AFM472 INVESTMENTS Introduction

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Outline

Course overview

Introduction to the Financial System

Overview of Equity

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Course overview

This course covers various aspects in equity investments. We look at: the environment in which investors, investment advisors, security analysts, and portfolio managers operate the techniques used to value assets and manage portfolios the risk-return relationship This course is not about teaching you how to make money or make you rich in 12 weeks rather, we examine how money was made

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Course objectives

We emphasize the following knowledge and skills throughout the course: Analytical ability: modeling skills that are key to making investment decisions Quantitative and computational skills: data analysis, probability evaluation of uncertain events Empirical knowledge of the equity markets, and empirical evaluation of real market data Fundamental analysis skills

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Course website

arts.uwaterloo.ca/~aghuang/AFM472/ Username: AFM472 Password: Invest A discussion forum will be set up on UWACE Your marks will be frequently updated on UWACE Preferred correspondence: directly email to aghuang@uwaterloo.ca

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Course materials

Lecture slides/notes Textbook: Bodie, Kane, Marcus, Perrakis and Ryan (BKMPR) Articles as posted on course website Recommended readings:
Chapter 6 of Trading and Exchanges: Market microstructure for practitioners, by Harris Quantitative Equity Investing: Technique and Strategies, by Fabozzi, Focardi, and Kolm (FKK)

Read the syllabus carefully!

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Course evaluation

The course mark will be bell curved in the end.

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Class project
You can choose either the Portfolio Project or the Stock Analysis Project Portfolio project: You use a trading platform to manage a hypothetical $1 million fund
Ocially runs from Oct. 1 to Nov. 15; but you can play with it from today as long as you acquire the account

Stock analysis project: You analyze the investment value of a rm acting as if you are a nancial analyst
Later at the course after the Mid-term

Due to resources limit, you cannot participate in both projects, and you must form a group with ve students (unless there are not enough students for roundup)

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Poster Competition (15%)

A poster competition will be held for the project at the following tentative time: 16pm, Nov. 25, Friday (More details will be announced.) It will be judged by faculty members and/or industry experts Expectation:
A poster summarizing your project, and a brief presentation Q&A within a Panel If advanced to the second round, presentation in front of industry experts

Location TBD

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Class Participation

Class participation is based on group and individual participation

70% of the participation mark is determined by the group answer 30% will be determined by individual contribution both to the group and to the class However, I reserve the right to alter the distribution based on your tracked participation

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Forming your Group

You should only attend class at your assigned class section You should only form groups within your assigned class section You should form your group by This Friday 4:00pm send an email, with the subject line AFM472 Group, Section (your section number) to Meng Wang at

m89wang@gmail.com

The decision of which project your group will be doing must be made before Sept. 30 and notify Meng by Sept. 30, 4:00 pm as well.

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Now...I am gonna take your picture

Starting next Monday, you will be seating at the assigned seat only. Please observe this rule ALL THE TIME. If you sit at somebody elses seat, he/she may earn your participation mark!
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AFM472 INVESTMENTS Introduction

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The Financial System

The nancial system can be viewed from two dierent angles: Institutional perspective: the nancial system encompasses the markets, intermediaries, instruments, clients etc.; and Functional perspective: the nancial system facilitates the allocation and deployment of economic resources, across time and space and in uncertain environment.

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Institutional compositions of the nancial system

Financial markets: equity (AFM472), xed income (debt) (AFM475), credits and derivatives (AFM474) Financial intermediaries: banks, insurance companies, mutual funds, investment banks, venture capital rms, and information providers etc. Financial infrastructure and regulation: trading rules, contract enforcement, account system, capital requirements etc. Governmental and quasi-governmental organizations: central banks (Bank of Canada), the Bank for International Settlement (BIS), the International Monetary Fund (IMF), the World Bank, etc.

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The functional view

The nancial system provides six functions: Transferring economic resources across time (e.g. student loans, retirement funds) and space (global nancial market, e.g. institutional investments) Clearing and settling payments to facilitate trades: money, check, mortgages, etc. Pooling of resources to undertake large-scale indivisible enterprises (equities, money market funds, mutual funds etc.) Information to coordinate decision-making & facilitate information ow and price discovery (e.g., equity indices, interest rates, volatilities etc.) Dealing with agency problems, mitigate moral hazard, adverse selection and principal-agent based problems that are caused by asymmetric information or incentive mis-matches Managing risks, bundling & packaging of cash ows (e.g., insurance companies, CMO)
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Stocks

Common stocks, aka equities, represent ownership of a corporation Two most important characteristics: residual claim, limited liability Sources of returns: dividends and capital gains; rT = PT + D T P0 P0

rT holding period return (HPR)

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Major Stock Exchanges

Two major stock exchanges in Canada:

TSX: 1,485 companies (2010) TSX Venture Exchange: lists junior companies, i.e., those whose assets, business and market capitalization were too small to be listed on the TSX. 2,143 companies with $49 bn

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The most memorable market crashes

The Crash of 1929 and the Great Depression October 29 over 4 days markets down 62% One-day panic in 1987 October 19, 1987 DJIA down 20%; TSX down 11% The current credit crisis starting 2007 The Internet bubble in the late nineties and the bear market of the new millennium

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Some Review

Optimization Variance-covariance of variables Discounted cash ow approach

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Global maximum/minimum of a function

Quadratic function: f (x ) = ax 2 + bx + c , a = 0 Whats its maximum/minimum? Taking the rst derivative

Taking the second derivative to verify

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Example
f (x ) = x 2 x 2

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Variance-covariance
Two variables: Var(aX + bY ) = a2 Var(X ) + b 2 Var(Y ) + 2ab Cov(X , Y ) Example: A portfolio consists of 30% of Stock X and 70% of Stock Y. The variance-covariance of X & Ys returns are: 0.09 0.03 0.03 0.04 Questions:
Whats the correlation of returns between X and Y? Whats the portfolios standard deviation?

More generally, Var

ai Xi
i

= ai2 Var(Xi ) + ai aj Cov(Xi , Xj )

i i j =i

Try write the variance out for a three-asset portfolio.

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Discounted Cash Flows

A method of valuing a project, company, or asset using the concepts of the time value of money.
N

PV =

t =0

(1 + r )t

CFt

Example: Assume that a stocks cash ow per share is 1.00, 1.10 and 1.20 for years 20112013 respectively, and 1.40 forever after 2013. Whats its ex-dividend price at the end of year 2011?

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Preparation for the Next Class

BKMPR Chapters 2 and 3 dierent methods of market indexing placing orderswhat types? Short selling and margin trading

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