This preview shows page 1. Sign up to view the full content.
Unformatted text preview: AEM220, Introduction to Business Management. AEM220, Wednesday 10/20 Securities Markets Bond and Capital Market Valuing Stocks and Tips on Investing The Financial Crisis of 2008 Types of Investments Types
Traditional Stocks/Bonds Government Securities Certificates of Deposit Money Market or Mutual Funds Real Estate High-Risk Stock on Margin Commodities Junk Bonds (mortgage-backed securities?) Junk (mortgage-backed Derivatives Why do companies take loans? Why
Supply side The normal transacting of business is made much easier by credit; The Banks are institutions that agglomerate small quantities of money that Banks we want to have access to and obtain a profit from lending (liquid we allocation) as opposed to investing (illiquid allocation) it; (illiquid Different investors have different appetite for risk. Demand side Short term loans allow to even out variability; Long term loans allow to leverage capital... That is, if you can take a Long leverage ... loan, and the proceeds of your long term investment are greater than the principal and interest on the loan, you basically have made more money on the same capital investment!!! money Bond Market Bond Coupon Rate/Interest Rate Principal Maturity Date Types - Unsecured/Debenture - Secured Sinking fund Callable Convertible Capital Markets Capital
Main activities Primary Markets (IPOs) Secondary Markets Common vs. Preferred Underwriting Specialists who assist in the issue and sale of new Specialists securities. securities. Investment banks Types of Investors Types
Institutional investors Large organizations – such as pension funds, mutual funds, Large insurance companies, and banks – that invest their own funds or the funds of others. funds Organizations that buy stocks and bonds and then sell shares in Organizations those securities to the public. those Individuals or companies that invest in new businesses in exchange Individuals for partial ownership of those businesses. A form of private equity. form Purchasing other firms or taking big stakes in them (and often taking Purchasing public firms private by purchasing most of their publicly traded shares) in order to reshape their businesses, and then sell these holdings for a profit. Private pools of capital that can invest, long or short, in whatever Private they please. they Mutual funds Venture capital Private equity Hedge funds Hedge Historical logarithmic graph of the DJIA logarithmic from 1896 through Mar 2009 from Valuing Stocks Valuing
Returns Growth Risk Price/Earnings Ratio The Capital Assets Pricing Model r = Rf + beta x ( Km - Rf ) where Rf
r is the expected return rate on a security; Rf is the rate of a "risk-free" investment, i.e. cash; Km is the return rate of the appropriate asset class; Km Beta is the volatility of the security relative to the asset class. Beta Is it worthwhile to invest in the stock market? market?
Rate of return S&P 500 1994-2001: 16%/year Rate of return managed mutual funds: 5%/year Well run stock markets are efficient; Therefore, they cannot be outguessed; Therefore, it is best to hold a portfolio of indexed funds. Short-term information and expectations; “Ponzi” mechanisms; Self-reinforcing information flows. “A Random Walk Through Wall Street” “Irrational Exuberance” Investment Strategies Investment
Valuing Stocks Returns Growth Risk 7-11% historical returns Weighted portfolios Do not follow speculative bubbles Long-term horizon Diversified investments Be contrarian! Hedging Hedging
The purchase or sale of a derivative The security in order to reduce or eliminate risk associated with undesirable price changes of another security. changes Derivatives Derivatives
Forward contract The purchase or sale of an item or service at a specified price for The delivery at a future date . delivery Financial contracts between two parties that allow the buyer, then owner, Financial of the option the right but not the obligation to buy/sell an agreed quantity right of a particular commodity or financial instrument from the seller of the commodity financial option at a certain time for a certain price. "Selling" in this context is not supplying something that the seller owns, but it means granting the buyer this right, against a fee. buyer Agreement in which both parties exchange a strip of future interest Agreement payments; one party paying fixed interest payments, and one party paying floating interest payments, on some notional value. The value of notional the swap is the net present value of all future interest payments. the Credit default swaps - $62 trillion mid 2008!!! Call and put options Swap The use of derivatives can result in large losses due to the use of leverage. Derivatives allow investors to earn large returns from small movements in the underlying asset's price. However, investors could lose large amounts if the price of the underlying moves against them significantly. There have been several instances of massive losses in derivative markets, including: derivative The Nick Leeson affair in 1994. The The bankruptcy of Orange County, CA in 1994. The The county lost about $1.6 billion through derivatives trading. The bankruptcy of Long-Term Capital Management in The 2000. The loss of $6.4 billion in the failed fund Amaranth The Advisors, which was long natural gas in September 2006 when the price plummeted. The loss of $7.2 Billion by Société Générale in January The 2008 through mis-use of futures contracts. An interpretation of the current crises An
Financial institutions of the “Street” set to Financial arbitrage the “efficiency gaps” left by the increasing mechanization of financial management and trading; management They did so through massive leverage Goldman – 1.1 trillion in assets against 40 billion in Goldman equity equity Changes in underlying value can wipe out the Changes institution! institution! Events Events
2000-2001 – End of the dot-com bubble. Increase 2000-2001 in liquidity. End of US budget surpluses. in September 2001 – Additional increase in liquidity September as a result of 9/11 as March 2003 – Start of the Iraq war. Additional March public debt incurred to finance the war public 2002 – 2006 – Real estate bubble. Growth of the 2002 subprime mortgage segment and related consumer debt. debt. 2008 – The Reckoning. Drastic reduction in 2008 investment banking. TARP. Bank “nationalization.” investment Financial Causes of the Crisis Financial
Securitisation—the packaging of bank loans into Securitisation—the tradable bonds—grew too complex. The incentives of those involved, especially loan originators, were warped. Lending standards plummeted as a result, not only in mortgages but in credit cards and corporate lending too. Investors over-reached for yield as interest rates fell. Everyone focused on credit ratings rather than the underlying credits. The Current Climate The
Decline in real estate and other assets value Non-performing mortgages and loans Attempts to shore up capital in response to nonperforming and deteriorating assets Credit crunch Consolidation has led to uncertainty and “toxic bonds” Iceland, Eastern Europe, and their ilk; Japan: 10% contraction in GDP Lack of confidence in financial instruments General weakness of world economy Take-Aways Take-Aways
The capital and securities markets are efficient The ways to aggregate the supply and demand of finance; finance; The main measures for investment valuation are The returns, growth, and risk; returns, In the absence of insider information, it is best to In invest for the long term, diversify, and shun quick movements into the “flavor of the month”. quick Still holds after the 2008 financial meltdown ...
View Full Document
This note was uploaded on 10/24/2010 for the course AEM 1200 at Cornell University (Engineering School).