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Unformatted text preview: Lecture 19 Handout: Finance Fixed‐income (or, debt) securities promise either a fixed stream of income or a stream of income that is determined according to a specified formula. E.g., a corporate bond or government bond. Common stock, or equity, in a firm represents an ownership share in the corporation. Derivative securities, such as options and futures contracts, provide payoffs are determined by the prices of other assets, such as bond or stock prices. A mutual fund is a company that invests its shareholders’ money in stocks, bonds and/or other assets. A hedge fund is like an actively‐managed mutual fund, except exempt from many of the regulations on mutual funds and hence can engage in more aggressive investment strategies. An index fund is a passively‐managed mutual fund that holds the stocks making up an index, like the S&P 500 (or the Russell 2000). Stock price = expected PV of firm assets – risk adjustment. The most basic theory of the risk adjustment is the Capital Asset Pricing Model (CAPM): ri = rf + (βi σm)[(rm – rf) / σm] = rf + βi (rm – rf) Expected return = risk‐free rate + amount of risk * price of risk. Efficient market hypothesis: Stock prices already reflect all available information, hence price changes are unpredictable (“random walk”). Weak form: “all available information” is information from market trading data, such as past prices and volume. Semi‐strong from: “all available information” is all publicly‐available information. Strong form: “all available information” is all information relevant to the firm, including insider information that is not publicly‐available. ...
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