FIN 534 Class Web Page, Summer '16
Jacksonville University
Instructor: Maggie Foley �
Term Project 1 � Factor Analysis �(Optional)
Term Project 2 Project II assignment��� (reference: Study of Efficient Frontier based on Matrix in Excel)
Weekly SCHEDULE, LINKS, FILES and Questions
Week 
Coverage, HW, Supplements  Required 
WSJ Papers Reference and other References 
Videos (optional) 

Week 1 
Market Watch Game Use the information and directions below to join the game. 1. URL for your game: 2. Password for this private game: havefun 3. Click on the 'Join Now' button to get started. *You should review time value of money by yourself. Get familiar with the subject by working on (in class exercise of chapter 5 and 6) from here: https://www.jufinance.com/fin500_16s Subject: What is Money, Fed and Interest Rate Section one: What is Money? � Reference: Stephen G. Cecchetti, Kermit L. Schoenholtz, "Money, Banking and Financial Markets (4th edition) � Chapter 2� PPT here (handout will be distributed in class) � 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 longterm 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? Let�s watch this video of Money supply of M0, M1, and M2. A Few Things the Fed Has Done Right (WSJ, by Dr. Cochrane) (We will debate on a few topics as suggested below, plus other topics if you have any): 1. How big is Fed�s balance sheet? Any concerns to you? 2. Fed pays interest on bank reserves. Good or bad? Why? 3. Can Fed stabilize the financial market by paying interests on reserves? Why do banks keep excess reserves with Fed instead of lending them out to consumers? 4. Is hyperinflation or deflation a concern here to the author? But reserves (both required and excess) are not counted in M1, M2, M3. What do you think? What is Fractional Banking System? Money Creation in a Fractional Reserve Banking System

Iteration # 
Deposited 
= 
Reserves 
+ 
Available to Lend 
Bank 
Lends to 

1. A 
1,000.00 
= 
100 
+ 
900 
A 
2. B 
900 
= 
90 
+ 
810 
B 
3. C 
810 
= 
81 
+ 
729 
C 
4. D 
729 
= 
72.9 
+ 
656.1 
D 
And the cycle continues� 
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 
Section Two:� Fed and Monetary Policy
Reference: Stephen G. Cecchetti, Kermit L. Schoenholtz, "Money, Banking and Financial Markets (4th edition) � Chapter 16, 18� PPT I here and PPT II here (handout will be given in class)
��
Fractional banking and the Fed system explained (Video)
�The FOMC holds eight regularly scheduled meetings during the year and other meetings as needed. Links to policy statements and minutes are in the calendars below. The minutes of regularly scheduled meetings are released three weeks after the date of the policy decision.
Federal open market committee meeting calendars, minutes and statement (20102016)
Section Three:� The limitation of what government can do to rescue the economy
The financial crisis explained (video)
Dodd Frank Act  ppt
Research paper of quantitative easing in China I �(FYI only)
 Excessive Debt, Financial Stress, and Real Economic Downturns: Theory and Evidence from China
Research paper of quantitative easing in China II �(FYI only)
 Estimation of the Liquidity Trap Using a Panel Threshold Model
Section Four: Interest rate
Reference:� Fundamental of� Financial Management, by Brigham, chapter 6
Interest rate PPT (handout will be distributed in class)
Formula
r = r* + IP + DRP + LP + MRP
r = required return on a debt security
r* = real riskfree rate of interest
IP = inflation premium
DRP = default risk premium
LP = liquidity premium
MRP = maturity risk premium
MRP_{t} = 0.1% (t � 1);��
DRP_{t} + LP_{t} = Corporate spread * (1.02)^{(t−1)}
�Summary of Yield Curve Shapes and Explanations
Normal Yield Curve
When bond investors expect the economy to hum along at normal rates of growth without significant changes in inflation rates or available capital, the yield curve slopes gently upward. In the absence of economic disruptions, investors who risk their money for longer periods expect to get a bigger reward � in the form of higher interest � than those who risk their money for shorter time periods. Thus, as maturities lengthen, interest rates get progressively higher and the curve goes up.
Steep Curve � Economy is improving
Typically the yield on 30year Treasury bonds is three percentage points above the yield on threemonth Treasury bills. When it gets wider than that � and the slope of the yield curve increases sharply � longterm bond holders are sending a message that they think the economy will improve quickly in the future.
Inverted Curve � Recession is coming
At first glance an inverted yield curve seems like a paradox. Why would longterm investors settle for lower yields while shortterm investors take so much less risk? The answer is that longterm investors will settle for lower yields now if they think rates � and the economy � are going even lower in the future. They're betting that this is their last chance to lock in rates before the bottom falls out.
Flat or Humped Curve
To become inverted, the yield curve must pass through a period where longterm yields are the same as shortterm 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 30year bonds the second we saw their yields start falling toward shortterm 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.
Class discussion Topics
How does today�s yield curve look like?
What can you learn about the market from the yield curve?
How is the interest rate determined? For example, the yield of 20 year bond issued by Treasury is less than that by WalMart. Meanwhile, GE�s bond with similar maturity condition would be cheaper than that of WalMart. How come? Which bond sounds more attractive to you?
HW of first week:
1. Week One�s Case Study (Due before mid term)
2. A Few Things the Fed Has Done Right (WSJ, by Dr. Cochrane)
Please answer the following questions (Due next week before the class)
� How big is Fed�s balance sheet? Any concerns to you?
� Fed pays interest on bank reserves. Good or bad? Why?
� Can Fed stabilize the financial market by paying interests on reserves? Why do banks keep excess reserves with Fed instead of lending them out to consumers?
� Is hyperinflation or deflation a concern here to the author? But reserves (both required and excess) are not counted in M1, M2, M3. What do you think?
Market data website:
http://finramarkets.morningstar.com/BondCenter/Default.jsp (FINRA bond market data)
Market watch on Wall Street Journal has daily yield curve and interest rate information.
http://www.marketwatch.com/tools/pftools/
https://www.youtube.com/watch?v=yph8TRldW6k
******************��� Fed Balance Sheet��� ********************
http://www.federalreserve.gov/releases/h41/20071129/
Fed Balance Sheet as of Nov 29^{th}, 2007
(At that time, Fed assets = 882,848)
http://www.federalreserve.gov/releases/h41/20081128/
Fed Balance Sheet as of Nov 28^{th}, 2008
http://www.federalreserve.gov/releases/h41/20091127/
Fed Balance Sheet as of Nov 27^{th}, 2009
http://www.federalreserve.gov/releases/h41/20101126/
Fed Balance Sheet as of Nov 26^{th}, 2010
http://www.federalreserve.gov/releases/h41/20111125/
Fed Balance Sheet as of Nov 25^{th}, 2011
http://www.federalreserve.gov/releases/h41/Current/
Fed Balance Sheet as of Nov 29^{th}, 2012
http://www.federalreserve.gov/releases/h41/current/h41.htm
Fed Balance Sheet as of Nov 27^{th}, 2013
http://www.federalreserve.gov/releases/h41/current/h41.htm
Fed Balance Sheet as of Feb 26th, 2015
Fed Exit Strategy: How Challenging Will it Be?
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
Week 2
Part I: Bond Market
bond market data in FINRA (Treasury, corporate and muni)
Market data website:
1. FINRA
http://finramarkets.morningstar.com/BondCenter/Default.jsp (FINRA bond market data)
2. WSJ
Market watch on Wall Street Journal has daily yield curve and bond yield information.
http://www.marketwatch.com/tools/pftools/
https://www.youtube.com/watch?v=yph8TRldW6k
3. Bond Online
http://www.bondsonline.com/Todays_Market/
Reference:� Fundamental of� Financial Management, by Brigham, chapter 8
� Call provision
� Current yield, capital gain yield
� Chapter 11 and Reorganization
� Interest rate risk; reinvestment risk
� Default risk and credit rating
� Reorganization and liquidation
Exercises:
����
Chapter 8 PPT supplement (duration and convexity) (fyi)
Duration and Covexity Calculator (Template, excel)
P = price of the bond
C = semiannual coupon interest (in dollars)
y = onehalf the yield to maturity or required yield
n = number of periods
M = maturity value (in dollars)
P_{} = estimated price if yield decreases by a given amount, Dy
P_{+}= estimated price if yield increases by a given amount, Dy
P_{0} = initial observed bond price
Dy = change in required yield, in decimal form
Chapter 8 Home Work��� (due next week)
81�� A 5 year bond with a par value of $1,000 and an 8% yield to maturity. Right after the purchase, interest rates fell and the new YTM = 7%. Calculate the percentage change in price for each bond after the decline in interest rates? Fill� the table as follows:
Price @8% ���� Price @7% ���������������� Percentage Change
10year, 10% annual coupon ���
10year zero coupon
5year zero coupon
30year zero coupon
�
Which one is more sensitive to interest rate change?
(Answer:
$1,134.20 
$1,210.71 
6.75% 

$463.19 
$508.35 
9.75% 

$680.58 
$712.99 
4.76% 

$99.38 
$131.37 
32.19% 

)
82� 6 years ago, Firm AAA issued a twenty year bond with 14% coupon and $1000 par value. The bond call premium is 9% with 5 years of call protection. The bond is called by the firm. Calculate rate of return who bought the bond when issued and held it till called. Does investors feel happy for the called bond?
�(Answer:� YTC 15.03%; YTM 14%)
83 You plan to buy a bond issued two years ago. It has 9.55 annual coupon and 30 years maturity and 5 year call protection, after which it can be called at 109% of par. The current price of the bond is $1,165.75.
a. Find out YTM and YTC
b. If you bought this bond, which return you can earn?
(Answer:�� YTC 8.04%; YTM 7.06%)
84 Firm AAA has bonds outstanding with par value of $1000 and 10 years left to maturity. The coupon rate is 11% and current price is $1,175. Bond can be called in five years @ 109% of par.
�a. Calculate YTM and YTC.
b. Which yield might investors expect to earn on these bonds? Why?
(Answer:�� YTC 8.35%; YTM 8.13%)
Chapter 8 Case study (Due before midterm)
Part II: Stock Evaluation
Reference:� Chapter 9, Corporate Finance by Berk and DeMarzo
�
Case of chapter 9 (Due before mid term)
�
To calculate bond price� in EXCEL (annual coupon bond):
Price=abs(pv(yield to maturity, years left to maturity, coupon rate*1000, 1000)
To calculate yield to maturity (annual coupon bond)::
Yield to maturity = rate(years left to maturity, coupon rate *1000, price, 1000)
To calculate bond price (semiannual coupon bond):
Price=abs(pv(yield to maturity/2, years left to maturity*2, coupon rate*1000/2, 1000)
To calculate yield to maturity (semiannual coupon bond):
Yield to maturity = rate(years left to maturity*2, coupon rate *1000/2, price, 1000)*2
Math Equations (FYI)
C: Coupon, M: Par, $1,000; i: Yield to maturity; n: years left to maturity
For Semiannual, F=2 for semiannual coupon
(www.jufinance.com/fin500_15f)
Stock screening tools
� Reuters stock screener to help select stocks
http://stockscreener.us.reuters.com/Stock/US/
� FINVIZ.com
http://finviz.com/screener.ashx
� WSJ stock screen
http://online.wsj.com/public/quotes/stock_screener.html
� Simply the Web's Best Financial Charts
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 

How to pick stocks
Capital Asset Pricing Model (CAPM)Explained
https://www.youtube.com/watch?v=JApBhv3VLTo
Ranking stocks using PEG ratio
https://www.youtube.com/watch?v=bekW_hTehNU
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
Treasury Bond Auction Website
What is duration? (not required but useful)
Duration is defined as the weighted average of
the present value of the cash flows and is used
as a measure of a bond price's response to
changes in yield.
If duration = 10 years, then for 1% increase in interest rate, the bond price will drop by 10
times of 1%, which is 10%.
You can calculate duration in excel.
Syntax
DURATION(settlement, maturity, coupon, yld, frequency, [basis])
https://www.youtube.com/watch?v=9HFLGNaEWl8
How to calculate bond prices using exact
date? (not required but useful)
Use price function in Excel. Returns the price
per $100 face value of a security that pays periodic interest.
Syntax
PRICE(settlement, maturity, rate, yld, redemption, frequency, [basis])
Excel How to use the PRICE formula video
https://www.youtube.com/watch?v=4UzFPKv2Tnw
Calculate bond yield using exact date?(not required but useful)
Use YIELD to calculate bond yield.
Syntax
YIELD(settlement,maturity,rate,pr,
redemption, frequency, basis)
Excel yield function video
https://www.youtube.com/watch?v=vi27yLPgwZc
Risk of Bonds
Bond risk (video)
Bond risk � credit risk (video)
Bond risk � interest rate risk (video)
Useful website
money.msn.com/investing
zacks.com
minyanville.com
moneychimp.com
navellier.investor.com/portfoliograder/
nasdaq.com
marketwatch.com
superstockscreener.com
gurufocus.com
portfoliomoney.com
stockconsultant.com
marketgrader.com
moderngraham.com
stockpickr.com
stockta.com
thestreet.com
askstockguru.com
quotes.wsj.com
oldschoolvalue.com
fool.com
analystratings.com
barchart.com
stock2own.com
theonlineinvestor.com
seekingalpha.com
Week 3, 4
Portfolio Optimization (Project, please bring your laptop)
Part I: Risk and Return�
�Risk and Return Chapter 10 PPT part i
Risk and Return Chapter 10 PPT part ii
Reference:� Fundamental of� Financial Management, by Brigham, chapter 8
Fama French factors
http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html
Fama French 3 factor model paper (reference)
Assignments:
#1: Case Study� of Risk and Return
#2: Homework (due next week)
1. Stock A�s expected return=8% and standard deviation = 15%.� Stock B�s expected return =15% and standard deviation = 45 percent.� When correlation=0.4, 1, 1, respectively calculate portfolio�s expected return and standard deviation, when this portfolio has 40% of A and 60% of B. Change the percentage of A and B in the portfolio and recalculate the portfolios� r and σ and draw three plots. �
6. The above is the FamaFrench three factor model. What are the three factors? The followings are given.b=0.9. risk free rate = 6.8%. market risk premium = 6.3%. value for size factor=4%. Value for book to market factor=5%. C=0.5. d=0.3. Then how much is the expected stock return?


7. Using the above information, how much is the expected return based on CAPM?
Part II: Project II (Portfolio Optimization, required.)
Project II assignment��� (reference: Study of Efficient Frontier based on Matrix in Excel)
Sample Project II from prior semester FYI (EXCEL)
Sample project II from prior semester FYI (Writing)

�
�
Efficient Frontier using Solver
Optimal portfolio with solver
https://www.youtube.com/watch?v=OGhGz8trZtw
https://www.youtube.com/watch?v=yFge0qK1YZg
�Markowitz portfolio optimization � Solver
http://people.brunel.ac.uk/~mastjjb/jeb/finance/markowitz_qp.pdf
(highly recommend)
https://www.youtube.com/watch?v=FZyAXP4syD8
(highly recommend)
https://www.youtube.com/watch?v=ZfJW3ol2FbA
Week 5
Part I:� �Investor Behavior and Capital Market Efficiency
Chapter 13 PPT (Reference:� Chapter 13, Corporate Finance by Berk and DeMarzo)
HW of chapter 13 (due next week)
1. Your brother Joe is a surgeon who suffers badly from the overconfidence bias. He loves to trade stocks and believes his predictions with 100% confidence. In fact, he is uninformed like most investors. Rumors are that Vital Signs (a startup that makes warning labels in the medical industry) will receive a takeover offer at $20 per share. Absent the takeover offer, the stock will trade at $15 per share. The uncertainty will be resolved in the next few hours. Your brother believes that the takeover will occur with certainty and has instructed his broker to buy the stock at any price less than $20. In fact, the true probability of a takeover is 50%, but a few people are informed and know whether the takeover will actually occur. They also have submitted orders. Nobody else is trading in the stock.
Describe what will happen to the market price once these orders are submitted if in fact the takeover will occur in a few hours. What will your brother�s profits be: positive, negative or zero?� What range of possible prices could result once these orders are submitted if the takeover will not occur. What will your brother�s profits be: positive, negative or zero?
2. Davita Spencer is a manager at Half Dome Asset Management. She can generate an alpha of 2% a year up to $100 million. After that her skills are spread too thin, so cannot add value and her alpha is zero. Half Dome charges a fee of 1% per year on the total amount of money under management (at the beginning of each year). Assume that there are always investors looking for positive alpha and no investor would invest in a fund with a negative alpha. In equilibrium, that is, when no investor either takes out money or wishes to invest new money. �What alpha do investors in Davita�s fund expect to receive?� How much money will Davita have under management?� How much money will Half Dome generate in fee income?
3. 1) �Using the factor beta estimates in the table shown here and the expected return estimates in Table 13.1 (page 438), calculate the risk premium of General Electric stock (ticker: GE) using the FFC factor specification.
Factor 
MSFT 
XOM 
GE 
MKT 
1.068 
0.243 
0.747 
SMB 
0.374 
0.125 
0.478 
HML 
0.814 
0.144 
0.232 
PR1YR 
0.226 
0.185 
0.147 
Table 13.1: FFC Portfolio average monthly returns, 19262008
Factor Portfolio���������� Average Monthly Return (%)�������� 95% Confidence Band (%)
Mkt  r_{f}_{ }���������������������������0.59����������������������������������������������������� + 0.34
SMB��������� ����������������������0.23���������������������������������������������������� +0.21
HML������������������������������ 0.41���������������������������������������������������� +0.22
PR1YR�������������������������� 0.77����������������������������������� ���������������+0.29
2) You are currently considering an investment in a project in the energy sector. The investment has the same riskiness as Exxon Mobil stock (ticker: XOM). Using the data in Table 13.1 and the table above, calculate the cost of capital using the FFC factor specification if the current riskfree rate is 6% per year.
3) You work for Microsoft Corporation (ticker: MSFT), and you are considering whether to develop a new software product. The risk of the investment is the same as the risk of the company. Using the data in Table 13.1 and in the table above, calculate the cost of capital using the FFC factor specification if the current riskfree rate is 5.5% per year.
Part II Efficient Market Hypothesis
Efficient market hypothesis ppt
Efficient Market Hypothesis Critics by Malkiel (FYI)
Alpha:� �
FamaFrenchCarhart (FFC) Factor Specifications
Bad Year Made Worse for Stock Pickers Outmatched by Complexity (FYI, thanks Horrace)
Dani BurgerJul 29, 2016 2:14 am ET
(Bloomberg)  The stock market may be getting too complicated to be left to ordinary money managers.
Active funds are having a rough stretch in 2016, with the proportion of stock pickers beating their benchmark falling below 25 percent in one of the worst showings ever recorded. Money is being yanked at an unprecedented clip and being pumped into index funds and ETFs, where share selection is neutralized.
According to analysts at Nomura Securities, a bad year is being made worse because active managers did a particularly bad job policing their picks for secondary qualities that had the potential to alter returns, things like high cash balances or analyst coverage. Nomura joins a chorus of firms who say a greater focus on such characteristics  factors, in quant parlance  is needed in an industry trying to reverse years of underperformance.
�It�s inexcusable to not be aware of the factor bets you�re making,� said Benjamin Dunn, president of Alpha Theory Advisors, which works with hedge funds overseeing about $6 billion. �If a risk can be measured and you can speak about it, you should at least have a reason for why you�re choosing to take that risk.�
Quantitative processes are having a star turn of late. Point72�s Steven A. Cohen is committing as much as $250 million of capital to be managed by 5yearold online platform where members build computerized trading models and earn a share of profits. Daniel S. Loeb�s Third Point LLC hedge fund said in an investor letter Tuesday that factor risk is driving hedge fund underperformance in an up market this year.
Explanations
In determining why a fund does well or poorly, there�s a simple explanation and a complicated one. At a basic level, mutual funds struggled in the first half because they crowded into stocks that fell and shunned the ones that gained. Human managers were famously concentrated in megacap technology shares and owned fewer energy firms, choices that soured when oil rebounded and companies like Netflix slid.
As befits their mathematical bent, quants take a more analytical approach, looking for subtle, often hidden mistakes that cause stock picks to founder. One process they employ is factor attribution, which compares the earnings, valuation or price characteristics of a set of stocks to what worked in the market over a given period.
Say a fund manager is enamored with value and likes to buy shares trading at a discount to earnings. But in his rush to own cheap shares, he inadvertently buys a bunch of companies with, say, weak balance sheets. He can be blindsided if market suddenly turns against companies with shoddier finances.
�Stock picking matters, sometimes more, and sometimes less. But the wrong factor exposures can undermine stock picking,� Joseph Mezrich, managing director at Nomura, said by phone. �It is very unlikely that managers know all of the unintended factor exposures in their portfolios.�
According to Nomura, active mutual funds committed catastrophic factor errors in the first half of 2016. Growth managers owned stocks whose research budgets were particularly high and which the market killed in the first quarter. Core managers bought companies with high cash balances in the first half of the year  shares that fell 18 percent.
Terrible Results
For growth funds in the first quarter, �nine of their 10 highest positive factor exposures had negative returns, while all 10 of their most negatively exposed factors had positive returns,� Nomura wrote. �Value funds have had terrible results in 2016. Their main active factor exposures and corresponding factor returns in the first half of the year show why: positively exposed factors had negative returns and negatively exposed factors had positive returns.�
Like Bloomberg LP, Nomura sells tools to diagnose fund manager performance, and it may not be surprising that analysts on its quantitative investment strategy team see eliminating unintended style exposure as the key to maximizing gains. Still, in the first half of 2016, they say excess tilts were to blame for a big chunk of the losses among actively managed portfolios.
To be sure, every factor that creeps into a portfolios isn�t harmful to returns. Take a growth manager who also ends up making a bet on profitability  those two factors could easily combine to enhance gains. But active managers ran into trouble this year because nearly every extra bet, intentional or not, fell flat.
Value managers� biggest additional factor exposure was to companies with higher return on invested capital. That strategy sank 4.6 percent as normally bullish harbingers like buybacks and activist interest didn�t work in the first half of 2016. Meanwhile, value funds were tilted away from the few strategies that paid off, such as dividend yield, which produced an 8.9 percent return, according to Nomura data. The S&P 500 gained 2.7 percent over the same period.
While it may be unrealistic to completely strip out all secondary style tilts, knowing what you own is helpful when factor performance starts to shift, said Mezrich.
�The awareness of the unintended factor exposures could point to obvious offenders to remove or stocks to include to adjust the portfolio exposures,� he said. �If things are not obvious, but there are large unintended exposures, then reducing tracking error could be useful.�
No Surprise
It�a no surprise that value and growth managers got blindsided, according to Abhra Banerji, director of quantitative research at Evercore ISI. In an environment where lowvolatility and dividendyielding stocks have been two of the few moneymaking strategies, other factors have above average correlations, making it difficult for investors to fight off unintended exposures, he said.
�I don�t think they�re being careless. It�s a consequence of the moves we�ve seen,� said Banerji. �PostBrexit, we�ve seen some of the highest and weirdest correlations, like between momentum and low volatility.�
Even if managers had weeded out excess factors, they still likely would have seen disappointing results yeartodate. In a longshort strategy that gives you pure exposure, value and growth would have fallen 2.4 and 1.4 percent through July 26 respectively, data from Bloomberg�s portfolio analytics tool show.
�There are a lot of global macro risks, and all of those are powerful determinants of returns in a world where value and growth are muted,� said David Bechtel, principal at Stamford, Connecticutbased Barrow Street Advisors. �That allows other factors to dominate returns.�
�2016 Bloomberg L.P.
https://www.youtube.com/watch?v=h5JDftgykcg
Week 6
Derivatives
ppt�� �Reference:� Fundamental of� Financial Management, by Brigham, chapter 18
Class discussion topics:
Apple price will go up because of IPhone 7. Google price could fall based on some news you just heard. Anticipating large changes in stock prices of Apple and Google, how shall you act?
http://www.cboe.com/delayedquote/quotetable.aspx?ticker=aapl
Aug 09, 2016 @ 15:44 ET
Bid: 108.91 Ask: 108.92 Size: 13x17 Vol: 21718240
Last 108.919 Change +0.549
Calls
AUGUST 2016 (EXPIRATION: 08/12)
Strike 
Last 
Net 
Bid 
Ask 
Vol 
Int 
2.04 
+0.39 
2.06 
2.11 
1273 
7807 

1.27 
+0.27 
1.25 
1.30 
3028 
10519 

0.67 
+0.16 
0.66 
0.69 
1438 
10065 

0.29 
+0.04 
0.28 
0.31 
1229 
13169 
Puts
AUGUST 2016 (EXPIRATION: 08/12)
Strike 
Last 
Net 
Bid 
Ask 
Vol 
Int 
0.16 
0.16 
0.13 
0.15 
2067 
9726 

0.35 
0.34 
0.33 
0.35 
2076 
5546 

0.74 
0.46 
0.72 
0.75 
537 
1698 

1.41 
0.57 
1.34 
1.38 
233 
2014 
Calls
AUGUST 2016 (EXPIRATION: 08/19)
Strike 
Last 
Net 
Bid 
Ask 
Vol 
Int 
2.43 
+0.35 
2.42 
2.45 
371 
12765 

1.70 
+0.20 
1.71 
1.75 
910 
9733 

1.12 
+0.15 
1.15 
1.18 
1463 
7772 

0.72 
+0.09 
0.73 
0.75 
1046 
48489 
Puts
AUGUST 2016 (EXPIRATION: 08/19)
Strike 
Last 
Net 
Bid 
Ask 
Vol 
Int 
0.50 
0.28 
0.47 
0.50 
907 
8855 

0.83 
0.35 
0.77 
0.79 
172 
5344 

1.27 
0.42 
1.19 
1.23 
529 
775 

1.85 
0.69 
1.77 
1.80 
54 
9431 
CBOE free option calculator (See examples in the website)
Definitions:
Delta: The ratio comparing the change in the price of the underlying asset to the corresponding change in the price of a derivative. Sometimes referred to as the "hedge ratio."
Gamma: The rate of change for delta with respect to the underlying asset's price. Gamma is an important measure of the convexity of a derivative's value, in relation to the underlying.
Theta: A measure of the rate of decline in the value of an option due to the passage of time. Theta can also be referred to as the time decay on the value of an option. If everything is held constant, then the option will lose value as time moves closer to the maturity of the option.
Vega: The measurement of an option's sensitivity to changes in the volatility of the underlying asset. Vega represents the amount that an option contract's price changes in reaction to a 1% change in the volatility of the underlying asset.
Rho: The rate at which the price of a derivative changes relative to a change in the riskfree rate of interest. Rho measures the sensitivity of an option or options portfolio to a change in interest rate.
Call and Put price of AAPL on Google Finance
Call and Put price of AAPL on Nasdaq
Call Options Trading for Beginners in 10 min (video)
Put Options Trading for Beginners in 10 min (video)
Home Work
1. Case study
2. A call option on Bedrock Boulders stock has a market price of $7. The stock sells for $30 a share, and the option has an exercise price of $25 a share. a. What is the exercise value of the call option? b. What is the premium on the option?
3. The exercise price on one of Flanagan Company�s call options is $15, its exercise value is $22, and its premium is $5. What are the option�s market value and the stock�s current price?
4. Which of the following events are likely to increase the market value of a call option on a common stock? Explain. a. An increase in the stock�s price b. An increase in the volatility of the stock price c. An increase in the riskfree rate d. A decrease in the time until the option expires
5. BLACKSCHOLES MODEL Assume that you have been given the following information on Purcell Industries:
Current stock price = $15
Exercise price of option =$15
Time to maturity of option = 6 months
Riskfree rate = 10%
Variance of stock price = 0.12
d1 = 0.32660
d2 = 0.08165
N(d1) = 0.62795
N(d2) = 0.53252
Using the BlackScholes Option Pricing Model, what is the value of the option?�
BlackScholes model
https://www.youtube.com/watch?v=D9_Jar2UpQ
https://www.youtube.com/watch?v=q_z1Zx_BALo
http://www.tradingtoday.com/blackscholes
http://www.mngt.waikato.ac.nz/kurt/frontpage/StudentWork/DanielChaiNov2003/bitree2.htm
Bullish option strategies example on optionhouse
Bearish option strategies example on optionhouse
Week 7
Project Valuation
Part I: Cost of Capital
Ppt �Reference:� Fundamental of� Financial Management, by Brigham, chapter 10
Case study� (due with final)
Discount rate to figure out the value of projects is called WACC (weighted average cost of capital)
�
�
Part II: Cash Flow Analysis
Ppt �Reference:� Fundamental of� Financial Management, by Brigham, chapter 12
Case study (due with final)
Part III: Capital Budgeting
Ppt �Reference:� Fundamental of� Financial Management, by Brigham, chapter 11
Case study (due with final)
WACC = weight of debt * cost of debt *(1tax rate) + weight of equity *( cost of equity)
Kd = Cost of debt = rate(nper, coupon, price � flotation costs, 1000)*(1tax rate)
Ke = Cost of equity = D1/ Po+g, use CAPM, Bond Risk Premium model
WACC = Wd*Kd +We*Ke�
NPV Excel syntax
Syntax
NPV(rate,value1,value2, ...)
Rate is the rate of discount over the length of one period.
Value1, value2, ... are 1 to 29 arguments representing the payments and income.
� Value1, value2, ... must be equally spaced in time and occur at the end of each period. NPV uses the order of value1, value2, ... to interpret the order of cash flows. Be sure to enter your payment and income values in the correct sequence.
IRR Excel syntax
Syntax
IRR(values, guess)
Values is an array or a reference to cells that contain numbers for which you want to calculate the internal rate of return.
Guess is a number that you guess is close to the result of IRR.
MIRR Excel syntax
Syntax
MIRR(values, finance_rate, reinvest_rate)
Values: required. An array of a reference to cells that contain numbers.
These numbers represent a series of payments (negative numbers) and income (positive values) occurring at regular period.
Finance�_rate: Required. The interest rate you pay on the money used in the cash flow.
Reinvest_rate: Required. The interest rate you receive on the cash flows as you reinvest them
�
Week 8
Final (Coming by 8/19, due on 8/29 6am)
Final Questions