FIN 310 Class Web Page, Fall '17
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):
HW Question: what are the causes of the financial crisis?
Read the following paper and answer one question: Can we prevent the next financial crisis?
What Is your opinion?
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
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 9/26_):
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?
WSJ Papers for Discussion in class
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?
For discussion: What are the possible ways to reduce money supply?
Part II What is Fractional Banking System?
In a fractional reserve banking system, banks create money when they make loans.
Bank reserves have a multiplier effect on the money supply.
Example: You deposited $1,000 in a local bank
Summary: Template here FYI
Homework of chapter 2 (due on 9/28)
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? Template here FYI
5. Debt ceiling: Why the US government insists on raising debt ceiling? Do you have better solutions than borrowing more?
6. What is this new Fed policy? How will the market react to this news?
The Debt ceiling is real
Question for class discussion:
US government needs to borrow more money. Where does this borrowing pressure come from? Money supply is expected to increase with debt. How come?
The Fed is taking a major step away from its Great Recession policy (video and article both)
Questions for class discussion:
What is quantitative easing?
What are consequences of this new Fed policy?
Some strategists say that creates the opportunity for a sudden wake up call and a rush of volatility when the Fed releases its statement at 2 p.m. Fed Chair Janet Yellen briefs the media at 2:30 p.m. ET.
Chances are that the market continues to have a muted response, but some bond pros say the announcement could also jolt the markets one way or other, depending on the Fed's tone and its forecast for interest rates.
The Federal Open Market Committee is expected to announce Wednesday afternoon that it will start to reverse quantitative easing, the massive bond buying program it initiated during the financial crisis to save the economy. Now with $4.5 trillion in assets on its balance sheet, the Fed is taking the step of moving away from the final stages of that program, which has been to replenish those bonds as they mature.
"It really is peculiar. You have the Fed doing this, you don't even know who the chairman is going to be in the next couple of months, you have a chance for a fairly decent change in tax policy…The bigger story is there's no market reaction to much of anything lately," said Michael Schumacher, director of rate strategy at Wells Fargo.
He said if the Fed announcement goes as expected, yields could first move lower for a week or two and then rise, based on the past reaction to Fed interest rate hikes.
"It's a first, and you can tell I'm hedging because the Fed has never done this," he said. "Longer term, it really opens Pandora's box. The Fed has never done anything like this. Really no big central bank has done this."
The Fed plans to shrink its balance sheet in a slow and steady
process. Even though quantitative easing, or QE, ended long ago, the Fed has
been keeping liquidity high with its purchases to replace maturing
securities. The Fed plans to slow down those purchases to replace bonds and
mortgage securities at an initial pace of $10 billion a month, increasing it
by that same amount each quarter until it reaches a total of $50 billion.
While banks and central banks will buy some of the Treasurys and mortgages that the Fed is stepping away from, private investors will also need to step up to buy more. That growing supply in the market could have some impact on rates, pressuring them higher.
"I'm at least of the view that the total cumulative impact of this supply should have an impact on rates markets, raise longer term rates and steepen the curve. The market does not really seem to be too concerned about this," Cabana said.
BlackRock's Rick Rieder, the global chief investment officer of fixed income, said the $10 billion initial step is "a drop in the bucket" but the impact of the program will change a year from now when the Fed's balance sheet reduction is much larger and that could help send yields higher. But rates won't go too high because of global demand for bonds.
"I think we're going to be in a low rate environment for a long time," he said, noting that global central banks are still providing heavy accommodation, and U.S. yields look attractive compared to Japan and Europe. The European Central Bank is talking about paring back its bond buying, but it still will be buying securities.
"We're in an unbelievable conundrum," he said. Rieder said real rates are extremely low given where they should be, based on the economic growth around the world. He said longer dated Treasurys are responding more to the easing policies of the Bank of Japan or ECB in some ways than they are to the Fed.
"There's not enough bonds in the world at an attractive level," Rieder said.
The Fed has indicated it would separate the balance sheet announcement from other policy moves, so it is not expected to raise interest rates Wednesday. But many strategists expect it to hike rates at its December meeting. Also in play is whether the Fed changes its long-term interest rate forecast.
As for stocks, strategists say if the Fed surprises by sounding hawkish, that would be a negative for a stock market near record highs. But Art Hogan, the chief market strategist at Wunderlich Securities, said the stock market may also not want to see the Fed lower its interest rate forecast for future years, in a dovish stance.
"That's not a positive…We want them to sound slow and steady," said Hogan, adding cutting back the rate forecast would mean too little economic growth on the horizon. But he did say if the Fed sounds too hawkish about a December hike, now in its forecast, that could also send stocks lower. While the market expects more than a 50 percent chance for a December hike, Hogan said there is some expectation in the stock market that the temporary damage to the economy from Hurricanes Irma and Harvey could get the Fed to stand down for a while.
Nomura's head rate strategist George Goncalves also says the market is not pricing in the Fed balance sheet operation.
"It all depends on how they characterize things," Goncalves said. "They want to do it to take away liquidity. Don't make it sound like it's not a big deal. It is a big deal. They have a large balance sheet because of QE which was meant to get the economy going, get inflation going. They ended up instead with asset inflation."
He said if the bond market rallies, meaning yields move lower, "The market would be thinking we are making a policy mistake," he said.
Goncalves said if the Fed downplays the program exit too much, it's possible the strategy could back fire and send investors into the bond market, driving rates higher instead. Bond prices move opposite yields. If the Fed announces the balance sheet reduction and also lowers the forecast for future interest rate hikes, included in a chart it calls the "dot plot," that would sound dovish.
"If there's very little changes in their forecast and the balance sheet gets started, we should view that as the Fed is committed to the tightening process," said Goncalves. Rates could then move higher.
"By the Fed normalizing policy and draining liquidity, if that's happening at a time when tax policies are changing that could really be a watershed moment," said Goncalves. "At a minimum, a healthy backup in rates by the Fed normalizing policy and draining liquidity would just be a validation that market understands it and this is a form of tightening."
How the market will move after the Fed unveils its plans to shrink the balance sheet is also up for interpretation.
Schumacher said it could mean higher yield in the 5-year duration, since the Fed has made more purchases in that area.
Cabana said if the Fed were to cut its interest rate forecasts, that would signal a more accommodating Fed and the yield curve could steepen, or the spread between long term yields and short would expand.
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)
Hide Side Order Type (video) – an example showing how to trade smartly.
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.
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 (required)
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 10/5) Based on the above article, what is Hide not slide order?
'Hide Not Slide' Orders Were Slippery and Hidden (FYI only)
It's good when the victim of a market-structure abuse is called Trading Machines. Lets you know the stakes.
By Matt Levine
January 12, 2015, 7:35 PM EST
Today, the Securities and Exchange Commission fined the Direct Edge stock exchanges$14 million for violations involving their "Hide Not Slide" order types. Here's a 2012 Wall Street Journal article that comes with basically a graphic novel devoted to how a "Hide Not Slide" order works, and I refer you to there if you want to know how it works. The thing is that you probably don't want to know how it works. But here's the basic idea, without the cartoon of a jumping man in a suit:
· The national best bid and offer for a stock are $10.00 / $10.01.
· For reasons of your own, you want to bid $10.01 for it, but you don't want to just buy the stock offered at $10.01 on, say, Nasdaq.
· Instead, you want to put up a standing buy order at $10.01 on a Direct Edge exchange (EDGA or EDGX) and wait until someone hits your bid.
· You can't do this, because the SEC has rules against "locked markets" -- if the national best offer is $10.01, you can't bid $10.01, you gotta just lift the offer (or bid $10.00).
· But the name of the game is customer service, so the exchanges come up with ways to let you enter orders that would otherwise lock markets.
Simplifying enormously, Direct Edge offered two ways of doing this:
1. A limit order: You enter a $10.01 bid at 1:00 p.m. Because it locks the market, Direct Edge "slides" it back to $10.00 and displays it as though it's a $10.00 bid. But at 1:05 p.m., the market becomes unlocked: There's no more $10.01 offer, the national best offer is $10.02, so you can display your $10.01 bid. So Direct Edge changes your order back to a $10.01 bid, with a 1:05 p.m. time stamp.
2. A Hide Not Slide order: Same, except your order is changed back with a 1:00 p.m. time stamp.
Earlier time stamps get priority in execution, so you get a better chance to actually buy stock at $10.01 if you choose option 2 rather than option 1. So why would you choose option 1? The short answer seems to be, roughly, that you didn't: Option 1 was the default option, and you could only choose option 2 if you thought about it.
That is of course an insurmountable barrier for many people, but just in case, Direct Edge put up another barrier, which is that they did sort of a rotten job of describing how Hide Not Slide works. Not necessarily worse than I just did, but still pretty bad. For one thing, Direct Edge's rules did not describe Hide Not Slide at all: "Displayed price sliding" of limit orders -- that is, option 1 above -- "was the only price sliding functionality provided for in EDGA and EDGX's rules." Hide Not Slide was never mentioned.
That sounds terrible, though it wasn't quite as terrible as it sounds; Hide Not Slide was described in a "trade desk notification" sent to Direct Edge subscribers by e-mail and posted on the website, and was at least hinted at in the technical specifications, so Direct Edge's customers could find out about it if they wanted to. Direct Edge just forgot to put it in the rules. But, separately, the description on the website was wrong: It was right for a little while, but "became outdated shortly thereafter," due to technical changes to Hide Not Slide that are -- you will have to trust me on this -- even less interesting than what we've talked about so far. And the website was never updated for those changes.
That's bad. You should update your website! Here's Andrew Ceresney:
“This is a serious violation with serious implications,” Andrew Ceresney, head of the Washington-based agency’s enforcement division, said on a call with reporters on Monday afternoon. “The idea here is that if you’re going to have order types, you need to specifically, completely and accurately disclose the nature of those order types.”
A good heuristic is that if an enforcement official says that something is "a serious violation," he doesn't really mean it. If someone steals a billion dollars from widows and orphans, you can just say, "This guy stole a billion dollars from widows and orphans! Come on!" and everyone will understand that it's serious. But when someone doesn't fully update its rule filings to describe the time priority of order display in locked markets, you have to just be like, "Trust me, guys, this is super serious," because if you actually say what happened no one will pay attention through the end of the sentence.
ð The rest is on the right.
Part II of the 'Hide Not Slide' Orders Were Slippery and Hidden (FYI only)
So is it important? I mean, obviously people should update their websites. But my stupid little story above started off with you wanting to lock a market. That is the hinge on which all of this turns: There is stock for sale at $10.01, and you want to pay $10.01 for that stock, but you don't want to buy the stock that's for sale at $10.01. You want to buy some other stock for $10.01, later. But not much later -- you want to be the first person to buy it at $10.01 after it stops being available for sale at $10.01. I know, I know. This can actually be a perfectly reasonable desire, for a lot of reasons, but it is a niche desire.
It is of course a desire that is felt mainly by high-frequency traders. Unlike many market-structure issues, there are clear and identifiable victims of Direct Edge's, um, hiding of its Hide Not Slide rules. Those victims are not widows and orphans, though. They're robots. Specifically, they're trading machines. Even more specifically, they're Trading Machines LLC, a high-frequency trading firm started by Haim Bodek. From that 2012 Journal article:
His firm did well at first, Mr. Bodek says, but in 2009 its performance worsened on several trading platforms, including Direct Edge, a computerized market based in Jersey City, N.J. Trading Machines' profits fell by more than $10,000 a day, Mr. Bodek says.
He suspected a bug in his trading code and talked with officials of several trading venues. Then at a holiday party hosted by Direct Edge on Dec. 2, 2009, Mr. Bodek says, he spoke with the company's sales director, Eugene Davidovich. Mr. Bodek says Mr. Davidovich told him his problem wasn't a bug -- he was using the wrong order type.
Mr. Bodek had been using common "limit orders," which specify a price limit at which to buy or sell. Mr. Davidovich, according to Mr. Bodek, suggested that he instead use an order type called Hide Not Slide, which Direct Edge had introduced in early 2009, about the same time Trading Machines' performance started to suffer.
Mr. Bodek says Mr. Davidovich told him Direct Edge had created this order type -- which lets traders avoid having their orders displayed to the rest of the market -- to attract high-frequency trading firms.
And so Bodek brought the order-type controversy to the SEC's attention, and the SEC looked into it. And its investigation bore out Bodek's claims: Hide Not Slide seems to have been created at the request of, and with continuing advice from, two high-frequency trading firms ("Trading Firm A" and "Trading Firm B"); Firm A actually said that it would send more trading Direct Edge's way if it implemented Hide Not Slide. Unsurprisingly, the Direct Edge exchanges talked more with these firms about Hide Not Slide than they did with the people who didn't help create it. Andrew Ceresney
They also gave information about order types only to some members, including certain high-frequency trading firms that provided input about how the orders would operate.
There's a hint in that quote of, "Oh those high-frequency traders, what will they think of next," but, again, the victims here were the high-frequency traders who weren't in the room. If you're buying 100 shares at a time with market orders in your personal account, this is not your problem. If you're buying a million shares at a time for your mutual fund, it's probably not your problem either.
On the other hand, if you're a high-frequency trader, this is something you care about, and it really ought to be described clearly and fairly for everyone. So, good for the SEC for catching it and fixing it. But notice that the fix is purely about disclosure: "The SEC does not allege that there was anything inherently inappropriate about the order type functionality," says Direct Edge's current owner, and that is quite right. But it is also controversial: "I’m uncomfortable with having all these order types," the chief executive officer of the company that owns the New York Stock Exchange has told Congress. "I don’t know why we have them." I bet Trading Firm A knows, though.
You could have two views of the order-type debate: You could think that markets should provide the same simple tools to everyone, or you could think that markets should be free to provide specialized tools for specialized purposes. In the latter model, high-frequency traders who care about time priority and liquidity rebates should have access to tools like Hide Not Slide, and fundamental investors who care about maximizing execution size and certainty should have access to other tools that do different things, and everyone can either work to figure out the tools or else constantly be taken advantage of by the people who understand the tools. This takes work, but then, everything takes work: If order types are simple, then you have to combine them in complex ways. The idea of complicated order types is that, instead of relying on your broker, or writing your own algorithms, to decide how to go about buying stock, you can outsource some of the decisions to the exchanges. Order types can be little pre-programmed algorithms offered by the exchanges to make decisions for you.
The first model is a lot simpler and more soothing to those who don't spend a lot of time on market structure, but you can see why the second is more appealing to the exchanges. Their customers come to them and say, "Hey you know what would be cool is [some new order type]." What are they going to do, say no? Why not make the customers happy and try to pick up more business that way? As long as, you know, you don't do it by keeping other customers in the dark.
Here's Haim Bodek's reaction today:
“I was quite impressed by the level of sophistication the SEC took towards this case,” Bodek said in a phone interview today. “It’s completely knowledgeable about the intricacies of the market. I’d be very surprised if that competency that they’ve shown was just limited to just this one case.”
This seems right; the SEC order is very much in the weeds of market intricacy. And yet in some sense the SEC's conclusion is not that sophisticated: It's just "keep doing what you're doing, but disclose it better."
This fits with my general theory of the SEC's recent market-structure enforcement efforts. I think that the SEC understands how the stock market works, and is basically OK with it. (After all, it's largely the SEC's doing.) It's also aware that much of the public doesn't understand, and is not OK with it: "The market is rigged! High-frequency traders are evil!" Etc. And it's aware that there are real problems that give rise to that public impression, though the problems might be smaller than they appear.
So the SEC keeps bringing cases like this one, which is pretty perfectly calibrated to that world view. This case fixes a real market abuse: Direct Edge really should tell people how its order types work. It satisfies the public demand to crack down on high-frequency traders and the exchanges that cater to them. But it doesn't actually change anything fundamental about market structure.
10/3/2017: Lecture by guest speaker: Mr. Peluso
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 10/12):
1. The Thailand Co. is considering the purchase of some new equipment. The quote consists of a quarterly payment of $4,740 for 10 years at 6.5 percent interest. What is the purchase price of the equipment? ($138,617.88)
2. The condominium at the beach that you want to buy costs $249,500. You plan to make a cash down payment of 20 percent and finance the balance over 10 years at 6.75 percent. What will be the amount of your monthly mortgage payment? ($2,291.89)
3. Today, you are purchasing a 15-year, 8 percent annuity at a cost of $70,000. The annuity will pay annual payments. What is the amount of each payment? ($8,178.07)
4. Shannon wants to have $10,000 in an investment account three years from now. The account will pay 0.4 percent interest per month. If Shannon saves money every month, starting one month from now, how much will she have to save each month? ($258.81)
5. Trevor's Tires is offering a set of 4 premium tires on sale for $450. The credit terms are 24 months at $20 per month. What is the interest rate on this offer? (6.27 percent)
6. Top Quality Investments will pay you $2,000 a year for 25 years in exchange for $19,000 today. What interest rate are you earning on this annuity? (9.42 percent)
7. You have just won the lottery! You can receive $10,000 a year for 8 years or $57,000 as a lump sum payment today. What is the interest rate on the annuity? (8.22 percent)
Summary of math and excel equations
FV = PV *(1+r)^n
PV = FV / ((1+r)^n)
N = ln(FV/PV) / ln(1+r)
Rate = (FV/PV)1/n -1
Annuity: N = ln(FV/C*r+1)/(ln(1+r))
Or N = ln(1/(1-(PV/C)*r)))/ (ln(1+r))
EAR = (1+APR/m)^m-1
APR = (1+EAR)^(1/m)*m
Study Guide for the First Mid Term (Close book close notes)
Date of first mid term: 10/10
First Mid Term Exam Study guide
Short Answer Questions (10*10=100 points)
1. Answer questions based on the article “What caused the financial crisis”
2. What are the six parts of the financial markets? What are the five core principals of finance? Why do we need stock exchanges? (10 points)
3. Answer questions based on “Everything You Need to Know About High-Frequency Trading”
4. Answer questions based on “The Fed is taking a major step away from its Great Recession policy”
5. Compare M0, M1, and M2.
6. The fractional banking table question (similar to HW)
7. A time value of money question (just write down the math equation)
8. Order types question. Order types covered: market order, limit order and stop loss order.
9. IPO question: What is under writer? Do you think that under writers leave money on table for the IPO investors?
10. Answer questions based on “How ‘hide not slide’ orders work”
All papers for reference will be provided in the exam.
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 10/24):
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 bond 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 10/24)):
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.”
Greenspan: Bond bubble about to break because of 'abnormally low' interest rates
· Former Fed Chief Alan Greenspan said "abnormally low" interest rates will break a bubble in the bond markets.
· Greenspan is famous for warning markets about "irrational exuberance" and the consequences it can bring.
Published 7:49 AM ET Fri, 4 Aug 2017 Updated 1:15 PM ET Fri, 4 Aug
Former Federal Reserve Chairman Alan Greenspan issued a bold warning Friday that the bond market is on the cusp of a collapse that also will threaten stock prices.
In a CNBC interview, the longtime central bank chief said the prolonged period of low interest rates is about to end and, with it, a bull market in fixed income that has lasted more than three decades.
"The current level of interest rates is abnormally low and there's only one direction in which they can go, and when they start they will be rather rapid," Greenspan said on "Squawk Box."
That low interest rate environment has been the product of current monetary policy at the institution he helmed from 1987-2006. The Fedtook its benchmark rate to near zero during the financial crisis and kept it there for seven years after.
Since December 2015, the Fed has approved four rate hikes, but government bond yields remained mired near record lows.
Greenspan did not criticize the policies of the current Fed. But he warned that the low rate environment can't last forever and will have severe consequences once it ends.
"I have no time frame on the forecast," he said. "I have a chart which goes back to the 1800s and I can tell you that this particular period sticks out. But you have no way of knowing in advance when it will actually trigger."
One point he did make about timing is it likely will be quick and take the market by surprise.
"It looks stronger just before it isn't stronger," he said. Anyone who thinks they can forecast when the bubble will break is "in for a disastrous" experience."
In addition to his general work at the Fed, which also featured an extended period of low rates though nowhere near their current position, Greenspan is widely known for the "irrational exuberance" speech he gave at the American Enterprise Institute in 1996. The speech warned about asset prices and said it is difficult to tell when a bubble is about to burst.
Those remarks foreshadowed the popping of the dot-com bubble, and the phrase has found a permanent place in the Wall Street lexicon.
"You can never be quite sure when irrational exuberance arises," he told CNBC. "I was doing it as part of a much broader speech and talking about the analysis of the markets and the like, and I wasn't trying to focus short term. But the press loved that term."
Alan Greenspan argues that current low yields on bonds is the result of irrational exuberance by investors. The former Fed chairman said higher yields are inevitable and he predicted a stagflation not seen since the 1970s.
For class discussion: Which side do you support?
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
3. Conflict of interest?
4. 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
The ratios are combined in a function known as the Z-score that yields a score for each company. The equation for calculating Zscores 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.
Cracks Emerge in Corporate Debt Confidence
Traders turn to derivatives to hedge against potential losses.
September 6, 2017, 2:00 PM EDT
Investors are starting to get worried about the $7.2 trillion U.S. investment-grade bond market.
they are still pouring money into this debt and accepting near-record low
yields to own it. But look a little closer and it's
clear these bond buyers are starting to show some signs of unease. Traders
are increasingly turning to derivatives to hedge against potential losses.
This is a marked shift from earlier in the year, when many bond investors
seemed unwilling to give up any returns for such protection. During most of
2017, trading volumes in credit-default swaps sagged well below recent years'
volumes alone don't determine whether traders are actually becoming more
bearish, analysts are interpreting this surge as a sign of investor caution.
Indeed, investors are earning yields of less than 3 percent on average to own investment-grade corporate bonds compared with nearly 5 percent yields over the past two decades. Not only that, but the debt has become riskier in some respects. It is more vulnerable to losses if benchmark borrowing costs rise, its average maturity has been lengthening and lower-rated bonds account for a growing proportion of the market.
course, this has been the case for a while and these securities have remained
a haven, delivering more than 6 percent annualized returns since 2008,
according to Bloomberg Barclays index data. Even the
prices on these derivatives don't seem to suggest that investors are
preparing for a full-out market swoon, or even partial one.
Homework Questions (Due 10/26):
1. What has been done to hedge risk for the corporate bonds by the traders?
2. Why a hike showed up on 8/11 in the CDS trade graph (the first graph)?
3. Bond investors are long term oriented. Why do they need to pay attention to what is happening in the market?
Credit rating firms are downgrading more US companies than at any other time since financial crisis. Discussion Questions (not hw):
1. Why does S&P downgrade those firms in some industries? Increased borrowing by those firms is one of the reasons. Why do they do so? Are they not afraid of the punishment such as being downgraded by the rating agencies?
2. The spread between corporate bonds and Treasury bonds has increased. Do you worry about the health of the economy?
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