Professional Documents
Culture Documents
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This course
It may not be what you want/expect if
you are looking for a model answer for investments. It is
common to have conflicted/different views. That means you
may not know what to do or how to proceed at some point.
The 34 analysts offering 12-month price forecasts for Tesla Inc have
a median target of 1,002.50, with a high estimate of 1,580.00 and a
low estimate of 67.00. Jan 5 ,2022 source: cnn.com
• https://www.youtube.com/watch?v=c-2uuIz_sAQ
• Key points?
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How to tell your investment return?
2020 and 2021
• S&P500 index: about 16% and 27%
• The average annualized return from1926 to 2021 is
10.49%. https://www.investopedia.com/
• Nasdaq composite: 43% and 22%
• Average return about 10% for the last 15 years
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What is the current concern?
• Raising interest rate by the Fed. due to
inflation
• Can be reflected by rising yield of say 10-
year US treasury bond
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Ch. 2
Chapter
*Note: who cares? As a small individual investor, you may not have
many choices. However, in the future, you may be a fund manager or
be investing for your firm, your choices do matter. Many investors
ignore the risk when they invest. Also compound return matters in the
long run
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Real questions retail investors asked
Is it realistic to get 8-9% return?
I'd like to get an 8-9% return on my money in as safe a method as possible. If it were
you what would you recommend? Mutual funds? Any specific ones you'd recommend
to get that return?
https://www.reddit.com/r/investing/comments/85etoz/is_it_realistic_to_get_89_return/
https://www.marketwatch.com/story/the-millennials-looking-to-get-rich-or-die-tr
yin-off-one-of-wall-streets-riskiest-oil-plays-2016-03-30
“Y-O-____-LO,” the teen wrote, flashing his trading statement. “900 to 55K in
12 days!”
On Reddit, he’s known as “World Chaos,” a Florida high schooler who earlier
this year multiplied his money by betting against the S&P 500.
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2.1 Asset Classes
Common Stock
Asset
Classes
Fixed Income
Securities
Derivative Securities
• Money Market (more
(options to be details)
covered) • Bond Market
• Preferred Stock
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2.1 The Money Market: Instruments
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2.1 The Money Market: Certificates of Deposit (CDs)
Certificates of Deposit
Issuer: Depository Institutions
Denomination: Any, $100,000 or more
Maturity: Varies, Typically 14-day Minimum
Liquidity: High for CDs <3 months,
Default Risk: First $250,000 Federal Deposit
Insurance Corporation (FDIC) insured
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T-bills vs CDs
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Figure 2.2 Spreads on CDs and Treasury Bills
5.0
OPEC I
4.0
Financial crisis
3.5
OPEC II
Percentage points
3.0
Penn Square
2.5
Market crash
2.0
1.5
LTCM
1.0
0.5
0.0
1970
1972
1974
1976
1980
1982
1984
1986
1990
1994
1996
2000
2006
2010
2014
1978
1988
1992
1998
2002
2004
2008
2012
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2.1 The Money Market: Commercial Paper
CP
Issuer: Large creditworthy corps.; financial institutions
Denomination: Minimum $100,000
Maturity: Maximum 270 days, usually 1-2 months
Liquidity: CP < 3 months, liquid
Default Risk: Unsecured, rated, mostly high quality
Interest Type: Discount
e.g. A firm offers investors $1.008 million in face
value in exchange for $1 million in cash
GE relies on commercial paper to help fund its daily operations, and it used
to be one of the biggest issuers of the debt……
https://www.bloomberg.com/news/articles/2018-10-03/ge-downgrade-will-lift
-its-costs-in-a-debt-market-it-once-ruled
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2.1 The Money Market
• Bankers’ Acceptances
• Maturity between 30 to 180 days
• Purchaser authorizes a bank to pay a seller for goods
at later date (time draft)
• When purchaser’s bank “accepts” draft, it becomes
contingent liability of the bank
• banker’s acceptances’ function based on the
creditworthiness of the banking institution
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2.1 The Money Market
• Bankers’ Acceptances
• e.g. US firm buys toys from a HK firm
• How to make sure the HK firm will get payment from
the US buyer once toys are shipped to USA?
• Flipped classroom video (1 min. 32 sec):
https://www.investopedia.com/terms/b/bankersacce
ptance.asp
• Eurodollars
• Dollar-denominated time deposits held outside U.S.
• Pay higher interest rate than U.S. deposits
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2.1 The Money Market: Repurchase Agreements
• Repurchase Agreements (RPs or repos)
• Short-term sales of securities with promise to
repurchase at higher price
• So a (short-term) borrowing
• RP is a collateralized loan
• Many RPs are overnight; some may have a 1-month
maturity
• Reverse RPs(the party on the other side of RPs)
• Lending money; obtaining security title as collateral
Video:
https://www.investopedia.com/terms/r/repurchaseagreement.asp
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2.1 The Money Market: Instrument Yields
• Yields on money market instruments not always
directly comparable
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Figure 2.1 Treasury Bills (T-Bills)
0.01967%x365/177 =0.041%
Treasury Bills
DAYS TO ASKED
MATURITY MATURITY BID ASKED CHG YIELD
28-Nov-2014 73 0.010 0.005 -0.005 0.005
2-Jan-2015 108 0.015 0.010 0.000 0.010
12-Mar-2015 177 0.045 0.040 0.000 0.041
28-May-2015 254 0.045 0.040 -0.005 0.041
23-Jul-2015 310 0.080 0.075 0.000 0.076
So ask yield of 0.04% means dealer willing to sell the bills at a discount
from face value of 0.04% x (177/360) =0.01967%
i.e. $10,000 x (1-0.01967%) =$9,998.033
Source: The Wall Street Journal Online, September 14, 2014. Please try
example in the text
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2.1 The Money Market
• Bank Discount Rate (T-bill quotes)
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2.1 The Money Market: Bond Equivalent Yield
10,000 − P 365
r = ×
BEY P n
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2.1 The Money Market: Effective Annual Yield
Note: the key point here is: to understand the yield the instrument is referring to
instead of simply investing the one with highest yield,
For exam. purpose, all you need to know is included in this powerpoint
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2.2 The Bond Market
• You should have the basics from FM course.
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2.2 The Bond Market: Private Issue
• Before we leave the bond topic, you should know that bonds are
not always safe investments, e.g. corporate bond (recent local
example: China Evergrande) and the MBS
• Corporate Bonds
• Investment grade vs. speculative grade
• Mortgage-Backed Securities (MBS),
• see my in-class example or
https://www.investopedia.com/terms/m/mbs.asp
• Backed by pool of mortgages with “pass-through” of monthly payments;
covers defaults
• Private banks purchased and sold pools of subprime mortgages
• Issuers assumed housing prices would continue to rise
• MBS, the second largest segment of the US fixed
income market after US Treasuries
• MBS: total outstanding about $10 trillion in 2019
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2.4 Stock Indexes
• Uses of indexes
• Track average returns
• Compare performance of managers
• Base of derivatives (e.g. Hang Seng Index
futures and options)
• Factors to be considered in
constructing/using index
• Representative?
• Broad/narrow?
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2.4 Stock Indexes
• Construction of Indexes
• How are stocks weighted?
• Price weighted (DJIA)
• https://us.spindices.com/indices/equity/dow-jones-industrial-av
erage
• https://www.investopedia.com/articles/financial-theory/10/intro
duction-to-the-dow.asp
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2.4 Stock Indexes
• Constructing Market Indexes
• Weighting schemes
• Price-weighted average: Computed by adding
prices of stocks and dividing by “divisor”
• Market value-weighted index: Return equals
weighted average of returns of each
component security, with weights proportional
to outstanding market value
• Equally weighted index: Computed from
simple average of returns
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2.4 Stock Indexes
Stock PriceB QuantityB P1 Q1
Price-Weighted A $10 40 $15 40
Series B 50 80 45 80
C 140 50 150 50
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2.4 Stock Indexes
Stock PriceB QuantityB P1 Q1
Price-Weighted A $10 40 $15 40
Series (B: 2 for 1 B 50 80 25 160
stock split at time 1) C 140 50 150 50
• Denominator = 2.624869
• Time 1 index value: (15 + 25 + 150)/2.624869 = 72.38
• Other problems:
• Similar % change movements in higher-price stocks cause proportionally larger
changes in the index
• Splits arbitrarily reduce weights of stocks that split in index
• Value-Weighted Series
(15 40) (25 160) (150 50)
IndexV = 100 106.14
(10 40) (50 80) (140 50)
• Equal-Weighted Series A split you get 12
shares (originally 6
• invest say $300 in each shares)
(15 30) (25 12) (150 2.143)
IndexE = 100 119.05
(10 30) (50 6) (140 2.143)
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Equal-Weighted Series (alternative method)
• RC=150/140-1=7.14%
• R-Return
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2.4 Stock Indexes
Case 1 Case 2
Stock PB QB P1 Q1 P1 Q1 Case 1 VW = 100.43
A $10 40 $12 40 $10 40 Case 1 EW = 106.67
B 100 80 100 80 100 80
C 50 200 50 200 60 200
• Why do the two differ?
• Case 2: 20% change in price of large-cap firm
(10 40) (100 80) (60 200)
IndexV = (10 40) (100 80) (50 200) 100 110.86
• Assume $100 investment in each stock
(10 10) (100 1) (60 2)
IndexE = 100 106.67
(10 10) (100 1) (50 2)
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2.4 Stock Indexes
• Examples of Indexes
• Dow Jones Industrial Average, DJIA (30 stocks)
• Standard & Poor’s 500 Composite
• NASDAQ Composite (>3,000 firms)
• Wilshire 5000 (>6,000 stocks)
• Hang Seng Index (www.hsi.com.hk)
• Hang Seng China Enterprises Index
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Figure 2.10 Stock Options on Apple
Let’s try a more volatile stock option: Tesla, put option using August
22, 2017 data OR you want to try Apple (>$2 trillion market value
2020) first?
Source: www.cboe.com, September 17, 2014,
you may try the text example using 2017 figures of Apple
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2.5 Derivative Markets
• Using the Stock Options on Apple (Call)
• The right to buy 100 shares of stock at a stock
price of $95 using the October contract would
cost $635 (ignoring commissions)
• Is this contract “in the money”?
• When should you buy this contract?
• When will you make money?
• When should you write it?
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2.5 Derivative Markets
• Using the Stock Options on Apple (Put)
• The right to sell 100 shares of stock at a stock price of
$95 using the October contract would cost $33 (ignoring
commissions)
• Is this contract “in the money”?
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Option: In case you miss our class
• https://www.investopedia.com/terms/s/stock
option.asp
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2.5 Derivative Markets
• Futures Contracts
• Allow you to lock in the buying/selling price of
the underlying asset.
• Your self learning. You are welcome to come to
me for discussion.
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