Overview 2004.ppt
62
Overview of Financial Markets in the US • What makes a good market? • Major equity markets: NYSE and NASDAQ • U.S. Market Indicies • Types of Orders • Margin Trading and Short Selling • Market Efficiency • Historical Performance of Financial Assets • Global Perspective
description
Transcript of Overview 2004.ppt
- 1. Overview of Financial Markets in the US
- What makes a good market?
- Major equity markets: NYSE and NASDAQ
- U.S. Market Indicies
- Types of Orders
- Margin Trading and Short Selling
- Market Efficiency
- Historical Performance of Financial Assets
- Global Perspective
- 2. What makes a good market?
- Availability of information
- Liquidity
- Price continuity (depth)
- Moderate transaction costs
- 3. Major U.S. Equity Markets
- Buttonwood Agreement - 1792
-
- => New York Stock Exchange
- The Curb prior to 1910
-
- => American Stock Exchange
- NASDAQ - 1971
- Regionals - Chicago, Pacific, Cincinnati, Boston, etc.
- 4. The NYSE
- Its an auction market
- 1366 members:
-
- Commission Brokers
-
- Floor Brokers
-
- Registered Traders
-
- Specialists
- 5. The NYSE
- The Specialist:
-
- Market maker, broker, and dealer
-
- Physical location
-
- All trades recorded
-
- Maintain order book
-
- Trade for themselves
-
- Monopolist?
- 6. The NASDAQ
- Its a dealers market
- No physical location
- Multiple dealers compete for trading volume
- Collusion? Preferencing?
- 7. Market Indicies
- Price Weighted (DJIA, Nikkei)
- Value Weighted (S&P 500, FT100)
- Equally Weighted (Value Line, FT OSI)
- Does selection of an index matter?
- 8. Investing in Stock Indexes
- Investor may buy stock or stock derivative securities
-
- The value of derivative securities follow underlying stock prices or prices of specific stock portfolios (index)
-
- Lower transaction costs
-
- Stock index returns have matched actively managed portfolios
-
- Exchange-traded funds (ETFs) designed to match major stock indexes
- 9. Exchange-Traded Funds (ETFs) vs. Indexed Mutual Funds
- Both ETFs and indexed mutual funds
-
- Share price adjusts in response to change in index
-
- Pay dividends earned in added shares
-
- Lower management fees than actively managed mutual funds
- ETFs are different from mutual funds in that they
-
- May be traded on an exchange any time during the day
-
- May be purchased on margin and sold short
-
- Capital gains tax only
-
- Value of ETF shares = underlying value of shares
-
- Investor must pay transaction costs when buying/selling
- 10. Types of Exchange-Traded Funds (ETFs)
- Cube (QQQ)
-
- Tracks Nasdaq100 index
-
- Traded on Amex
-
- Investors may speculate on future of technology stocks
-
-
- Purchase on margin
-
-
-
- Sell short
-
- Spider (S&P Depository Receipt)
-
- Tracks S&P 500 index
-
- Trade at one-tenth S&P 500 Index level
- 11. Trading: Types of Orders
- Market Order
-
- Buy/Sell at best available price
- Limit Order
-
- typically triggered if conditions improve
-
- Price trigger
-
- Time tag (FOK, day, GTC)
- Stop-Loss Order
-
- typically triggered if conditions worsen
-
- Used to close a position
- 12. Margin Trading
- Can borrow funds from broker and amplify position. Why?
- Margin = Equity / MV = (Assets - Liabilities) / MV
- How much can you borrow
-
- Initial Margin: max 50% (Fed)
-
- Maintenance Margin: min 25% (Fed)
- Examples
- 13. Short Selling
- Opposite of Long position
- Borrow and sell shares with expectation that their price will fall
- After price falls, buy shares, cover short position (repay loan of shares)
- Uptick rule
- All short sales are margin trades
- 14. Program Trading
- Trading completed by computer program
- Initial use with institutional, large order, high volume to take advantage of technology
- NYSE listed stocks dominate program trading
- Trading a function of parameters set in program, such as over-valued shares
- Used also to manage portfolio risk
-
- Portfolio insuranceuse of stock index futures
-
- Protect gain or minimize loss in portfolio
- 15. Program Trading, cont.
- Program trading associated with increased volatility of stock market or inciting significant market declines
-
- Research has refuted claim that program trading has increased stock market volatility
-
- Has not been the initial starter of sharp market declines
- NYSE implemented collars or curbs to program trading in volatile periods
- Circuit breakersmarket time out
- 16. Regulation of Stock Trading
- Purpose of stock trading regulation
-
- To make market more efficient
-
-
- Promote and preserve competition
-
-
-
- Prevent unfair or unethical trading practices
-
-
- Provide adequate disclosure of information
-
- To prevent market failurecircuit breakers
- Securities Act of 1933 and SEC Act of 1934
- SEC uses surveillance system to watch trading
-
- Insider trading
-
- Attempts to corner market
- 17. Securities and Exchange Commission
- Congress provided SEC with broad powers to regulate stock markets
-
- May prescribe accounting standards and the extent of financial disclosure
-
- Establish regulations for stock trading and disclosure from insiders
-
- Regulates stock market participants to maintain a fair and orderly market
- 18. Structure of the SEC
- Five Commissioners
-
- Appointed by president
-
- Confirmed by Senate
- Five-year staggered terms
- President appoints Chair
- SEC Divisions
-
- Division of Corporate Finance
-
- Division of Market Regulation
-
- Division of Enforcement
- 19. SEC Oversight of Corporate Disclosure
- Regulation Fair Disclosure (FD), October, 2000
-
- Requires corporations to disclose relevant information broadly to investors at the same time
-
- Forbade old practice of providing selected analysts new information during teleconference calls
- Means of disclosing new information
-
- Company Web siteWeb cast
-
- 8-k form filing
-
- News release
-
- Above simultaneously with conference call
- 20. Market Efficiency
- What is an efficient market?
- The Efficient Market Hypothesis
- Technical Analysis
- Fundamental Analysis
- Tests of EMH
- 21. Efficient Capital Markets
- In an efficient capital market, security prices adjust rapidly to the arrival of new information, therefore the current prices of securities reflect all information about the security
- Whether markets are efficient has been extensively researched and remains controversial
- 22. Why Should Capital Markets Be Efficient?
- The premises of an efficient market
-
- A large number of competing profit-maximizing participants analyze and value securities, each independently of the others
-
- New information regarding securities comes to the market in a random fashion
-
- Profit-maximizing investors adjust security prices rapidly to reflect the effect of new information
- Conclusion: the expected returns implicit in the current price of a security should reflect its risk
- 23. Efficient Market Hypothesis
- Depending on the information set, we can designate three forms of the EMH
- Weak form:
-
- prices already reflect all information contained in past prices (and other historical data)
- Semistrong form:
-
- prices reflect all publicly available information
- Strong form:
-
- prices reflect all relevant information including inside information
- 24.
- Technical Analysis - using prices and volume information to predict future prices.
-
- Weak form efficiency & technical analysis
- Fundamental Analysis - using economic and accounting information to predict stock prices.
-
- Semi strong form efficiency & fundamental analysis
- 25. Weak-Form EMH
- Current prices reflect all security-market information, including the historical sequence of prices, rates of return, trading volume data, and other market-generated information
- This implies that past rates of return and other market data should have no relationship with future rates of return
- 26. Testing Market Efficiency
- Weak form:
-
- autocorrelation tests R t = a + bR t-1 + cR t-2 + dR t-3 + . . .
-
- runs tests +++-+--++-+---+-++++--+--++
-
- filter rules If +5%, sell and short; if -5%, cover and buy
- 27. Tests and Results of Weak-Form EMH
- Results generally support the weak-form EMH, but results are not unanimous
-
- some statistical evidence that there is serial correlation for many individual stocks for certain periods of time
-
- difficult to generate an economic profit from this result. (momentum trading)
- 28. Semistrong-Form EMH
- Current security prices reflect all public information, including market and non-market information
- This implies that decisions made on new information after it is public should not lead to above-average risk-adjusted profits from those transactions
- 29. Testing Market Efficiency
- Semistrong form:
-
- Event studies Abnomal return = Actual - Expected Expected return = forecast
-
- r it = a i + b i r mt + e it
-
- AR it = e it
-
- CAR = Cumulative abnormal return
-
- Examples
- 30. Keown-Pinkerton Study of Merger Announcements
- 31. Tests of Semistrong-Form EMH
- Stock split studies show that splits do not result in abnormal gains after the split announcement, but before
- Initial public offerings seems to be underpriced by almost 18%, but that varies over time, and the price is adjusted within one day after the offering
- Listing of a stock on an national exchange such as the NYSE may offer some short term profit opportunities for investors
- 32. Tests of Semistrong-Form EMH
- Stock prices quickly adjust to unexpected world events and economic news and hence do not provide opportunities for abnormal profits
- Announcements of accounting changes are quickly adjusted for and do not seem to provide opportunities
- Stock prices rapidly adjust to corporate events such as mergers and offerings
- The above studies provide support for the semistrong-form EMH
- 33. Other tests of semistrong form
- Post-earnings announcement drift
- SUE = Standardized Unexpected Earnings
- EPS Actual EPS Estimated
- SUE = ------------------------
- Std Error of Estimate
- 34. Results of SUE analysis
- 35. Tests of Semistrong-Form EMH
- Quarterly Earnings Reports
-
- Large Standardized Unexpected Earnings (SUEs) result in abnormal stock price changes, with over 50% of the change happening after the announcement
-
- Unexpected earnings can explain up to 80% of stock drift over a time period
- These results suggest that the earnings surprise is not instantaneously reflected in security prices
- 36. Anomalies
- Small firm effect
- January effect
- Neglected firm effect
- Market-to-Book ratios
- Reversals (Overreaction)
- Day of the week
- Weather
- 37. Strong-Form EMH
- Stock prices fully reflect all information from public and private sources
- This implies that no group of investors should be able to consistently derive above-average risk-adjusted rates of return
- This assumes perfect markets in which all information is cost-free and available to everyone at the same time
- 38. Tests of the Strong Form of EMH
- Strong form:
- Corporate insiders
- Stock exchange specialists
- Professional money managers
- 39. Corporate Insider Trading
- Corporate insiders include major corporate officers, directors, and owners of 10% or more of any equity class of securities
- Insiders must report to the SEC each month on their transactions in the stock of the firm for which they are insiders
- These insider trades are made public about six weeks later and allowed to be studied
- 40. Corporate Insider Trading
- Corporate insiders generally experience above-average profits especially on purchase transaction
- This implies that many insiders had private information from which they derived above-average returns on their company stock
- 41. Stock Exchange Specialists
- Specialists used to have monopolistic access to information about unfilled limit orders
- You would expect specialists to derive above-average returns from this information
- The data generally supports this expectation
- 42. Professional Money Managers
- Trained professionals, working full time at investment management
- If any investor can achieve above-average returns, it should be this group
- If any non-insider can obtain inside information, it would be this group due to the extensive management interviews that they conduct
- 43. Performance of Professional Money Managers
- Most tests examine mutual funds
- New tests also examine trust departments, insurance companies, and investment advisors
- Risk-adjusted, after expenses, returns of mutual funds generally show that most funds did not match aggregate market performance
- Persistence in MF performance is weak when we adjust for expenses
- 44. Are Markets Efficient?
- Its not a yes or no question.
- Anomalies indicate that its not perfectly efficient
- Evidence generally supports semistrong form
- Markets are very efficient
- 45. Implications for Investment Analysis
- Technical analysis cant work if markets are perfectly efficient. There is some support of momentum trading strategies, though
- Fundamental analysis is necessary to make markets efficient. Superior analysis should produce superior estimates of relevant variables
- Attend to anomalies.
- Risk can be diversified whether markets are efficient or not
- 46. Historical Performance of Financial Assets
- What are our investment alternatives?
- How have stocks, bonds, cash, and other financial assets performed in terms of risk and return?
- Why is a global perspective on investing important?
- How does historical performance influence the asset allocation decision?
- 47. Historical Performance of Financial Assets
- Investment alternatives?
-
- Real vs. financial?
-
- Capital Market vs. Money Market?
-
- Equity:
-
-
- US
-
-
-
- Foreign (ADRs)
-
-
-
- Mutual Funds
-
- 48. Historical Performance of Financial Assets
- Investment alternatives:
-
- Cash Equivalents (rates from 10/27/04)
-
-
- Savings Accounts (0.90% at Fleet)
-
-
-
- CDs (1.50% at Fleet)
-
-
-
- T-bills (0.97%)
-
-
-
- Commercial Paper (1.41% GMAC)
-
-
-
- MMMF
-
- 49. Historical Performance of Financial Assets
- Investment alternatives:
-
- Fixed Income:
-
-
- US Treasury securities (notes 4.55%, bonds 5.38%)
-
-
-
- US Agency Securities (FNMA 5.63%, FHLB, FHA)
-
-
-
- Municipal Bonds (GO vs. Revenue, 3.98% for AAA)
-
-
-
- Corporate Bonds (collateral, subordination, etc., 6.02%)
-
-
-
- Preferred Stock (tax issues)
-
-
-
- International Bonds (domestic, Euro, Yankee)
-
- 50. Historical Performance of Financial Assets
- Investment alternatives?
-
- Derivatives
-
-
- Options (calls, puts, warrants)
-
-
-
- Futures (financial, commodity, index)
-
-
- Real Estate
-
- Precious Metals
-
- Art
- 51. Historical Performance of Financial Assets
- Issues which should matter in return performance
-
- Risk!
-
-
- Seniority of claim (bonds vs. stock)
-
-
-
- Business risk
-
-
-
- Financial risk
-
-
- Liquidity!
-
-
- Secondary market issues
-
- 52. Historical Performance of Financial Assets
- Ibbotson and Sinquefield (I&S) examined nominal and real rates of return for seven major classes of assets in the United States
-
- 1. Large-company common stocks
-
- 2. Small-capitalization common stocks
-
- 3. Long-term U.S. government bonds
-
- 4. Long-term corporate bonds
-
- 5. Intermediate-term U.S. Treasury bills
-
- 6. U.S. Treasury bills
-
- 7. Consumer goods (inflation)
- 53. Basic Series: Historical Highlights (1926 - 2002)
- Geometric Mean Arithmetic Mean Standard Deviation
- Large Stocks 10.01% 12.04% 20.55%
- Small Stocks 11.64 17.74 39.30
- LT US Govt Bonds 5.38 5.68 8.24
- US Tbills 3.78 3.82 3.18
- CPI 3.05 3.14 4.37
- 54. Importance of the Global Perspective
- 1. Absolute and relative sizes of U.S. and foreign markets for stocks and bonds
-
- U.S. = about 52% of total value of securities
-
- More opportunities globally
- 2. Rates of return available on non-U.S. securities often exceed U.S. Securities
-
- Higher returns on equities are justified by higher growth rates for the countries where they are issued
- 3. Diversification with foreign securities can reduce portfolio risk
- 55. Importance of the Global Perspective: Market Size, $2.3 Trillion in 1969
- 56. Importance of the Global Perspective: Market Size, $49.1 Trillion in 1997
- 57. Importance of the Global Perspective: Better Equity Returns? (1986-1997)
- 58. Importance of the Global Perspective: Diversification of
Risk
- Returns from risky assets can stabilize one another when held together.
- Why?
-
- Some sources of risk are different (unsystematic)
-
- Some sources of risk are common (systematic)
- Unsystematic sources of risk tend to offset. Only systematic risk matters in a well diversified portfolio.
- 59. Importance of the Global Perspective: Diversification of Risk (Correlation!)
- 60. Importance of the Global Perspective: Diversification of
Risk
- Correlation Coefficients for Equity Markets
- CN EU JP SW UK US
- EU .193 .700
- JP .409 .319
- SW .353 .907 .359
- U.K. .428 .392 .262 .568
- U.S. .618 .386 .334 .505 .616
- W .652 .516 .698 .631 .686 .818
- 61. Diversification of Risk: Computing Covariance and
Correlation
- Covariance: absolute measure of comovement between two rate of return series
- Correlation: relative measure of comovement
-
- can be positive or negative
-
- can be strong or weak
- Example
- 62. Importance of the Global Perspective: Summary
- Many opportunities to invest outside the US
- May be able to enhance expected return
- Opportunity to exploit weaker correlations among country returns to diversify risk