2015F Investments 01 Introduction and Review

7/23/2019 2015F Investments 01 Introduction and Review

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InvestmentsWeek 1: Introduction and

Review

Fall 2015

Professor Albert Wang王文奇



Page 2

Week 1 Agenda

►Administrative Personal !"llabus #lass $ist: !tudent I%& 'mail (W1 to)be)emailed t*is week& due Week + ,1 -ct 2015.

►Introduction /obs W*at are investments Financial securities (ow are securities traded

►Finance 101 Review ime value #omounding '3uit" 4aluation and P' ratios



Page +

Personal Introduction

►'ducation: enn W*arton& 6I !loan

►Work: #ornell %"son& Industr" !ellside and7u"side

►8ow: eac*ing in aiwan to e9ose "ou to t*esame course material as t*e to businesssc*ools in t*e world Primaril" for t*ose ursuing careers in nance

Also useful for an"one w*o *as or wants mone"; $earning standards and e9ectations will be t*e

same as an" of t*e to 7usiness !c*ools in t*e world



Page <

!"llabus

►In)class overview

►Will be revised as needed



Page 5

-t*er Information

►Prere3uisites #ollege)level mat*& statistics& and intro

nance=

/unior!enior #ourse►#lassroom 'ti3uette:

%o not disturb "our classmates►!ilent t"ing if "ou bring a lato

► urn o> ke"stroke sounds and volume on an"electronic devices

►!et cell*ones to vibrate& answer foremergencies onl"



Page ?

-t*er Information

►Reading @uidelines Read t*e main te9t rst►'9amles& cases& and aendices are otional

$earn t*e anal"tical tools resented in t*ete9t

Ask 3uestions in class

►Attendance and Particiation Active articiation can increase "our

grade #ome reared wit* 3uestions and

comments


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#ourse -verview

► *is course is 8- BIntro FinanceC

A surve" of all investment t"es

A secialiDed course on ricing

A memoriDation e9ercise


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#ourse -verview

► *is course I! Investment Anal"sis

+ main tools of nancial management►Increasingreducing nancial e9osure

►%iversif"ing nancial e9osure

►Insuring nancial e9osure

*ese are tools wit* w*ic* "ou cananal"De an" nancial scenario►'ac* situation calls for di>erent alications

and combinations of tools


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W*at /ob %o Gou Want

► I)7anking ,I7%. Issue securities ,rimar" market. '9ecute and advise on cororate nance transactions 7$@' 7RA#H' vs bouti3ue

►!ales J rading ,!J. rade securities ,secondar" market. "icall" art of an investment bank 7roker for institutions and large clients

► Investment 6anagement ,I6. 6anage investments for ot*ers (edge funds& 6utual funds& P' funds& rivate wealt*

management


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#urrent 'vents ,1< !e 2015.

► AI'K Inde9: E+02

►!JP500 Inde9: 1&?105 ,11 !e.

►

Recent nancial news August 6arket urmoil

Fear of #*ina slowdownrecession►R67 mini)devaluation

! Federal Reserve



Page 11

#urrent 'vents ,@oogle.



Page 12

W*at are Investments

►Financial Assets Wealt* storage t*roug* time wit* risk in

transaction rice ,an alternative to cas*.

►#onsumtion transfer from resent to future

Wealt* creation►At least welfare imrovementL no need to

BgorgeC

-wners*i claims on assets

Risk allocation and management tools



Page 1+

"es of Investments,selected.

► 6one" 6arket ,cas*.: )bills& #%s& commercial aer& bankersM accetances& 'urodollars&

reos& fed funds& brokersM calls& $I7-R► Fi9ed Income

)notesbonds& agencies& international& municials ,munis.&cororates& mortgage)backed securities& collateraliDed

► '3uities #ommon and referred s*ares

► #urrencies► #ommodities

Precious metals& agricultural& energ"

► Real 'state► %erivatives

-tions& futures& *"brids& e9otics► -t*ers N baseball cards& cars& wine& stams& Lan"t*ing of

value;



Page 1<

Financial /argon

►Financial Instruments include nancialassets& derivatives& and ot*er contracts

►Financial Assets reresent owners*i of

assets !tocks& bonds

►%erivatives derive value from underl"inginstruments and are in Oero 8et !ul"

Futures& otions►Real Assets are valuable non)nancial assets

,ie t*ose wit* a BrealC use. #ommodities& real estate& mac*ines& atents&

ollution credits& intellectual roert"



Page 15

W*o 8eeds Financial6arkets

►(ouse*olds ,individuals. Primar" Role: Investlend funds

►7usinesses ,cororates. Primar" Role: Raise Funds for Real

Investments

►@overnments ,sovereigns. Primar" Role: Redistribute Wealt*

►A$$ 6anage Risks



Page 1?

@lobaliDation►%omestic rms comete in global markets

►#ontinuous trading in man" markets

►

Performance in regions deends on ot*er regions

Financial 'ngineering and ec*nolog"►8ew bundles of e9isting nancial instruments

►

#omuter advancements ,algorit*mic trading& (Fs.►-n)line trading ,no longer innovative.

►6ore comlete and timel" information& and t*eabilit" to act instantl" on t*at information

Financial Innovations



Page 1

►Allows international diversication ofinvestments and business lines

►Aligns nancial ,and t*erefore olitical.incentives of di>erent countries Imagine if eac* countr" *as a !WF *olding

an identical diversied ortfolioLever"one would *ave identical nancialobectives

►Introduces FK risks to bot* sides of t*ebalance s*eet -ften onl" risk in Assets is e9licitl"

considered& but donMt forget $iabilities;

Imlications of @lobaliDation



Page 1E

►7undling and unbundling of cas*Qows

►!licing& allocation& and distributionof cas* Qows

'9amles: mortgage)backed securit"Btranc*esC& rincialinterest slits&

e9otic otions& etc►%one rig*t& allows t*ose wit*

caacit" to *old risk to *old it

%one wrongL

Financial 'ngineering



Financial 6arkets and

rading



Page 20

Auction a ,W% +0. 8ew Pen

► ake out "our wallets& e9amine "our cas* Put awa" all *ones& ens& aers& camerasL A$$

materials into bags and under tables

►!AR A#I-8& Accet 7ids

6inimum rice tick W%100►date 1 N 6arket !tructure #*ange

6inimum rice tick W%1

►date 2 N 8ew Information A 20 digit al*anumeric code to be written on t*e board for

10 seconds& will be on midterm e9am -nl" ens for salema" be used in class for t*ese 10 seconds

►date + N 8ew 6aterial Information *e 20 digit code will be wort* 0 oints on t*e e9am



Page 21

Financial 6arkets

►Forums to transfer risks andowners*i between investorstraders '9amle: Pen For !ale;

►Primar" 6arket Public ->erings ,IP-& !'-.

I7%

►!econdar" 6arket '9c*anges& -# markets& etc



Page 22

Financial '9c*anges

►Auction markets wit* centraliDed orderaggregation

►%ealers*i function: can be

cometitive or assigned b" t*ee9c*ange ,!ecialists.

►'9amles: 8G!'& A6'K& Regionals&

#7-'& !'#



Page 2+

#osts of rading

►#ommission: fee aid to broker formaking t*e transaction

►7idAsk !read: cost of trading against

a limit order 7id: rice dealer will bu" from "ou Ask: rice dealer will sell to "ou

!read: ask N bid ST sread is aid on eac* transaction

,entire sread is aid on a round tritransaction.



Page 2<

"es of -rders

►Instructions to t*e brokers on *ow tocomlete t*e order 6arket

$imit ,good till secied time.

!to loss

Programmed strategies

►%o not confuse t*is wit* Brogram tradeC& atrade in a basket of 15U stocks wit* marketvalue V1millionU

(undreds of ot*ers& all based on above



Page 25

►-wning onl" a ortion of t*e value of aninvestment& and borrowing t*e rest from t*ebroker

►!*orting an" investment in an amount w*eret*e account could go to Bnegative e3uit"C ,forstocks& commodities& or FKL =an"= amounts*ort re3uires a margin arrangement.

►6argin arrangements di>er vastl" fordi>erent nancial instruments !tocks S50& Futures S10& FK S2

6argin rading



Page 2?

7u"ing and !elling

►!imle 6a"be notL

►7u" ,to own.

►7u" to #over N bu" to close a s*ort osition

►!ell $ong N sell to close a long osition

►!ell !*ort N sell somet*ing t*at is not

currentl" owned



Page 2

!*ort !ale

►!elling an asset t*at is not currentl" owned

►A !*ort osition rots from a decline in t*e rice ofa stock or securit"

6ec*anics of a !*ort !ale

►7orrow securit" t*roug* a dealer or from anot*erinvestor w*o is willing to loan it

►!ell it and deosit roceeds into margin account

►#losing out t*e osition: bu" t*e securit" and returnt*e s*ares to t*e art" from w*ic* it was borrowedinstead of into own account



Page 2E

!*ort !ell !ul"6aniulation

► *ere is onl" 1 s*are of B!(!'C stock Investor 1 owns itand is not willing to sell 7roker1 *olds it for *im

►Investor 2 bu"s a s*are from rader A& w*o s*ort sells7rokerA BlocatesC t*e s*are at 7roker1 and borrows it to

deliver to 7roker2 8ow t*e s*are is deosited at 7roker2►Investor + bu"s a s*are from rader 7& w*o s*ort sells

7roker7 BlocatesC t*e s*are at 7roker2 and borrows it todeliver to 7roker+ 8ow t*e s*are is deosited at 7roker+

►4ia s*ort)selling& raders A and 7 *ave created new s*ares&

so t*at t*ere are now + investors w*o eac* own a s*are of!(!' stockL t*oug* t*ere is onl" 1 s*are in e9istence; If !ul" increases& t*en riceL



Page 2

Regulation of !ecurities6arkets

►Institutions @overnment Regulation

!elf)Regulation

►Reasons Insider rading

#ororate dis*onest" ,accounting

scandals& etc.

►!ta" on moral *ig* ground



Page +0

Finance 101 Review

►!tarting eas"& moving fast



Page +1

Review& ime 4alue

►All investments can be reresented as aseries of ,e9ected. #A!( F$-W! valued wit*aroriate RI!H)A%/!'% %I!#-8 RA'!

%iscount Rate #ost of #aital Re3uired Rateof Return Relevant Rate L

BP4 of Future #as* FlowsC

►BV1 toda" is wort* more t*an V1 tomorrowC

W*at must be t*e case for t*is to be true► r" to t*ink of value e3uivalentl" at di>erent

oints on t*e time line



Page +2

Review& ime 4alue

►W*at Is t*e correct %iscount Rate Risk)Free Rate alies to Risk)Free cas* Qows

onl" ,*istoricall" ! government liabilities& but

in ractice w*atever t*e local sovereign is. WA## Weig*ted Average #ost of #aital&

rate alied to all roects w*en t*ere aredi>erent funding sources wit* di>erent

relevant rates %etermining t*e BcorrectC discount rate is

e9tremel" comle9



Page ++

Review& ime 4alue

►Present 4alue ,P4.: P4 of V1 from time t is t*e %iscount Factor& %F,t. %F,t.1X1Ur,t.Y

►

Future 4alue ,F4.: F4 at time t of V1 toda"►F4,t. P4=,1Ur,t..

►8o arbitrage rules for discounting ,ie torevent risk)free trading rots. 0 Z %F,t. [ 1 r \ 0 %F,t. ] %F,tUn. Lw*en n]0 *ese no)arbitrage rules *ave been broken

recentl"; !ee #(F interest rates;



Page +<

Review& ime 4alue

►Peretuit" P4 #r►P4 at time t^ # at time tU1^ 9ed discount rate ,r.►Imagine "ou *ave V1 million Gou could send it all

now Gou could invest in a risk)free& 9ed)rateeretuit" (ow muc* would it a" eac* "ear

►@rowing Peretuit" P4 #,r)g.►Fi9ed cas* Qow growt* rate ,g.

►@ordon @rowt* 6odel Alication of eretuit" formula for e3uit"

ricing '3uit"Price %ivXr,e.)g,%iv.Y



Page +5

Review& ime 4alue

►Annuit" %erive it from t*e eretuit" formula and P4 rule

-ne eretuit" wit* # starting at time 1& less

anot*er eretuit" wit* # starting at time tU1►P4 X#r ) #,r,1Ur._t.Y

►#r a"s out forever& #,r,1Ur._t. negates a"mentsfrom tU1

►@rowing Annuities #as* Qow grows at a constant rate►P4 #,r)g.X1)X,1Ug.,1Ur.Y_t.Y

►#,r)g. a"s out forever& #X,1Ug.,r,1Ur.Y_t negatesa"ments from tU1



Page +?

Review& InQation

►InQation !ame dollar amount bu"s less in t*e

future

,1Unominal. ,1U real.=,1UinQation. Rule of t*umb:►Alwa"s convert ever"t*ing to nominal rates

and nominal cas* Qows& -R

►Alwa"s convert ever"t*ing to real rates andreal cas* Qows

R i I t t



Page +

Review& Investment%ecisions

►(ow do we decide if a roect iswort*w*ile + met*ods ,worst to best. :

►+ Pa"back Period

►2 IRR

►1 8P4



Page +E

Review& Pa"back eriod

►Pa"back Period 6oves linearl" and successivel" t*roug*

time

► "icall" assumes a single negative cas* Qow#F0 at t*e outset of a roect

►!um #F0& #F1& #F2L ,no discounting. untilsum is greater t*an Dero

►Pa"back eriod t*e rst eriod in w*ic*sum\0

Rule: ake lower Pa"back eriod

%ownfalls: 6an"



Page +

Review& IRR

►IRR IRR is t*e Bdiscount rateC t*at makes 8P4

0

L is to roects w*at G6 is to bonds

Rule: ake *ig*er IRR

%ownfalls: *rows awa" temoralinformation& 6ultile Roots

...)1()1()1(

01

1+

+

+

+

+

+

−=

+

+

t

t

t

t

s

s

IRRCF

IRRCF

IRRCost



Page <0

Review ,contMd.

NPV=PV(All Project CFs)

►8P4 BFair ProectsC are Dero 8P4 since #Fs are

discounted at cost of caital t*at is aroriatefor t*e risk taken& ie t*e aroriate oortunit"cost►'9amle: if riskfree bonds cas* Qows are discounted at

t*e riskfree rate& t*en t*e resulting rice is fair

Rule: W*en c*oosing amongst alternatives&c*oose *ig*est 8P4►BA @ood Proect *as Positive 8P4C

►#*oose combination of roects wit* t*e *ig*est total8P4

%ownfalls



Page <1

Review& #omounding

►#omounding #onversions and #onventions Annual Percentage Rate ,APR. 8ominal Annual Rate

eriodic rate = eriods er "ear #ontinuousl" #omounded Rate ,##R. rate if aid

Bcontinuousl"C '>ective Annual Rate ,'AR& ie Annuall". rate if aid

once annuall"

►n eriods er "ear

►#onvention is t*at BrC reresents 'AR unless noted

► It is easiest to convert all rates to a single

1)1( −+= n

n

APR EAR

1−= CCRe EAR



Page <2

Review& #omounding

►'9amles 10 APR comounded mont*l"

,1U112._12)1 10< Annuall"

10 continuousl" comounded e9,1.)11052 Annuall"

1052 Annuall"

ln,1U1052.)1 10 continuous



Page <+

Price Ratio 4aluation

► Al"ing t*e eretuit" formula and assuming full a"out of'arnings& Price'arnings ratio is inverse of growt*)adusteddiscount rate

(i P' $ow discount rate or else $o P' (ig* discount rate or else

► In alication we can use ast& resent& or future P or '

g r E P

g r P E

g r

E P

−

=

−≈

−

=

1/

/



Page <<

P' 4aluation '9amle

► Gou work for 6"7ank t*e Ibank& Inc Firms A& 7& and# are identical in most relevant measures of rmrosects ,growt* rosects& industr"& siDe&location& cas* Qow& emlo"ee 3ualit"& management

skill& debt level& accounting measures& etc. FirmsA and 7 are trading in secondar" markets P',A. 20^ P',7. 21 Firm earnings for # are V1millioner "ear Firm # wants "ou to issue 250H s*ares ofstock& w*ic* will reresent owners*i of *alf of t*e

rm Assuming Firm # e9ecutives would like t*eirstock to areciate in value roug*l" 10 on t*erst da" of trade& w*at s*ould t*e rimar" marketissuance rice er s*are be



Page <5

P' 4aluation '9amle

►!olution 250H s*ares T of rm 500H s*ares entire rm V1mm500H earnings V2s*are er "ear #omarables Anal"sis P' of # s*ould be roug*l" 20 to

21►P2 20 P <0

►P2 21 P <2

►!*ares of # s*ould be wort* V<0 to V<2 eac*

Want gain of 10►P,issue.=11 <0 P,issue. <011 P,issue. +?+?

►P,issue.=11 <2 P,issue. <211 P,issue. +E1E Recommendation

►Issue at +?+? N +E1E►W*at ot*er issues ma" come u on t*e da" of rimar"

issuance



#onclusions and Assignments

► *atMs all of our intro nance review Available for *el in -`ce (ours ,see

s"llabus.

►(W1 to)be)emailed osted& due in 2weeks

►Read 7H6 #(22)2+ for ne9t week

►Form (W @rous 8ow

►Particiation documentation s*eets

Documents

2015F Investments 01 Introduction and Review