A Random Walk Down Wall Street

A Random Walk Down Wall Street - A Random Walk Down Wall...

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A Random Walk Down Wall Street A Random Walk Down Wall Street – Chapter 1-4, 6 Summaries I. Chapter 1: Firm Foundations and Castles In the Air A. What is a Random Walk? 1. One in which future steps or directions cannot be predicted on the bases of past actions B. Investments as a way of life today 1. Factors that differentiate investing from speculating a. Time period of investment return b. Predictability of returns 2. Our economy today a. Analysts predict relative price stability will continue—inflation fell to 2% in the early 2000s b. Becoming increasingly service-oriented productivity improvements harder to come by C. Investing in Theory: 2 Approaches to Asset Valuation 1. The Firm Foundation Theory a. Basic Argument: Each investment instrument has intrinsic value. When markets fall below/rise above this value, a buying/selling opportunity occurs b/c the fluctuation will eventually be corrected i. Intrinsic value = PV of future dividends b. Difference in growth rates important factor in stock valuation 2. Castle in the Air Theory c. Basic argument: Analyzing how crowd of investors are likely to behave in the future and how during periods of optimism they tend to build their hopes into “castles in the air” i. Tries to estimate which investments are most susceptible to public castle-building and then buy before the crowd d. Applied psychological principles rather than financial evaluation e. Optimal strategy: “To predict what average opinion is likely to be about what the average opinion will be.” f. “A thing is only worth what someone else will pay for it.” II. Chapter 2: The Madness of Crowds A. The Tulip Bulb Craze 1. Holland early 17 th century 2. Mosaic: Non-fatal virus that caused petals to develop stripes called “flames” a. Infected bulbs (“bizarres”) became valuable 3. Price skyrocketed and call options were popular as a way to leverage (increase potential rewards/risks) of investment. B. The South Sea Bubble 1
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1. 17 th century England a. Stock was one of the few forms of property women could own 2. South Sea Company established to restore faith in government’s ability to meet its obligations. a. Took on a government IOU of £10 million in exchange for monopoly of South Sea trade. 3. The Mississippi Company – A French capital enterprise a. Started by John Law b. Goal to create more liquidity through a national paper currency backed by the state and controlled through a network of local agencies c. Increased English Jingoism for South Sea Company 4. Passed bill to offer to fund entire national debt a. Skyrocketed prices of SSC stock b. Backers of bill given option w/a twist: Granted stock w/o having to pay for it which was “sold” back to the company when the price increased and individual simply collected profit 5. Some people subscribed to the “Greater Fool Theory” – Prices will increase, buyers will be found, and money will be made 6. Bubble burst when people realized price of shares had no relationship to real prospects for the company a. Bubble Act:
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