questions   

Week

Coverage, HW, Supplements

-        Required

WSJ Papers for Discussion in class  

Videos (optional)

Intro.

 

Marketwatch Stock Trading Game (pass code: havefun)

Use the information and directions below to join the game.

1.        URL for your game: 
http://www.marketwatch.com/game/jufin310-2016     

2.        Password for this private game: havefun.

3.        Click on the 'Join Now' button to get started.

4.        If you are an existing MarketWatch member, login. If you are a new user, follow the link for a Free account - it's easy!

5.        Follow the instructions and start trading!

Daily earning announcement: http://www.zacks.com/earnings/earnings-calendar

IPO schedule:  http://www.marketwatch.com/tools/ipo-calendar

 

 

Chapter 1 Introduction 

Capital flow chart

Introduction to Capital Markets - ION Open Courseware (Video)

How the stock market works (video)

 

 

image001.jpg

 Note:

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.

image002.jpg

 

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?

Financial crises: Explanations, types, and implications (pdf)

What caused financial crisis.

HW Question: what is it?

Fall of Lehman Brother part i

https://www.youtube.com/watch?v=aPOtQkSiCk8

 

Fall of Lehman Brother part ii

https://www.youtube.com/watch?v=l0N_FX0kUMI&feature=relmfu

 

Fall of Lehman Brother part iii

https://www.youtube.com/watch?v=YmZd3vVoPgY&feature=relmfu

 

Fall of Lehman Brother part iv

https://www.youtube.com/watch?v=FcO_dQCJ3HA&feature=relmfu

 

Fall of Lehman Brother part v

https://www.youtube.com/watch?v=L4gqzRePtes

 

Fall of Lehman Brother part vi

https://www.youtube.com/watch?v=Ms_tnEe4wFk&feature=relmfu

 

Chapter 1

Chapter 1 An Introduction to Money and the Financial System

ppt

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?

Transparency

Anonymous

Guarantee and settlement

Regulated

5.      What is high frequency trading? pros and cons

Ppt

Videos

Watch high-speed trading in action

High frequency trading (https://www.youtube.com/watch?v=z4nCTdQlH8w)

 

Chapter 1 supplement I – Behavior Finance and Introduction of Trading

 

Behavior Finance PPT                                 

The following videos will help you to understand how your mind works

NBR | Behavioral Finance Basics | Your Mind and Your Money

NBR | Following the Crowd | Your Mind and Your Money | PBS

NBR | Investor Overconfidence | Your Mind and Your Money | PBS

NBR | Perception vs. Reality | Your Mind and Your Money | PBS

NBR | Report: Framing | Your Mind and Your Money | PBS

 

Questions
Explain the following concepts with one example 

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

http://stockscreener.us.reuters.com/Stock/US/

 

FINVIZ.com

http://finviz.com/screener.ashx

 

 

Zack Recommendation of stocks (Daily)

 

http://www.zacks.com/stocks/zacks-rank

 

 

Summary of stock screening rules from class discussion

PEG<1

PE<15  (? FB’s PE>100?)

Growth rate<20

ROE>10%

Analyst ranking: strong buy only

Zacks average =1 (from Ranking stocks using PEG ratio)

current price>5

 

 

MSN Money

You can find analyst rating from MSN money

For instance,

ANALYSTS RATINGS

Zacks average brokerage recommendation is Moderate Buy

RECOMMENDATIONS

CURRENT

1 MONTH AGO

2 MONTHS AGO

3 MONTHS AGO

Strong Buy

26

26

25

24

Moderate Buy

4

4

4

4

Hold

8

8

8

9

Moderate Sell

0

0

0

0

Strong Sell

0

0

0

0

Mean Rec.

1.51

1.51

1.53

1.58

 

 

 

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?

 

Everything You Need to Know About High-Frequency Trading

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?

 

 

Flash Crash' a Perfect Storm for Markets

A complex cast of characters – including the European debt crisis, high-frequency traders, a big mutual fund and allegedly a London-based day trader – led markets to swing violently on May 6, 2010.

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?

 

Former Goldman Programmer Found Guilty of Code Theft

Questions: (not HW, but potential mid term Qs)

1. No doubt. He is guilty. Do you agree?

 

Quants: The Alchemists of Wall Street - A Documentary about algorythmic trading

 

 

 

 

The Great HFT Debate With Michael Lewis On CNBC

 

 

 

 

 

 

The Billion Dollar Secret

 

The Zacks Rank Guide to Trading Success

 

 

 Chapter  2

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)

·          

 

image003.jpg  image004.jpg

 

image005.jpg

 

Questions for discussion:

Which measure of money is correct?

Why M2 is >> M0?

 

Let’s watch this video of Money supply of M0, M1, and M2.

 

Part II What is Fractional Banking System?

 

Money Creation in a Fractional Reserve 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

 

image006.jpg

 

Iteration #

Deposited

=

Reserves

+

Available to Lend

Bank

Lends to

1. A

1,000.00

=

100

+

900

A

2. B

900

=

90

+

810

3. C

810

=

81

+

729

C

4. D

729

=

72.9

+

656.1

D

And the cycle continues…

 

Summary:

 

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

 

 

 

Homework of chapter 2 (due on 9/22)

1.      Write down the definition of M0, M1, M2 and M3.

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

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

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

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?

 

 

 

 

 

 

 

 

 

 

 

Draw Me The Economy: Money Supply

 

 

 

 

 

Milton Friedman on Inflation and Money Supply


 

9/15 (Thursday): Guest Speaker “How did I last so long in Wall Street?” by Mr. Peluso.

PPT

 

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

 

Ppt

 

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

 

University: Four Markets

 

  

Part II: Order types (supplement materials)

Order types (market, limit, stop), video

Understanding order types by wall street survivor, video

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.

 

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. 

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?

 

IPO Calendar

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

 • 8 Total

Company Name

Proposed Symbol

Exchange

Price Range

Shares

Week Of

AC Immune

ACIU

Nasdaq

$11.00 - $13.00

6,000,000

9/19/2016

Apptio

APTI

Nasdaq

$13.00 - $15.00

6,000,000

9/19/2016

AzurRX Biopharma

AZRX

Nasdaq

$6.00 - $8.00

1,700,000

9/19/2016

CapStar Financial Holdings

CSTR

Nasdaq

$14.50 - $16.50

2,585,000

9/19/2016

e.l.f. Beauty

ELF

NYSE

$14.00 - $16.00

8,333,333

9/19/2016

Full Spectrum

FMAX

Nasdaq

$7.00 - $9.00

1,875,000

9/19/2016

Gridsum Holding

GSUM

Nasdaq

$10.50 - $12.50

6,521,740

9/19/2016

Valvoline

VVV

NYSE

$20.00 - $23.00

30,000,000

9/19/2016

Next Week

 • 4 Total

Company Name

Proposed Symbol

Exchange

Price Range

Shares

Week Of

Fulgent Genetics

FLGT

Nasdaq

$12.00 - $14.00

4,600,000

9/26/2016

MedEquities Realty Trust

MRT

NYSE

$12.00 - $14.00

19,925,333

9/26/2016

Nutanix

NTNX

Nasdaq

$11.00 - $13.00

14,000,000

9/26/2016

Tabula Rasa HealthCare

TRHC

Nasdaq

$13.00 - $15.00

4,300,000

9/26/2016

 

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.

 

 

How 'Hide Not Slide' Orders Work

By 

SCOTT PATTERSON and

 

JENNY STRASBURG

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.

ENLARGE

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

https://www.youtube.com/watch?v=TPUDPhpCecA

https://www.youtube.com/watch?v=EX33ZpRPoUU&feature=related

 

 

NASDAQ on AWS - Customer Success Story

https://www.youtube.com/watch?v=vHSuwbklX4g

 

 

CBOT Trading Soybean market pit trading

https://www.youtube.com/watch?v=XZEBz01t5vg

 

 

MGEX - The final minute of trading in the pits, forever.

https://www.youtube.com/watch?v=S43zvtdJcxI&feature=related

 

 

Ira, Fixed Income Capital Markets, BNP Paribas CIB, New York

https://www.youtube.com/watch?v=qk8DxoLYj0w

https://www.youtube.com/watch?v=g-QZMW2zbhw&feature=relmfu

 

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

 

 Ppt

 

image007.jpg

image008.jpg

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)


University: Time Value of Money

Laugh And Learn About Personal Finance - InvestorED.ca

 

Funny Moneyman Credit Card Game Show

 

 

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 Implicationsand 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

 

               Chapter 6 PPT

 

1.      Cash flow of bonds

image009.jpg

 

 

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

Introduction to bond investing (video)

How Bonds Work (video)

 

2.      Risk of Bonds

Class discussion: Is bond market risky?

Bond risk (video)

Bond risk – credit risk (video)

Bond risk – interest rate risk (video)

Bond risk – how to reduce your risk (video)

 

3.      Choices of investment in bonds

 

FINRA – Bond market information

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

 

Treasury Bond Auction and Market information

http://www.treasurydirect.gov/

 

Treasury Bond

Corporate Bond

Municipal Bond

International Bond

Bond Mutual Fund

TIPs

Class discussion: 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?

Traders watching to see if that's the air beginning to leak from bond bubble (new video)

Robert Shiller Bond Bubble Likely but not crippling (video_

We are in a bond bubble now  (new video)

There's Going to be a Collapse in the Bond Market Like We've Never Seen Before (new video)

 

 

Class discussion Topics II

 

You can invest in junk bonds. Shall you? Or shall you not?

What is a high yield bond (Video)

Definition: A high yield bond – also known as a junk bond – is a debt security issued by companies or private equity concerns, where the debt has lower than investment grade ratings. It is a major component – along with leveraged loans – of the leveraged finance market.(www.highyieldbond.com)

 

image011.jpg 

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?

 

 

The new bond market: Bigger, riskier and more fragile than ever

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.”

 

 

Is There a Bond Market Bubble?

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?

 

 

 

Traders watching to see if that's the air beginning to leak from bond bubble

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?

 

How you should learn to stop worrying about the bond bubble and love the market

Question: (Not HW)
Can you stop worrying about the bond bubble?

 

Robert J. Shiller: "Are We Headed for Another Financial Crisis?" (final edition, as of MAR 8)

https://www.youtube.com/watch?v=ed0TXsGN3wc

 

 

Robert Shiller Interview -MoneyWeek

Robert Shiller Interview: why one of the world’s smartest economists is worried about the bond market

Chapter 7

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.

 image012.jpg

 

 

 

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.

 

Sovereigns Rating (http://countryeconomy.com/ratings/) – The lowest and the highest – Most recent

Country

S&P

Moody's

Fitch

Hong Kong

AAA

Aa1

AA+

Isle of Man

N/A

Aa1

 

Australia

AAA

Aaa

AAA

Canada

AAA

Aaa

AAA

Denmark

AAA

Aaa

AAA

Germany

AAA

Aaa

AAA

Luxembourg

AAA

Aaa

AAA

Netherlands

AAA

Aaa

AAA

Norway

AAA

Aaa

AAA

Singapore

AAA

Aaa

AAA

Sweden

AAA

Aaa

AAA

Switzerland

AAA

Aaa

AAA

Barbados

B-

Caa1

 

Belarus

B-

Caa1

B-

Jamaica

B

Caa2

B

Belize

B-

Caa2

 

Cuba

 

Caa2

 

Greece

B-

Caa3

CCC

Ukraine

B-

Caa3

CCC

Mozambique

CCC

Caa3

CC

Venezuela

CCC

Caa3

CCC

 

 

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: 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.

http://www.marketwatch.com/tools/pftools/

What is yield curve, video

 

Draw today’s yield curve yourself using the following information (5 extra points)

Date

1 Mo

3 Mo

6 Mo

1 Yr

2 Yr

3 Yr

5 Yr

7 Yr

10 Yr

20 Yr

30 Yr

10/19/16

0.17

0.22

0.49

0.61

1.02

1.31

1.73

2.06

2.24

2.64

2.98

·        Why do we need yield curve?

 

·        What can yield curve tell us?

More Proof of Economic Trouble Ahead. The U.S. Treasury Yield Curve Does Not Lie.

Deutsche Bank Recession Odds - Flattening of the Yield Curve

 

 

Daily Treasury Yield Curve Rates

 (https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yieldYear&year=2016)

 

Date

1 Mo

3 Mo

6 Mo

1 Yr

2 Yr

3 Yr

5 Yr

7 Yr

10 Yr

20 Yr

30 Yr

01/04/16

0.17

0.22

0.49

0.61

1.02

1.31

1.73

2.06

2.24

2.64

2.98

01/05/16

0.20

0.20

0.49

0.68

1.04

1.32

1.73

2.06

2.25

2.67

3.01

02/03/16

0.27

0.33

0.46

0.54

0.72

0.91

1.27

1.61

1.88

2.30

2.70

02/04/16

0.24

0.29

0.43

0.52

0.70

0.90

1.25

1.60

1.87

2.29

2.70

03/02/16

0.28

0.36

0.48

0.67

0.85

1.00

1.34

1.65

1.84

2.27

2.69

03/03/16

0.25

0.28

0.46

0.65

0.85

0.99

1.33

1.63

1.83

2.23

2.65

04/05/16

0.19

0.23

0.36

0.56

0.72

0.85

1.17

1.49

1.73

2.13

2.54

04/06/16

0.19

0.23

0.36

0.55

0.73

0.88

1.20

1.52

1.76

2.17

2.58

05/06/16

0.20

0.19

0.39

0.51

0.74

0.90

1.23

1.55

1.79

2.20

2.62

05/09/16

0.21

0.24

0.38

0.51

0.72

0.86

1.20

1.51

1.77

2.18

2.61

06/03/16

0.19

0.30

0.43

0.60

0.78

0.92

1.23

1.50

1.71

2.09

2.52

06/06/16

0.19

0.28

0.43

0.60

0.80

0.94

1.25

1.53

1.73

2.12

2.55

07/05/16

0.27

0.28

0.35

0.44

0.56

0.66

0.94

1.19

1.37

1.72

2.14

07/06/16

0.26

0.27

0.36

0.46

0.58

0.69

0.95

1.20

1.38

1.72

2.14

07/07/16

0.27

0.29

0.37

0.47

0.58

0.69

0.97

1.21

1.40

1.72

2.14

07/08/16

0.26

0.28

0.36

0.48

0.61

0.71

0.95

1.19

1.37

1.69

2.11

07/11/16

0.28

0.31

0.40

0.50

0.66

0.77

1.03

1.27

1.43

1.73

2.14

07/12/16

0.29

0.29

0.40

0.52

0.69

0.81

1.10

1.35

1.53

1.82

2.24

07/13/16

0.29

0.31

0.40

0.51

0.68

0.80

1.07

1.32

1.48

1.77

2.18

07/14/16

0.29

0.32

0.41

0.53

0.68

0.82

1.10

1.36

1.53

1.84

2.25

07/15/16

0.27

0.32

0.42

0.52

0.71

0.87

1.15

1.42

1.60

1.90

2.30

07/18/16

0.26

0.32

0.44

0.52

0.68

0.85

1.14

1.40

1.59

1.90

2.30

08/15/16

0.26

0.31

0.46

0.56

0.72

0.85

1.14

1.40

1.55

1.90

2.27

08/16/16

0.27

0.27

0.45

0.57

0.76

0.87

1.16

1.42

1.57

1.92

2.29

09/26/16

0.12

0.25

0.42

0.58

0.76

0.87

1.13

1.41

1.59

2.00

2.32

09/27/16

0.16

0.26

0.42

0.58

0.75

0.86

1.12

1.39

1.56

1.96

2.28

09/28/16

0.14

0.27

0.44

0.60

0.75

0.87

1.13

1.41

1.57

1.96

2.29

09/29/16

0.12

0.26

0.43

0.59

0.73

0.85

1.12

1.39

1.56

1.95

2.28

09/30/16

0.20

0.29

0.45

0.59

0.77

0.88

1.14

1.42

1.60

1.99

2.32

10/13/16

0.26

0.30

0.45

0.66

0.85

1.00

1.27

1.56

1.75

2.15

2.48

10/14/16

0.26

0.32

0.46

0.66

0.84

1.00

1.28

1.58

1.80

2.22

2.55

10/17/16

0.24

0.34

0.47

0.65

0.81

0.98

1.26

1.56

1.77

2.19

2.52

10/18/16

0.26

0.34

0.47

0.66

0.82

0.96

1.24

1.54

1.75

2.18

2.51

10/19/16

0.25

0.35

0.48

0.65

0.81

0.96

1.24

1.54

1.76

2.18

2.51

 

 

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?

 

 

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.

image013.jpg

 

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.

image014.jpg

 

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.

image015.jpg

 


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.

image016.jpg

 

 

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.

Example

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.

For discussion: 

Date

1 Mo

3 Mo

6 Mo

1 Yr

2 Yr

3 Yr

5 Yr

7 Yr

10 Yr

20 Yr

30 Yr

10/19/16

0.17

0.22

0.49

0.61

1.02

1.31

1.73

2.06

2.24

2.64

2.98

 

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?

 

 

HW:

1.                  Find Moody’s rating of Venezuela, Ukraine, Germany, and Japan. 

2.                  Go to