LEARNING MODULE 1:

INTRODUCTION & SECURITIES

MARKETS
Portfolio Management
Overview
◦ Investment Environment
◦ Real Assets versus Financial Assets
◦ Risk-return trade-off and efficient pricing

◦ Asset Classes
◦ Equity
◦ Fixed Income: Treasury bonds, corporate bonds, etc
◦ Derivatives

◦ How Securities Are Traded

◦ Security Issuance: IPO
◦ Market transactions
◦ Short selling and buying on margin: the purchase of an asset by using leverage and borrowing the balance from a bank or
broker
Rise of electronic trading and globalization of stock markets
◦ Any words feel confusing on the overview slide?
THE INVESTMENT
ENVIRONMENT
Real Assets vs. Financial Assets

Real Assets Financial Assets

• Have Productive Capacity ◦ Claims on real assets

◦ Do not contribute directly to

productive capacity

• Examples: Land, buildings, ◦ Examples: Stocks, bonds,

machines, intellectual property derivatives
Financial Assets
Financial Assets: Claims on Real Assets

Fixed-Income Securities: Equity:

Promises a fixed stream of income or Represents ownership share in a
a stream of income determined by a corporation; common Stock
specified formula; debt. For instance,
bonds.

Derivatives:
Provide payoffs that are determined by
the prices of other assets
Financial Markets and the Economy
◦ Informational Role: stock price reflects investors’ collective assessment of a firm’s current performance
and future.
◦ Apple: share price within the 6 months
The Investment Process
◦ Portfolio: Collection of investment assets
◦ Asset allocation
◦ Choice among broad asset classes
◦ Security selection
◦ Choice of securities within each asset class
◦ “Top-down” approach
◦ Asset allocation followed by security analysis
◦ “Bottom-up” approach
◦ Investment based solely on the price-attractiveness
Market Participants
Price of Capital Who Supplies Capital? Households

What Demands Capital? Firms

Quantity of Capital
• Role of Government?
• Can be either borrowers or lenders
• Financial Intermediaries: Pool and invest funds
• Investment Companies, Banks, Insurance Co., Credit Unions
ASSET CLASSES &
FINANCIAL
INSTRUMENTS
Overview
Fixed
Income
Asset Classes Equity

Derivatives
Fixed Income
Money
Markets
Fixed Income
Capital
Markets
Asset Classes Equity

Derivatives
The Money Market
◦ Subsector of the fixed-income market
◦ Short-term
◦ Liquid
◦ Low risk
◦ Often have large denominations and volumes: out of individual trading

◦ Money Market Securities

◦ Treasury bills
◦ Certificates of deposit
◦ Commercial paper
◦ Bankers’ Acceptances
◦ Eurodollars
◦ Repos and reverses
Commercial paper

◦ https://www.investopedia.com/terms/c/commercialpaper.asp
Yields on
Money Market Instruments
◦ Money market securities are not free of default risk
◦ The premium on bank CDs and the TED spread have often become greater during periods of financial
crisis
 The Capital Market
Treasur
y Notes
Treasur
Corporat
e Bonds y
Bonds

Capital
Inflation
Market -
Municipa
l Bonds
s Protecte
d
Securiti
es
Subsector of the fixed-income
market Federal
• Long-Term Internationa
l Bonds Agenc
• Liquid y Debt
• Low risk (but not as
low as the Money
Market)
Capital Market Securities: Government
◦ Treasury Notes and Bonds
◦ Inflation-Protected Treasury Bonds
◦ TIPS (treasury inflation protected securities)
◦ International Bonds: there could be a difference between the currency and the issuer’s country
◦ Eurobonds (e.g., a us dollar demoniated bond sold in uk) and Yankee bonds (a dollar-denominated bond sold in the
us by a non-us issuer)
◦ Municipal Bonds
◦ Issued by state and local governments
◦ Interest is exempt from federal income tax and sometimes from state and local tax
◦ General obligation: backed by full faith and credit of the issuer, vs revenue bond, issued to finance particular
projects and backed by the revenue of the project
Capital Market Securities: Non-
Government
◦ Corporate Bonds
◦ Issued by private firms
◦ Semi-annual interest payments
◦ Larger default risk than government securities
◦ Options in corporate bonds
◦ Callable: allows the issuer of the bond to retain the privilege of redeeming the bond at some point before the bond reaches its
date of maturity
◦ Convertible

◦ Mortgage-Backed Securities
◦ Proportional ownership of a mortgage pool or a specified obligation secured by a pool
◦ Produced by securitizing mortgages
Fixed-Income Markets
Equity
Common
Fixed Income
Stock
Preferred
Asset Classes Equity
Stock

Derivatives ADRs
Equity Securities
◦ Common stock
◦ Ownership
◦ Residual claim: stock holders are the last in line of all those who have a claim on the assets and income of the
corporation
◦ Limited liability: the most shareholders can lose in the event of failure of the corporation is their original investment

◦ Preferred stock
◦ Perpetuity: its promises to pay to its holder a fixed amount of income each year, similar to an infinite-maturity bond
◦ Fixed dividends
◦ Priority over common: they may have priority over common stock (ordinary shares) in the payment of dividends and
upon liquidation
◦ Tax treatment: preferred stock payments are treated as dividends rather than interest, they are thus not tax-deductible
expenses for the firm
Stock Market Indices Other Indices:
NYSE Composite
NASDAQ Composite
Wilshire 5000
◦ Dow Jones Industrial Average
◦ Includes 30 large blue-chip corporations Nikkei (Japan)
◦ Computed since 1896 FTSE (U.K)
◦ Price-Weighted Index DAX (Germany)
Hang Seng (Hong Kong)
◦ S&P 500
TSX (Canada)
◦ Broad based index of 500 firms
◦ Market-Value-Weighted Index All-Ordinaries
ASX200

◦ Investors can base their portfolios on an index

◦ Buy an index mutual fund
Derivatives
Fixed
Income
Asset
Equity
Classes
Options
Derivatives
Futures
◦ A derivative is a security that gets its value from the
value of another asset, such as commodity prices, bond
and stock prices, or market index values
Derivatives
Options Futures Contract
◦ Right, but not obligation, to buy ◦ Obliged to make or take delivery
or sell ◦ Long (short) position must buy
◦ Option is exercised only when it (sell) at the futures price
is profitable ◦ Futures contracts are entered
◦ Options must be purchased (pay into without cost
the premium)
HOW SECURITIES
ARE TRADED
How Firms Issue Securities
◦ Primary Market
◦ Market for newly-issued securities
◦ Firms issue new securities through underwriter to public
◦ Secondary Market
◦ Investors trade previously issued securities among themselves

◦ Privately Held Firms: owned by a relatively small no. of shareholders.

◦ Raise funds through private placement: when private firms wish to raise funds, they sell shares directly to institutional or wealthy investors in a
private placement.
◦ Lower liquidity of shares
◦ Fewer obligations to release financial statements: less disclosure of information
◦ Publicly Traded Companies
◦ Public offerings are marketed by underwriters
◦ Initial Public Offering
◦ Seasoned equity offering: the sale of additional shares in firms that already are publicly traded, e.g., a sale by Apple of new shares of stock.
Bid and Asked Prices
Bid Price Ask Price
◦ Bids are offers to buy ◦ Asked prices are sell offers

◦ In dealer markets, the bid price is the price at ◦ In dealer markets, the asked price is the price at
which the dealer is willing to buy which the dealer is willing to sell

◦ Investors “sell to the bid” ◦ Investors must pay the asked price to buy the
security

Bid-asked spread is the profit for making a market in a security

Trading Strategies
◦ Algorithmic Trading: use of computer programs to make trading decisions

◦ High-Frequency Trading: rely on computer programs to make extremely rapid decisions, for very small
profits, however with huge volume

◦ Dark Pools: large or block orders with anonymity.

◦ Bond Trading
◦ Most bond trading takes place in the OTC market among bond dealers
◦ Market for many bond issues is “thin” and is subject to liquidity risk
 Buying on Margin
◦ Borrowing part of the total purchase price of a position using a loan from a broker
◦ Investor contributes the remaining portion
◦ Margin refers to the percentage or amount contributed by the investor
◦ You profit when the stock rises
◦ Initial margin is the percentage of the purchase price of securities (that can be purchased on margin) that the investor
must pay for with his own cash or marginable securities.

◦ Initial margin is set by the regulator

◦ Typically 50%
◦ Maintenance margin
◦ Minimum equity that must be kept in the margin account
◦ Margin call if value of securities falls too much
Margin Trading: Initial Conditions
Share price $100
Initial Margin: 60%
Borrowing: 40%
Shares Purchased: 100

Initial Position
Stock $10,000 Borrowed $4,000
Equity $6,000
 Margin Trading: Margin Call
Stock price falls to $70 per share
New Position
Stock $7,000 Borrowed $4,000
Equity $3,000

Margin% = $3,000/$7,000 = 43%

 Margin Trading: Maintenance Margin
How far can the stock price fall before a
margin call? Let maintenance margin = 30%

Let P be the stock price. Since shares purchased is 100, we have

Equity = 100P - $4000
Percentage margin = (100P - $4,000)/100P

(100P - $4,000)/100P = 0.30

Solve to find:
P = $57.14
◦ The end. Thank you.