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Slides_for_class_4 - Relevant tools and concepts from...

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Unformatted text preview: Relevant tools and concepts from finance, part 2 Psychology, beliefs and incentives Each firm: Beliefs about future prices (market view) Risk preference (for certainty vs. uncertainty, type and magnitude of risk) Net hedging demand Average or aggregate beliefs about future prices and risk preference across buyers and sellers Rumors and manipulation of beliefs Role of management incentives in decisions about uncertainty Replication Role as basis of valuation of financial derivatives Limited relevant to physical products and supply chain 1 Role of market view and risk tolerance in contracting Role of market views of parties to contract: Contracting unlikely if one party very optimistic that conditions will change in their favor, or Both parties somewhat optimistic that conditions will move in their favor Role of risk tolerance of parties to contract: More risk averse more likely to contract, even if contract price is worse than expectations More risk tolerant willing to bet on future market conditions unless contract price advantageous Net hedging demand = relative desire of buyers (in aggregate) vs. sellers to hedge risk Key driver of forward contract price vs. average market view Understand and leverage differences across prospective counterparties! Market view, risk tolerance 2 Net hedging demand: Examples Buyer capacity investments in semiconductor industry Seasonality and risk exposure (e.g. electricity, agricultural goods, etc.) 3 Manipulation of beliefs: Why and how Beliefs (expectations) about the future are critical to buyer and supplier decisions Market views: Ours, and those of others Expected actions of others: Capacity and production decisions of suppliers Demand requirements and contracting strategies of buyers Beliefs are based on facts, but also assumptions and incomplete information How complete is available data about past, present and future: Prices (market prices, contract prices by contract type and counterparty) Supply (available capacity, fixed and variable cost structure) Demand (trends, buyer contracting strategies) When data is incomplete, beliefs can be influenced by signaling actions and rumors Can become self-fulfilling, but often only temporarily Examples Rumor of DRAM price spike Real estate bubble Sir James Goldsmith and gold futures 4 iSuppli Market research for high tech components Price (current market, forward contract), availability, lead time, market share, technologies, trends Data sources Publicly available data and analyst networking...
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This note was uploaded on 06/16/2010 for the course MS&E 369 taught by Professor Blakejohnson during the Spring '08 term at Stanford.

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Slides_for_class_4 - Relevant tools and concepts from...

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