Christoph Lymbersky: Financial Market Principles /so Financial … · 2010-06-16 · Algorithmic...
Transcript of Christoph Lymbersky: Financial Market Principles /so Financial … · 2010-06-16 · Algorithmic...
Christoph Lymbersky: Financial Market Principles
/so
Christoph Lymbersky (editor)
Financial Markets
Principles
C 261488
MANAGEMENTLABORATORYPRESS
Christoph Lymbersky: Financial Market Principles
ContentsAbout the Editor 5
Introduction 7
Contents 11
Table of Figures 31
Structure of the Book 35
General Knowledge 37
Securities 39
Debt and equity 39
The securities market 42
Types of Stock 45
Preferred Stock 45
Common Types of Preferred Stock 50
Treasury Stock 50
Market sentiment 53
Dividends 55
Joint Stock Company Dividends 55
Disadvantages of Dividents 58
Stock Valuation 62
Fundamental Criteria (Fair Value) 62
Market criteria (potential price) 63
Stock Market Prediction 65
Prediction Methods 65
Validity 66
What is a Stock Broker? 68
Requirements 68
Services Provided 68
History 69
Explanation of a City Trader's Job 71
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Christoph Lymbersky: Financial Market Principles
What is an Investment Bank? 73
Organizational Structure of an Investment Bank 74
Size of the Industry 77
Possible Conflicts of Interest 78
Electronic Trading 80
The Background ofEtrading 80
Impact of Electronic Trading 81
Technology and Systems 82
Value Investing 84
History of Value Investing •. 84
Value Investing Performance ".. 85
Well known Value Investors 86
The Different Types of Orders on the Stock Market 88
-Market Order 88
Limit Order 88
Time in Force 89
Conditional Orders 90
Stop Orders 90
Market-if-touched Order. 91
One Cancels Other Orders 91
Tick Sensitive Orders 92
Discretionary Order 92
Quantity and Display Instructions 92
Electronic Markets 92
Margins Explained 94
Margin Buying 94
Margin Requirements 95
Minimum Margin Requirement 96
Initial and Maintenance Margin Requirements 97
Margin Call 97
Price of Stock for Margin Calls 97
Reduced Margins 98
Margin-Equity Ratio 98
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Christoph Lymbersky: Financial Market Principles
Return on Margin 98
Random Walk Hypothesis 100
Kondratiev Wave 103
Characteristics of the Cycle 203
Explanation of the Cycleriod. 104
Initial Public Offering 107
Reasons for listing a Company on the Stock Exchange 107
The Procedure of an IPO 108
Business Cycle 109
The Dutch Auction 110
Pricing 110
Quiet Period I l l
Secondary Market Offering 112
Behavioral Finance 113
History 113
Methodology 115
Key observations 115
Behavioral finance topics 116
Behavioral Finance Models 117
Criticisms of Behavioral Finance 117
Quantitative Behavioral Finance 118
Financial Basics 119
Investment Theory 120
Efficient-Market Hypothesis 121
Historical Background. 121
Theoretical Background 122
Arguments concerning the Validity of the Hypothesis 124
Social Acceptance 127
An alternative Theory: Behavioral Finance 128
Adaptive Market Hypothesis 130
Implications 130
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Christoph Lymbersky: Financial Market Principles
The Cost of Capital 132
Summary 132
Cost of debt ."..' 132
Cost of equity 133
Comments 133
Alpha 136
Origin of the Concept 137
Relation to Beta 138
Beta : 139
Definition 139
Beta Volatility and Correlation : 140
Choice of Benchmark 141
Investing 142
Multiple Beta Model 142
Estimation of Beta 143 ,'
Extreme and Interesting Cases 143
Weighted Average Cost of Capital 145
The formula for a simple case 145
How it works 147
Sources of Information 147
Effect on Valuation 148
Arbitrage Pricing Theory 150
The APT model 150
Arbitrage and the APT. 151
Relationship with the Capital Asset Pricing Model 153
Using the APT 153
The Capital Asset Pricing Model 155
The Formula 255
Asset pricing 157
Asset-Specific Required Return 157
Risk and Diversification 158
The Efficient Frontier 158
The market portfolio 159
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Christoph Lymbersky: Financial Market Principles
Assumptions ofCAPM 159
Shortcomings of CAPM 160
Modern Portfolio Theory 162
Risk and Return 162
Mathematically 164
The Risk-Free Asset 167
Portfolio Leverage 168
The Market Portfolio 169
Capital Market Line 169
Asset Pricing 169
Applications to Project Portfolios and other "Non-Financial"
Assets ..-. 172
Applications of Modern Portfolio theory in other Disciplinesl73
Markets 175
Financial Markets 176
Definition 176
Types of Financial Markets 177
Raising Capital 177
The Capital Market 180
Primary Market 180
Secondary market 181
The Stock Market 183
Trading on the Stock Market 183
Market Participants 185
The History of Stock Markets 185
Importance of the Stock Market 186
Stock Market Cycles 190
The Bond Market 194
Market Structure 194
Types of Bond Markets 194
Bond Market Participants 195
Bond Market Volatility 295
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Christoph Lymbersky: Financial Market Principles
Bond Investments 196
Bond Indices 196
The Derivatives Market 197
Futures Markets 197
Over-the-Counter Markets 197
Netting 198
The Money Market 200
Common money market instruments 201
The Commodities Market .'. 202
History 202
The Size of the Commodities Market 203
investment Returns 204
Spot Trading 204
Forward contracts 204
Regulation of Commodity Markets 206 ,
Non-conventional Commodities 208
The Futures Market 211
History of Futures Exchanges 211
Nature of Futures Contracts 213
Standardization 213
Derivatives Clearing 214
Central Counterparty 214
Margin and Mark-to-Market 214
Regulators 215
The Foreign Exchange Market 217
Market Size and Liquidity 217
Market Participants 218
Trading Characteristics 221
Factors affecting Currency Trading 223
Algorithmic Trading in Forex 225
Financial Instruments 226
Speculation 227
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Christoph Lymbersky: Financial Market Principles
Options 231
What about Options? 232
Contract specifications 233
Types of Options 233
Valuation Models 234
Black Scholes Model 235
Stochastic Volatility Models 235
Model Implementation 7 236
Risks '.'. 237
Trading 239
Basic Trades of Traded Stock Options (American Style)....239
Option Strategies 243
Volatility Index VIX 246
Bond Options Explained 250
Types 250
Embedded option •. 251
Credit Default Option 252
Credit Default Swap 253
Description 253
How Credit Default Swaps are used 254
Terms of a Typical CDS Contract 259
Settlement 260
Criticisms 262
Systemic Risk 262
LCDS 263
Call Options 265
Example of a call option on a stock 265
Put Options 268
Example of a put option on a stock 268
Foreign Exchange Options 270
Swaption 274
The first known Swaption 274
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Christoph Lymbersky: Financial Market Principles
The Swaption Market 275
Swaption Styles 277
Valuation of Swaptions 277
Binary Options 279
LEAPS 281
Bonds 283
An Overview over Bonds 284
Issuing Bonds 284
Features of Bonds 284
Investing in Bonds 287
The Bond Market 290
Market structure ..290
Types of bond markets 290
Bond market participants 291
Bond market volatility 291
The Coupon of a Bond 292
Bond investments 293
Bond indices 293
Corporate Bond 294
Types 294
Risk Analysis 295
Corporate Bond Indices 295
Government Bond 296
Risk 296
Municipal Bonds 297
Purpose of Municipal Bonds 297
Characteristics of Municipal Bonds 298
Risk 299
Disclosures to Investors 300
Comparison to Corporate Bonds 300
High-Yield Debt 302
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Christoph Lymbersky: Financial Market Principles
Flows and Levels 302
Risk 302
Usage 304
High-Yield Bond Indices 305
Bond Valuation 306
General Relationship 306
Bond Pricing 308
Futures Contracts 311
What is a Futures Contract? 312
Futures vs. Forwards .\ 313
Standardization >. 325
Margin \ 315
Settlement 317
Pricing 318
Who trades Futures? 320
Options on Futures 320
Futures Contract Regulations 321
Funds 323
Exchange-Traded Funds 324
Structure 324
History 326
Investment Uses 327
Types of ETFs 328
Currency ETFs 329
ETFs compared to Mutual Funds 330
Criticism 332
Index Funds 334
Origins of the Index Fund 334
Economic Theory 335
Indexing Methods 336
Advantages of Index Funds 337
Disadvantages of Index Funds 338
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Christoph Lymbersky: Financial Market Principles
Diversification 339
Stock Market Index 341
Types of Indices „ 342
Weighting 342
Mutual Fund 346
History 346
Usage 347
Net Asset Value 348
Growth vs. Value 352
Index Funds versus Active Management ).. 353
Bond Funds 1 . . . 353
Money Market Funds "354
Funds of Funds 354
Hedge Funds 355
Mutual Funds vs. Other Investments 355
Share Classes 355
Hedge Fund 358
History 358
Industry Size 359
Hedge Fund Risk 359
Legal Structure 361
Hedge Fund Management Worldwide 363
Regulatory Issues 364
Hedge Fund Indices 369
Debates and Controversies 371
Inverse Exchange-Traded Fund 377
Strategies for Buy-and-Hold Investors 377
Fees and other Issues 378
Examples 378
Collective Investment Scheme 381
Generic Information -Advantages 382
Generic Information - Disadvantages 383
Style 384
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Christoph Lymbersky: Financial Market Principles
Types of Risk 386
Charging Structures and Fees 386
Internationally Recognised Collective Investments 388
Closed-End Fund 389
Availability 389
Distinguishing Features 390
Initial Offering 392
Exchange Traded 392
Discounts and Premiums 392
Comparison with Open-Ended Funds 393
Examples : 394
Traders & Trading Styles 395
What is a Trader? .: 396
Stock Trader 397
Stock Trader versus Stock Investor 397
Methodology 397
Expenses, Costs and Risk 398
Stock Picking 398
Accumulation / Distribution Method 399
Over-the-Counter Trading 400
OTC-Traded Stocks 400
OTC Contracts 401
Short Selling 402
The Concept of Short Selling 403
Example of Short Selling 404
History of Short Selling 405
Mechanism of Short Selling 406
Fees 408
Dividend & Short Selling 409
Markets for Short Selling 409
Risk 410
Strategies 412
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Christoph Lymbersky: Financial Market Principles
Criticism 413
The Regulatory Response 414
Hedge 416
Origins of Hedging : 417
Example Hedge 417
Types of Hedging 419
Categories of Hedgeable Risk 419
Hedging Equity and Equity Futures 421
Arbitrage 423
Conditions for Arbitrage 423
Examples 424
Price Convergence > 426
Risks .427
Types of Arbitrage 428
Swing Trading 433
The risks involved 434
Noise Trader 435
Day Trader 436
Types of Day Traders 436
Day Trading 438
Characteristics 438
History of Day Trading 440
Techniques 443
Cost 445
Regulations and Restrictions 447
Rogue Trader 448
Trading Strategy 450
Development 450
Forward Testing 450
Executing Strategies 451
Trading System 452
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Christoph Lymbersky: Financial Market Principles
Algorithmic Trading 454
History 454
Communication Standards 456
Strategies 456
Effects 458
Trend Following 459
Definition 459
Considerations 460
Example 460
Contrarian Investing 462
Similarity to Value Investing .-. 462
Examples of Contrarian Investing 463
Relationship to Behavioral Finance 464
Scalping (Trading) 465
Market Manipulation 465
Arbitrage & Scalping 465
Factors affecting Scalping 468
Technical Analysis 471
What is a Technical Analysis? 472
General Description 472
History 474
Principles 474
Prices Move in Trends 475
History tends to repeat itself 476
Industry 477
Systematic Trading 478
Combination with other Market Forecast Methods 479
Applicability 481
Random Walk Hypothesis 483
Chart Technique 484
Chart Pattern 484
Candlestick Chart 484
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Christoph Lymbersky: Financial Market Principles
Kagi Chart 488
Point and Figure Chart 490
Market Trend 492
Primary Market Trends 492
Bull Market 492
Bear Market 493
Secondary Market Trends 493
Secular Market Trends 494
Stock Market Bottom 497
Identifying a Market Bottom 498
Risks of Attempting to invest at a Market Bottom.... 502
2008 Market Drop 502
Concepts 507
Black-Scholes 507
Black Model 508
Dead Cat Bounce 509
Coppock Curve 520
Elliott Wave Principle 521
Momentum 520
'• SMA 521
Hikkake Pattern 522
Overlays 524
Support and Resistance 524
Support 524
Resistance 524
Trend Lines 527
Double Top 529
Price Channels 530
Moving Average 530
Simple Moving Average 531
Cumulative Moving Average 533
Weighted Moving Average 534
Exponential Moving Average 536
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Christoph Lymbersky: Financial Market Principles
Exponential Smoothing 538
Average True Range 539
Bollinger Bands 541
Head and Shoulders 543
Pivot Point Calculations 545
Price Based Indicators 547
Relative Strength Index 547
MACD 550
Average Directional Index 553
Commodity Channel Index 555
Parabolic SAR 557
Rahul Mohindar Oscillator 1 559
Stochastic Oscillator ^ 559
Trix 562
Accumulation/Distribution Index 564
Chaikin Oscillator 565
Money Flow 565
Price and Volume Trend 567
On-balance Volume 568
Crashes and troubled Times 571
Financial Crisis 572
Types of Financial Crises 572
Causes and Consequences of a Financial Crises 574
Theories of Financial Crises 578
History 579
Virtuous Circle and Vicious Circle 581
Example in Macroeconomics 581
Recession 584
Attributes of Recessions 584
Predictors of a Recession 584
Responding to a Recession 585
Central Bank Response 585
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Christoph Lymbersky: Financial Market Principles
The Stock Market and Recessions 586
Recession and Politics 587
History of Recessions 588
Possible 2008 Recession in some Countries 588
Stock Market Crashes 591
Mathematical Theory of Stock Market crashes 591
Wall Street Crash of 1929 593
Timeline 595
Economic Fundamentals 596
Impact and Academic Debate ; 597
Black Monday (1987) 600
Timeline 602
.Causes 603
October 27,1997 Mini-Crash 605
By the Numbers 605
October 28 606
1997 Asian Financial Crisis 608
History 609
1 The Role of the IMF 622
Consequences 620
1998 Russian Financial Crisis 623
Course of events 623
The Crisis and its Effects 625
Dot-com Bubble 630
The growth of the Bubble 630
Soaring Stocks 631
Free Spending 631
Thinning the Herd 632
Aftermath 634
Stock Market Downturn of 2002 636
Context 636
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Christoph Lymbersky: Financial Market Principles
Seeking a Bottom 637
Index Levels 637
Global Financial Crisis of 2008 641
Key Risk Indicators in September 2008 657
Global Responses 658
2008 Russian Financial Crisis 663
Background 663
Timeline 664
Stock Exchanges 669
About Stock Exchanges ; 670
History of Stock Exchanges : 670
The Role of Stock Exchanges .'; 670
Major Stock Exchanges 672
Listing Requirements 674
Ownership 675
Other Types of Exchanges 675
List of Stock Exchanges 678
American Stock Exchange 680
History 680
The Market 680
Hours 681
New York Stock Exchange 682
Business 682
History 684
Events 686
Australian Securities Exchange 688
Market Details 688
History 689
Timeline of significant events 689
Frankfurt Stock Exchange 695
History 696
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Christoph Lymbersky: Financial Market Principles
London Stock Exchange 698
History 698
Structure 701
Tokyo Stock Exchange..: 702
Structure 702
History 704
Hours 705
Alliances 705
Toronto Stock Exchange 706
History 706
Trading Hours 708
Hong Kong Stock Exchange 709
History 709
Differences from US Stock Exchanges 710
Trading Hours 711
Regulatory Role 711 .
Euronext 712
Background 712
Structure and Indices 712
Euronext.liffe 713
Alternext 714
Merger with NYSE 714
The World's Major Indeces 717
NASDAQ 718
History 718
Business 720
Dow Jones Industrial Average 721
Calculation 721
Criticism 722
S&P500 723
History 724
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Christoph Lymbersky: Financial Market Principles
Selection 725
Weighting 726
Index Maintenance 726
Investing 727
DAX 729
Nikkei 225 730
Weighting and Modifications 730
Changes to the Components 730
All Ordinaries 732
Hang Seng Index 733
Statistics 733
Hang Seng Industry Classification System 734
General Classification Guidelines: 734
Selection Criteria for the HSI Constituent Stocks 734
Calculation Formula for HSI 735
Appendix 739
Capital Gains Tax 740
Tax systems '. 740
References 753
Index 761
Financial Markets Certifications 811
Certified Financial Markets Professional - Foundation Exam 812
Certified Financial Markets Professional - Practitioner Exam 814
Room for Notes: 816
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