Search for notes by fellow students, in your own course and all over the country.
Browse our notes for titles which look like what you need, you can preview any of the notes via a sample of the contents. After you're happy these are the notes you're after simply pop them into your shopping cart.
Document Preview
Extracts from the notes are below, to see the PDF you'll receive please use the links above
15
...
• Empirical knowledge of the financial markets: equity, fixed income
(default-free and defaultable) and their respective derivatives
...
; and
• Functional perspective: the financial system facilitates the allocation
and deployment of economic resources, across time and space and in
uncertain environment
...
The institutional dimension results
from the functional needs
...
g
...
g
...
• Pooling of resources to undertake large-scale indivisible enterprise
(equities, money market funds, mutual funds etc
...
• Dealing with agency problems, mitigate moral hazard, adverse selection and principal-agent based problems that are caused by asymmetry information or incentive mis-matches (collateralization, CEO
incentive for company performance etc
...
)
Institutional Perspective
The institutional compositions of the financial system includes:
• Financial markets: equity, fixed income (debt), credits and derivatives
• Financial intermediaries: banks, insurance companies, pension funds,
mutual funds, investment banks, venture capital firms, asset management firms and information providers etc
...
• Governmental and quasi-governmental organizations: SEC, central
banks (Federal Reserve System), the Bank for International Settlement (BIS), the International Monetary Fund (IMF), the World
Bank, etc
...
g
...
defined
contribution plans
...
• Two important characteristics: residual claim and limited liability;
• Sources of returns: dividends and capital gains;
• Calculating returns: buy at time 0 and pay P0 , sell at time T and
receive PT and dividend DT :
– The percentage return is calculated as:
rT =
PT + D T − P 0
PO
– The log-return is calculated as:
�
�
PT + D T
rT = ln
PO
(1)
(2)
For small rT , the log-return and percentage return are close
...
), e
...
Nasdaq, SP500, DAX, FTSE etc
...
g
...
• Some important empirical evidence:
– Patterns in the cross-section of stock return: value (value vs
...
large), momentum (low vs
...
9/6/1993
-2%
-7%
-12%
9/6/1993
11/6/1997
9/6/1997
7/6/1997
5/6/1997
3/6/1997
1/6/1997
11/6/1996
9/6/1996
7/6/1996
5/6/1996
3/6/1996
1/6/1996
11/6/1995
9/6/1995
7/6/1995
5/6/1995
3/6/1995
1/6/1995
11/6/1994
9/6/1994
7/6/1994
5/6/1994
3/6/1994
1/6/1994
11/6/1993
-2%
-7%
-12%
1/6/1999
3/6/2000
3/6/2000
SBTSY10
Figure 1: Daily returns of SP 500-index, Nasdaq-index and T-Bonds 10 years
9/12/2001
7/12/2001
5/12/2001
3/12/2001
1/12/2001
3/6/2001
5/6/2001
3/6/2001
5/6/2001
9/6/2001
9/6/2001
7/6/2001
1/6/2001
1/6/2001
7/6/2001
9/6/2000
11/6/2000
11/6/2000
7/6/2000
11/12/2000
9/6/2000
7/6/2000
5/6/2000
1/6/2000
1/6/2000
5/6/2000
9/6/1999
9/12/2000
7/12/2000
5/12/2000
3/12/2000
7/6/1999
11/6/1999
1/12/2000
11/6/1999
5/6/1999
9/6/1999
7/6/1999
11/12/1999
3/6/1999
1/6/1999
11/6/1998
3/6/1999
9/6/1998
11/6/1998
9/6/1998
5/6/1999
9/12/1999
7/12/1999
5/12/1999
3/12/1999
7/6/1998
3%
5/6/1998
8%
7/6/1998
SBTSY10
1/12/1999
CCMP
5/6/1998
3/6/1998
3%
1/6/1998
8%
3/6/1998
SPX
1/6/1998
11/6/1997
9/6/1997
7/6/1997
5/6/1997
3/6/1997
1/6/1997
11/6/1996
9/6/1996
7/6/1996
5/6/1996
3/6/1996
1/6/1996
11/6/1995
9/6/1995
7/6/1995
5/6/1995
3/6/1995
1/6/1995
11/6/1994
9/6/1994
7/6/1994
5/6/1994
3/6/1994
1/6/1994
11/6/1993
CCMP
11/12/1998
9/12/1998
7/12/1998
5/12/1998
3/12/1998
1/12/1998
11/12/1997
9/12/1997
7/12/1997
5/12/1997
3/12/1997
1/12/1997
11/12/1996
9/12/1996
7/12/1996
5/12/1996
3/12/1996
1/12/1996
11/12/1995
9/12/1995
7/12/1995
5/12/1995
3/12/1995
1/12/1995
Stocks and Bonds
SPX
8%
3%
-2%
-7%
-12%
30%
25%
25%
20%
20%
Probability
Probability
30%
15%
10%
15%
10%
5%
5%
0%
0%
-5%
-0
...
080
-0
...
040
-0
...
020
0
...
060
0
...
060
-0
...
020
-
0
...
040
0
...
080
Daily Returns
Current Distribution
Normal-Distribution
Normal-Distribution
Figure 2: Return distribution of US 10 Year Bond
Data source for Figures 1, 2, and 3: Bloomberg Professional
...
Figure 4: Cash Flows, Source: RiskM etricsT M , Technical Document, p
...
109
Treasury bills, notes and bonds vary in maturity
...
The value of a bond can be reported in terms of price or yield to maturity
...
Market Performance
Monthly returns 1926/7 to 2000/12
Equity Portfolio∗ Treasury Bills
Mean
0
...
31%
Standard Deviation
5
...
26%
Total Return
$1’828
$16
...
1
...
1
...
1
...
1
...
1
...
1
...
1
...
How do we describe the term-structure:
• Shift
• Twist
• Butterfly
8 Yr
9 Yr
10 Yr 15 Yr 20 Yr 30 Yr
1
...
1999
1
...
2000
The Federal Funds Target Rates (set by FOMC) and the Discount Rates:
8
...
00
6
...
00
4
...
00
2
...
00
FOMC
1/1/2003
7/1/2002
1/1/2002
7/1/2001
1/1/2001
7/1/2000
1/1/2000
7/1/1999
1/1/1999
7/1/1998
1/1/1998
7/1/1997
1/1/1997
7/1/1996
1/1/1996
7/1/1995
1/1/1995
7/1/1994
1/1/1994
7/1/1993
1/1/1993
7/1/1992
1/1/1992
7/1/1991
1/1/1991
0
...
Corporate Bonds
Corporate bonds are similar in structure to Treasury issues, with one
important difference: default risk
...
• The difference in yields is referred to as credit spread
...
g
...
)
• The probability of default varies over time!
Figure 8: Standard & Poor’s one year transition matrix, Source: RiskM etrics T M − T echnical Document, p
...
Derivatives
Overview of Derivatives by Structure:
• Forward and Futures;
• Options;
• Futures;
• Path dependent (e
...
look-back), etc
...
;
• Fixed-Income Derivatives: caps/floors, swaps, swaptions, etc
...
;
• Other derivatives: FX, weather, ”exotics”, etc
...
Currency instruments have generally spoken the same type of parameters, however with different characteristics, e
...
currency return volatility, which is not shaped in the same form as the equity return volatility
...
Empirical evidence supports the statement, that financial innovation does provide social wealth:
• It caters to the investment diversity desired by the investors;
• It improves the opportunities for investors to receive efficient riskreturn trade-offs;
• It provides risk management tools for all market participants; and
• It promotes broad distribution and liquidity to economic resources
...
Securitization of the mortgage market: The national mortgage market
and mortgage-backed securities transform the residential house finance
from fragmented, local-based sources to a free-flowing, international base
of capital with depth and usually a higher credit rating
...
Credit Enhancement
FleetBoston plays ”Good Bank/Bad Bank,” unloading $1
...
See the following figure how FleetBoston’s problem loans made their way
from Fleet’s books to a special collateralized-loan obligation, funded by
investors
...
35 billion in funded loans plus
$ 150 million in unfunded loans
Figure 10: Setting-up a special purpose vehicle
...
75 million in single-A rated bonds
$ 35
...
036 billion cash
Summary
What to learn in this course? Analytical modeling skills, quantitative
tools, and empirical knowledge about the financial market and the financial instruments
...
• Does financial innovation add value?
• Sometimes abusive usage of financial innovation causes disruptions
...
Focus:
BKM Chapters 1 & 2;
• p
...
19 (securitization);
• p
...
g
...
);
• p
...
);
Reader: Sharpe (1995);
Type of potential questions: p
...
questions 1, 5, 11, 17, 23
Preparation for Next Class
Please read:
• BKM Chapters 3 & 5,
• Fama (1995), and
• Kritzman (1993)