B8306

Capital Markets & Investments

Course Introduction

9/10/2023 Capital Markets – Fall 2023 – Xuelin Li 1

Outline for Today
❑ Syllabus
▪ Course Requirements
▪ Introduction and Course Outline

❑ Valuation basics
▪ Basics
▪ Return Calculation

9/10/2023 Capital Markets – Fall 2023 – Xuelin Li 2

Capital Markets -- Culture
Present:
• Be on time and present for every session.
• If you can’t make it, have a conflict, and would like to attend the other section,
email me and the course TA.
Participating :
• Constructive participation expected and part of grade
• Complete necessary pre-work needed; expect cold calling
• Bring nameplates.
• Don’t be afraid of making a mistake (we all do)
• Ask lots of questions: If you don’t get it, many others don’t either
• Use your iPad only (no other electronic devices) unless otherwise instructed.
• Particularly later in the term, you will need your laptop in class.
• Also, review sessions are almost always laptop/Excel based

9/10/2023 Capital Markets – Fall 2023 – Xuelin Li 3

Canvas
❑ Everything will be
available on Canvas
▪ Ensure that you have
access and check Canvas
regularly!
▪ All lectures are recorded
▪ Class materials: syllabus,
lecture notes, readings
▪ Assignment: Cases and
HWs in groups of (at
most) 3 students
o People- HW&CaseGroup
- Drag Your Name
▪ Quizzes (timed)

9/10/2023 Capital Markets – Fall 2023 – Xuelin Li 4

Supports
❑ Suggested (not required) textbook
▪ Bodie, Kane, and Marcus, Investments, 10th, 11th or 12th edition
▪ Solutions manual for 10th edition on reserve in library
▪ Syllabus indicates relevant chapters (same in recent editions)
❑ Most Fridays there will be two review sessions:
▪ The course TAs, do Zoom office hours and in-person review sessions on Fridays 5:15-
6:45pm, Geffen 590
▪ I will do my own review sessions on Fridays 10:15 – 11:45 am, Kravis 680
o However, I will not be available on several Fridays---please check Canvas
▪ Both are optional and complementary
o Mine is more like open discussion Q&A and effectively my office hour
▪ We have additional review sessions for exams

9/10/2023 Capital Markets – Fall 2023 – Xuelin Li 5

Course Grading
❑ Cases (3 of 4 graded, 1-10 scale) 15%
▪ One submission/Group
❑ Problem Sets (5 of 6 graded, 1-10 scale) 25%
▪ One submission/Group
❑ Class participation & quizzes 15%
❑ Mid-term exam 20%
❑ End-of-term exam 25%
▪ Both exams are take home/open book/notes/Excel
❑ Grade is on a curve:
▪ Typically 50% get in the A-range
▪ Just under 50% get B’s
▪ Occasionally, someone gets a C – most often for lack of effort

9/10/2023 Capital Markets – Fall 2023 – Xuelin Li 6

Cases and Hoemwork
❑ There are 4 case assignments and 6 problem sets.
❑ Case 0 isn’t graded, but Cases 1, 2 & 3 are.
❑ PS 0 isn’t graded, but the PS 1 – 5 are.
▪ Case 0 (due Friday, 09/15) doesn’t need to be turned in.
▪ PS 0 (due Monday, 09/25) needs to be turned in on Canvas
❑ Submit to Canvas by 11:59 pm on due date.
▪ Please submit just one write-up per group
❑ Grades are 1 – 10 scales.

9/10/2023 Capital Markets – Fall 2023 – Xuelin Li 7

Weekly Canvas Quizzes

❑There are weekly quizzes on

Canvas:
▪ They may be taken any time between 8pm
Wednesday and the following Monday at 4pm.
▪ 3-4 questions, 30 minutes, can’t stop once
started
▪ work individually; honor code is in effect.

9/10/2023 Capital Markets – Fall 2023 – Xuelin Li 8

Setting Expectations
❑ Knowledge of the basics of finance and statistics
▪ Core Corporate Finance and Statistics classes are co-requisites
▪ We review background concepts briefly
❑ Because modern practical finance is quantitative, this course is, too
▪ Math is essential to arrive at precise answers to basic questions
▪ We emphasize intuition in class and exams
▪ Review sessions are helpful for additional math & stats background
❑ Don’t let yourself fall behind!
▪ This is a high-level finance course – it moves really quickly.
▪ Treat the weekly Canvas quizzes as a diagnostic.

9/10/2023 Capital Markets – Fall 2023 – Xuelin Li 9

Topics
1) Introductory Concepts 4) Portfolio Choice
1) Valuing Cash flows: NPV; IRR; No- 1) CAPM, Theory, and Evidence
Arbitrage methods. 2) Factor Models
2) Shorting and Leverage 3) Performance Evaluation
2) Fixed-Income 5) Investment Vehicles
1) Pricing Coupon Bonds 6) Taxation
2) Yield to Maturity 7) Options
3) Term Structure of Interest Rates 1) Put-call parity
4) Duration and Interest Rate Risk 2) Binomial model
Management
3) Black-Scholes model
5) Interest Rate Swaps
4) Option trading strategies
3) Equities
1) Valuation of Equity
2) Diversification
3) Efficient Frontier

9/10/2023 Capital Markets – Fall 2023 – Xuelin Li 10

Course Goals

Value securities Stocks, bonds, and options

Design a portfolio Evaluate its performance

Apply portfolio and valuation Speculation, hedging, and financing

theory to decisions

9/10/2023 Capital Markets – Fall 2023 – Xuelin Li 11

Valuation Axioms
Valuation Axioms:
❑ Investors prefer more to less &
Markets are competitive
❑ Individuals prefer to consume
sooner rather than later
❑ Investors are (mostly) rational
❑ Investors are risk-averse
9/10/2023
Corresponding Implications:
❑ Law of One Price &
No arbitrage opportunites
❑ Positive interest rates*
❑ No (few) investment bargains
❑ Risk premia for risky assets/portfolios.
Capital Markets – Fall 2023 – Xuelin Li 12
Security Valuation
Value of $100 invested at start of 1928
S&P 500 (includes
Years 3-month T.Bill US T. Bond Baa Corporate Bond Real Estate Gold
dividends)
1928 143.81 103.08 100.84 103.22 101.49 100.10

1929 131.88 106.34 105.07 106.33 99.40 99.95

1930 98.75 111.18 109.85 106.91 95.13 100.05

1931 55.46 113.74 107.03 90.14 87.38 82.66

1932 50.66 114.96 116.44 111.41 78.23 100.24

1933 75.99 116.06 118.60 125.86 75.25 127.57

1934 75.09 116.39 128.05 149.54 77.44 168.07

1935 110.18 116.58 133.78 169.44 85.00 168.80

1936 145.38 116.78 140.49 188.73 87.73 168.94

9/10/2023 Capital Markets – Fall 2023 – Xuelin Li 13

Security Valuation
❑ Average Returns
Average Annual Real Return
S&P 500 Baa
Years (includes 3-month T.Bill US T. Bond Corporate Real Estate Gold
dividends) Bond
1928-2022 8.27% 0.31% 1.88% 3.91% 1.28% 3.21%
1973-2022 7.56% 0.40% 2.63% 4.74% 1.50% 5.10%
2013-2022 10.78% -1.76% -1.91% 1.29% 4.91% -0.53%

❑ How do you calculate returns in a year?

❑ Stock example: The rate of return is what you get in the future divided by what you paid (minus 1)
𝑃1 + 𝐷1 𝐷1 𝑃1
𝑅= −1= + −1
𝑃0 𝑃
ด0 𝑃0
𝑖𝑛𝑐𝑜𝑚𝑒 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑔𝑎𝑖𝑛
𝑟𝑒𝑡𝑢𝑟𝑛 𝑜𝑟 𝑙𝑜𝑠𝑠
6 138
= + − 1 = 20%
ต 120
120
5% 15%
❑ Notation:
▪ 𝑅 = rate of return, 𝑃0 = price you paid (at time 0)
▪ 𝑃1 = price at which you can sell (at time 1), 𝐷1 = the dividends you received from time 0 to 1

9/10/2023 Capital Markets – Fall 2023 – Xuelin Li 14

Security Valuation
❑ How much are they now?
Value of $100 invested at start of 1928 in
S&P 500
(includes Baa Corporate
dividends) 3-month T.Bill US T. Bond Bond Real Estate Gold
2017 399,768.64 2,008.55 7,309.87 43,398.81 3,355.82 6,254.84
2018 382,870.94 2,047.44 7,308.65 42,199.86 3,507.93 6,196.71
2019 502,371.39 2,089.67 8,012.89 48,668.87 3,637.43 7,378.88
2020 592,914.80 2,097.08 8,920.90 53,736.05 4,013.76 9,162.31
2021 761,710.83 2,098.03 8,526.95 54,237.64 4,772.94 8,818.31
2022 624,534.55 2,140.51 7,006.75 46,379.53 5,121.52 8,866.76
❑ If you invest in S&P500, your $100 increases over 6,000 times or 600,000%.
❑ But remember the average annual return is only 8.23%, after almost 100 years, shouldn’t it increase by
823%?
❑ Compounding: Compound Annual Growth Rate (CAGR):
▪ where 𝑃𝑇 is the final value, 𝑃0 is the initial value, and 𝑇 is the number of periods.

1
𝑃𝑇 𝑇
𝐶𝐴𝐺𝑅 = −1
𝑃0

9/10/2023 Capital Markets – Fall 2023 – Xuelin Li 15

Functions of Financial System

❑ Of the 1%, by the 1%, for the 1%

❑ Four functions:
▪Capital allocation
▪Consumption smoothing
▪Risk sharing
▪Price discovery

9/10/2023 Capital Markets – Fall 2023 – Xuelin Li 16