微信客服：xiaoxionga100
微信客服：ITCS521
金融代写-FNCE30001
时间：2022-08-29
Dr Patrick J Kelly
Investments
FNCE30001
ASX200 Price Level: Why does the price jump around?
© 2020 Patrick J. Kelly 3
0
1000
2000
3000
4000
5000
6000
7000
8000
1
9
9
2
1
9
9
3
1
9
9
4
1
9
9
5
1
9
9
6
1
9
9
7
1
9
9
8
1
9
9
9
2
0
0
0
2
0
0
1
2
0
0
2
2
0
0
3
2
0
0
4
2
0
0
5
2
0
0
6
2
0
0
7
2
0
0
8
2
0
0
9
2
0
1
0
2
0
1
1
2
0
1
2
2
0
1
3
2
0
1
4
2
0
1
5
2
0
1
6
2
0
1
7
2
0
1
8
2
0
1
9
2
0
2
0
A
S
X
2
0
0
I
n
d
ex
L
ev
el
Source: https://www.marketindex.com.au/data-downloads
The Price is Right
• A typical assumption in finance is that the price of a traded good
is a correct price.
– Traded good: anything that is bought and sold in a market where buyers
and sellers voluntarily trade. Usually, we assume the trade is frequent.
• We assume traded goods have correct prices because if they
don’t traders can easily profit.
– Buy is the price is too low
– Sell if the price is too high
• Constant competition means that prices jump as soon as there is
new information
– More in Week 12 when we discuss market efficiency
© 2020 Patrick J. Kelly 4See BKM 13.3 for a more in-depth discussion
ASX200 Price Level: Why does the price jump around?
© 2020 Patrick J. Kelly 5
0
1000
2000
3000
4000
5000
6000
7000
8000
1
9
9
2
1
9
9
3
1
9
9
4
1
9
9
5
1
9
9
6
1
9
9
7
1
9
9
8
1
9
9
9
2
0
0
0
2
0
0
1
2
0
0
2
2
0
0
3
2
0
0
4
2
0
0
5
2
0
0
6
2
0
0
7
2
0
0
8
2
0
0
9
2
0
1
0
2
0
1
1
2
0
1
2
2
0
1
3
2
0
1
4
2
0
1
5
2
0
1
6
2
0
1
7
2
0
1
8
2
0
1
9
2
0
2
0
A
S
X
2
0
0
I
n
d
ex
L
ev
el
Source: https://www.marketindex.com.au/data-downloads
The Price is Right
• What is a correct price?
• Correct price: the price conforms to a model we believe in.
© 2020 Patrick J. Kelly 6
0 =
=1
∞
1 +
Note: the equity cost of
capital is constant for
all investment horizons.
This is the same as
what you saw in
Principles of Finance.
See BKM 13.3 for a more in-depth discussion
The Price is Right
• What is a correct price?
• Correct price: the price conforms to a model we believe in.
© 2020 Patrick J. Kelly 7
0 =
=1
∞
෪
1 + ǁ
CF= Cash flow
෩ on top means the
variable comes from a
random distribution.
stands for investor “Expectations”
about what’s inside the brackets.
The cost of capital is annualized, but we
allow it to vary by the investment horizon.
Important Assumption in this Subject
• In this subject we will usually assume that prices are correct.
– A fairly realistic assumption to make
• Implication of correct pricing:
Smart Investing is HARD
… and EASY
© 2020 Patrick J. Kelly 8
0 =
=1
∞
෪
1 + ǁ
If the price is right, then…
• It is very hard to make investments that perform unusually well.
• We will discuss in future lectures what “unusually well” means.
• If anyone is going to do particularly well, one might think it should
be professional investors.
• Let’s look at a real-life example.
© 2020 Patrick J. Kelly 9
The Hard Part: Are Investors Smart or Just Lucky?
© 2020 Patrick J. Kelly 10
9.27% vs. 4.27% (ASX 200)
On 12/07/2020: https://www.canstar.com.au/compare/managed-funds/?profile=Australian+Shares+%E2%80%93+Large+Cap&amount=25000
Superficially, these managers seem smart
• 9.27% is a lot better than 4.27%
– But we don’t know how risky the fund was.
– It is hard to tell if it could have just been luck.
• Let’s look at the distribution of a reported 5-year returns for all
managed funds in Australia that report their returns to
Morningstar.com.au
© 2020 Patrick J. Kelly 11
Distribution of 5-Year Managed Fund Return
© 2020 Patrick J. Kelly 12
1
501
1001
1501
2001
2501
3001
3501
4001
-15 to -12 -12 to -9 -9 to -6 -6 to -3 -3 to 0 0 to 3 3 to 6 6 to 9 9 to 12 12 to 15 15 to 18 18 to 21 21 to 24 24 to 27 27 to 30
C
o
u
n
t
o
f
F
u
n
d
s
Count of Managed Funds Coin Toss
9.27%
The yellow bars:
If beating the market were a simple
coin toss (50%-50% bet), how much
of the time (x-axis) would the number
of funds (y-axis) beat the market?
The histogram suggests….
• Even if a professional manager performs well, it is really hard to
tell whether it is any better than luck.
– And if it is just luck, why do I need to pay them?
• So what do we do, if even the pros have a hard time?
© 2020 Patrick J. Kelly 13
The Easy Part
• Easier anyway….
• Correct Pricing is good.
– It means that prices reflect a fair compensation for the risks we face.
• If prices are correct, the best we can do is:
– Be cognizant of the risks that we can get compensated for
– Minimize the risks we do not get compensated for.
© 2020 Patrick J. Kelly 14
The major concepts of this subject
• Prices of traded assets are always correct (almost)
• Diversification we can
– minimize risk and
– maximize our reward for taking risk.
• The only risks we should expect to earn a return for is risk that is
undiversifiable.
– Anything else is just luck.
• Or at least indistinguishable from luck.
© 2020 Patrick J. Kelly 15
16
The Subject Guide: Admin Details
Reading is important! Note about the textbook
• Essentials of Investments (12th edition)
– by Bodie, Kane and Marcus, 2022
– www.booktopia.com.au
– www.mheducation.com.au
• Very, very, very similar texts
– Principles of Investments (1st edition)
• by Bodie, Drew, Basu, Kane and Marcus, 2013
– Investments (12th edition)
• by Bodie, Kane and Marcus, 2021
– Essentials of Investments (11th edition)
• by Bodie, Kane and Marcus, 2019
17
Marking System
• Tutorial assignments 10%
– Weeks 1 & 6: no tutorial assignments, no tutorial
– Weeks 2 & 3: tutorial assignment, but not marked
– Weeks 4, 5 & 7-12: tutorial assignment marked
• You get to miss one for free
• Mid-semester exam (Week 6) 20%
– On-line, open-book multiple choice exam through the Canvas LMS.
– You MUST sit the mid-sem during the lecture in which you are enrolled
• Final 70%
– Sometime during the exam period from 31 October to 18 November
– On-line, open-book exam through the Canvas LMS both long answer and
multiple choice.
18
Tutorials and tutorial assignments: marking
• Tutorial Attendance is not mandatory,
but you would be foolish not to attend.
In tutorial you review assignments and address questions
• Tutorial Assignments are due at 10:00am on the Monday before
your tutorial in weeks 4, 5, and 7-12.
19
Tutorials and tutorial assignments: marking
• If you are sick or something horrible happens
– File for special consideration
• There is a new rule about formally requesting extensions on time
to complete.
– We don’t do extensions.
– Unfair to other students
• If something happens that doesn’t qualify for special consideration
– We replace your lowest tutorial assignment with 1.25 marks
20
ALL Content-Related Questions
• During:
– lectures,
– tutorials and
– consultation hours with me or tutors
• Through the “Discussions” board on the LMS
– Questions get posted to a searchable FAQ
• Good way to learn from the questions of others
• Levels the playing field across students
– I have instructed tutors to direct any and all content questions not during
tutorials to the on-line tutor.
21
Subject Coordinator Consultation Hours
• My consultation hours via Zoom:
– Tuesday 3:15pm to 4:15pm via Zoom
• Link is on the LMS under “Zoom”
• Meeting ID: 882 3868 8961
• Password: Investment
22
Contact for non-content questions: Admin and other….
• Please put FNCE30001 in the subject line
• Lecturer in charge: Dr Patrick J Kelly
patrick.kelly@unimelb.edu.au
– Please contact me, if
• You see errors in the slides
• All content questions must go through the “Discussions” board
– OR – ask in tutorial, or come to consultation hours, whether mine or
another tutor’s.
23
Academic Honesty
• Unless specifically instructed, all work in this subject is to be your
own. Representing someone else’s work as your own is unethical.
– although group discussion prior writing up a tutorial assignment is fine.
• If you are caught representing someone else’s work as your own,
you will be punished to the full extent of the university’s rules.
24
Outline of Topic in Investments
(Mostly) Stock Investing
• Why we invest?
• How should we invest?
– Types of Assets and Asset Classes
– Details of Trading (margin purchases and short sales)
– Measuring risk and reward (return)
– Portfolio theory
– Managed Funds
– Index Models
• Asset Pricing (Pricing Risk)
• The mid-semester exam (Week 6)
© 2020 Patrick J. Kelly 26
Technical
details
The important stuff, but
mostly a repeat from
Principles of Finance
Adding Risky Debt
• More Asset Pricing and Forecasting
• Bond pricing
• Term Structure of Interest Rates
• Duration and Bond portfolio management
Bringing it all together
• Performance evaluation
• Market Efficiency
© 2020 Patrick J. Kelly 27
Similar to Principles, but introducing risk
Types of Investment Assets
Calculating Return
Why invest?
Why do we invest?
• In order to
Increase consumption and/or
smooth our consumption
– Life cycle planning
– Hedging
• Why do people save for retirement?
• Why do most people buy houses or cars with loans?
© 2020 Patrick J. Kelly 29BKM 1.3
Why do we get (demand) a return from investing?
1. “Time value of money”
2. Risk
• “Consumption timing” is important and we need to be
compensated for
– not consuming now and for
– the risk we may not be able to consume later
© 2020 Patrick J. Kelly 30BKM 1.3
© 2020 Patrick J. Kelly 31
Examples of Investments
• Stocks
– Common, Preferred and Depository Receipts
• Bonds
– Treasury Notes and Bonds, Certificates of Deposit, and more
• Derivatives: Calls, Puts, Futures
• Health Insurance, Life Insurance
• A company’s purchase of a factory
• Education
• Real Estate ?
• Children ?
BKM 1.1, 2.1-2.7
Real Assets
Financial
Assets
Real vs. Financial Assets
• Real Assets:
– The stuff used in the production of goods and services
• Financial Assets:
– Claims to real assets and their income
• One Key distinction:
– With real assets, there is no debtor
– With financial assets one person’s asset is another’s liability
© 2020 Patrick J. Kelly 32BKM 1.1
© 2020 Patrick J. Kelly 33
What is an investment?
• Anything that gives us return (or any benefit), in exchange for
some cost and, usually, some risk
• Return in this subject it is profit as a percentage of the initial
investment
Return =
Revenue− Cost
Cost
Realized or Historic Return
ǁ+1 =
෫Revenue+1 −
Expected Return
BKM 1.Intro
© 2020 Patrick J. Kelly 34
You’ve seen this before
• This
• Is the same as, something you might have seen in Principles
• It is just more general.
Return =
Revenue− Cost
Cost
= 0 =
1 − 0 + 1
0
BKM 5.1
Holding Period Return=
Trading Stocks
The plan
• Raising Capital: The Primary Market
– You need to know this – but it is covered more completely in the textbook.
• Trading stocks: The Secondary Market
– Details of trading
• Costs of Trading
• Limit order book
• Types of orders
– Margin trades
– Short sales
© 2020 Patrick J. Kelly 36BKM Chpt. 3
Raising Equity Capital
• There is only one time in the life of a stock that the firm actually
gets the proceeds of the sale of a stock.
– The Initial Public Offering (IPO) – the first time a stock is issued to the
public.
– Seasoned Equity Offering (SEO) – any issuance of new stock after the
initial offering.
• Both occur on the Primary Market and are intermediated by
Investment Banks.
– The Primary Market is not a physical location, but just reference to the
market for new shares that (usually) investment banks help create.
– Investment banks act as brokers, like real estate agents, helping find
buyers for the new issue of stock.
© 2020 Patrick J. Kelly 37BKM 3.1
Secondary Markets
• Once has stock has been sold to the initial investors, it can trade
on a secondary market.
• Typically there are two forms of secondary markets:
– Auction markets
• Usually a continuous and simultaneous double auction where there is bidding on both
the buy and the sell side.
• Example: ASX
– Dealer markets:
• A dealer is a firm that keeps an inventory of an asset and makes that asset available
to sell and stands ready to buy.
• OTC markets (Over the Counter) are dealer markets. NASDAQ in the US is a dealer
market.
© 2020 Patrick J. Kelly 38BKM 3.2
© 2019 Patrick J. Kelly 39
Costs of Trading (on secondary markets)
• Commission: fee paid to broker for making the transaction
• Spread: cost of trading with a dealer or exchange
– Ask (Offer): price dealer will sell to you
– Bid: price dealer will buy from you
– Spread: ask – bid
• Price Impact: the temporary change in price that occurs as the
result of placing a relatively large order.
§3.5BKM 3.2 and 3.7
© 2020 Patrick J. Kelly 40
The Limit Order Book
Source: http://finance.yahoo.com/q/ecn?s=MSFT
The dealer or
other investors are
offering $26.12 to
buy up to 24,595
shares
The dealer or
other investors are
asking $26.14 to
sell up to 30,363
shares
BKM 3.2
© 2020 Patrick J. Kelly 41
Bid-Ask Spread
Source: http://finance.yahoo.com/q/ecn?s=MSFT
The Bid-Ask Spread is $0.02
$26.14 - $26.12 = $0.02
Ask - Bid = Bid-Ask Spread
BKM 3.2
© 2020 Patrick J. Kelly 42
Types of Orders
• Market Order
• Limit Order
– Buy when price falls below limit
– Sell when price goes above limit
• Stop Loss Order
– Sell when the price goes below a limit
– Buy when the price goes above a limit
• (often accompanying short sales)
Instructions to the brokers on how to complete the order
BKM 3.2
© 2020 Patrick J. Kelly 43
Market order
• Market buy occurs at the Ask (Offer)
• Market sell occurs at the Bid
BKM 3.2
© 2020 Patrick J. Kelly 44
The Limit Order Book
Source: http://finance.yahoo.com/q/ecn?s=MSFT
The last trade
occurred at the
bid, $26.12
BKM 3.2
© 2020 Patrick J. Kelly 45
The Limit Order Book
Source: http://finance.yahoo.com/q/ecn?s=MSFT
What price?
A market buy order for 500 shares
A market sell order for 3000 shares
A market buy order for 35,000 shares
What if a market buy and sell for 400 shares came in at the
same time?
BKM 3.2
© 2020 Patrick J. Kelly 46
The Limit Order
Source: http://finance.yahoo.com/q/ecn?s=MSFT
You place a limit buy order for $26.10 for 200 shares
You place a limit sell order for $26.17 for 100 shares
BKM 3.2
© 2020 Patrick J. Kelly 47
Why Limit Orders?
1. To buy on a dip or sell on a rise
2. To avoid paying the spread
3. In the form of stop orders to prevent loss or lock in a gain
(more shortly)
§3.2BKM 3.2
Question
• Before the market opens, you place a limit sell order on Rio Tinto
(RIO) to sell 1000 shares for $100.
• At the start of trading RIO
– opens at $95 per share.
• During the day
– the lowest price was $90
– The highest price was $105
– The stock closed at $97 per share
• You made no changes to your order during the day.
© 2020 Patrick J. Kelly 48
Fun fact
• What happens if you put in a limit sell for $100, but the bid-ask
spread is
– Ask= $102
– Bid = $101
• Answer: $101
– Limit orders are executed at the best price or better.
© 2020 Patrick J. Kelly 52
Margin Trading
© 2020 Patrick J. Kelly 54
Why buy stock on margin?
Buying on margin = borrowing money to buy stock
Suppose you wish to invest $2000 in MSFT and you finance your
purchase with $1000 of your own money and $1000 from a margin
loan from your broker.
• What is your return on investment if MSFT increases in value by
10% during the next year, if your broker charges you 4% interest?
=
−
BKM 3.8
Cost?
Invest $2000 in MSFT grows by 10%
with $1000 -- own money (this is called margin)
and $1000 -- margin loan at 4% interest rate
• Answer: $1000
© 2019 Patrick J. Kelly 55BKM 3.8
Revenue?
Invest $2000 in MSFT grows by 10%
with $1000 -- own money
and $1000 -- margin loan at 4% interest rate
• Revenue
– MSFT grows by 10%
– But you have to pay back your 4% loan of $1000 first
= $2000 × 1.10 − $1000 × 1.04
= $2200 − $1040
= $1160
© 2019 Patrick J. Kelly 56BKM 3.8
© 2020 Patrick J. Kelly 57
Why buy stock on margin?
Suppose you wish to invest $2000 in MSFT and you finance your
purchase with $1000 of your own money and $1000 from a margin
loan from your broker.
• What is your return on investment if MSFT increases in value by
10% during the next year, if your broker charges you 4% interest?
=
−
=
$1160 − $1000
$1000
= 16%
BKM 3.8
© 2019 Patrick J. Kelly 58
Margin Percent (also often confusingly called just “Margin”)
=
ℎ
=
−
=
= 1 −
BKM 3.8
Margin Trading: Examples
© 2020 Patrick J. Kelly 60
Margin Trading - Initial Conditions
X Corp $70
1000 Shares Purchased
50% Initial Margin
40% Maintenance Margin
Initial Position
Stock $70,000
Equity $35,000
Borrowed $35,000
BKM 3.8
Initial margin is the minimum
amount of your own money
you must invest. Often set by
law.
Maintenance margin: minimum
amount equity your account can
have before additional funds must
be put into the account
Margin call: notification from
the broker that you must put
up additional funds or assets
will be sold.
© 2020 Patrick J. Kelly 61
Margin Trading - Maintenance Margin
Stock price suddenly falls to $60 per share
New Position
Stock 1000 x $60 = $60,000
Call Loan is still $35,000
What is our Margin Percent?
=
−
=
60,000 − 35,000
60,000
=
25,000
60,000
= 41.67%
BKM 3.8
© 2020 Patrick J. Kelly 62
Margin Trading - Margin Call
How far can the stock price fall before a
margin call?
=
−
0.40 =
1000 − 35,000
1000
400 = 1000 − 35,000
35000 = 600
= $58.33
BKM 3.8
© 2020 Patrick J. Kelly 63
Your Turn
Y Corp $20
60% Initial Margin
40% Maintenance Margin
1000 Shares Purchased
Initial Position
Stock Equity
Borrowed
______
______
______
BKM 3.8
© 2020 Patrick J. Kelly 64
Your Turn
Y Corp $20
60% Initial Margin
40% Maintenance Margin
1000 Shares Purchased
Initial Position
Stock Equity
Borrowed
$20,000
$8,000
$12,000
BKM 3.8
© 2020 Patrick J. Kelly 65
Your Turn
Stock price falls to $15 per share
New Position
Stock Borrowed $8,000
Equity
Margin % =
______
_____
_____________
BKM 3.8
© 2020 Patrick J. Kelly 66
Your Turn
Stock price falls to $15 per share
New Position
Stock Borrowed $8,000
Equity
Margin % =
$15,000
7,000
$7,000/$15,000 = 46.67%
BKM 3.8
© 2020 Patrick J. Kelly 67
Your Turn
How far can the stock price fall before a
margin call?
P =______
BKM 3.8
© 2020 Patrick J. Kelly 68
Your Turn
How far can the stock price fall before a
margin call?
(1000P - $8,000) / 1000P = 40%
$13.33
BKM 3.8
“Investment Loans”
© 2019 Patrick J. Kelly 69
https://www.anz.com.au/personal/investing-super/investment-loans/
BKM 3.8
Loan to Value, but Still Margin Calls
• List of stocks and the maximum loan to value
• Margin calls occur when price 5% higher than maximum loan to
value
© 2019 Patrick J. Kelly 70https://www.anz.com.au/content/dam/anzcomau/documents/pdf/anz-investment-lending-approved-stocks.pdf
Try this example
• Suppose you purchased 1000 shares of BLD at $4.96 per share
on Friday, 23 Aug. 2019. You decided to buy on margin with a
60% Loan to Value using an Investment Loan from a local bank.
– The bank will make a margin call if the loan to value increases to 5%
over the maximum loan to value of 70%.
– At what price will the bank make a margin call?
© 2019 Patrick J. Kelly 71BKM 3.8
At what price will the bank make a margin call?
• Suppose you purchased 1000 shares of BLD at $4.96 per share
on Friday, 23 Aug. 2019. You decided to buy on margin with a
60% Loan to Value using an Investment Loan from a local bank.
– The bank will make a margin call if the loan to value increases to 5% over
the maximum loan to value of 70%.
=
= 1 −
0.75 =
.60 × 1000 × $4.96
1000
750 = $2976
= $3.97
© 2019 Patrick J. Kelly 72BKM 3.8
Investments
FNCE30001
ASX200 Price Level: Why does the price jump around?
© 2020 Patrick J. Kelly 3
0
1000
2000
3000
4000
5000
6000
7000
8000
1
9
9
2
1
9
9
3
1
9
9
4
1
9
9
5
1
9
9
6
1
9
9
7
1
9
9
8
1
9
9
9
2
0
0
0
2
0
0
1
2
0
0
2
2
0
0
3
2
0
0
4
2
0
0
5
2
0
0
6
2
0
0
7
2
0
0
8
2
0
0
9
2
0
1
0
2
0
1
1
2
0
1
2
2
0
1
3
2
0
1
4
2
0
1
5
2
0
1
6
2
0
1
7
2
0
1
8
2
0
1
9
2
0
2
0
A
S
X
2
0
0
I
n
d
ex
L
ev
el
Source: https://www.marketindex.com.au/data-downloads
The Price is Right
• A typical assumption in finance is that the price of a traded good
is a correct price.
– Traded good: anything that is bought and sold in a market where buyers
and sellers voluntarily trade. Usually, we assume the trade is frequent.
• We assume traded goods have correct prices because if they
don’t traders can easily profit.
– Buy is the price is too low
– Sell if the price is too high
• Constant competition means that prices jump as soon as there is
new information
– More in Week 12 when we discuss market efficiency
© 2020 Patrick J. Kelly 4See BKM 13.3 for a more in-depth discussion
ASX200 Price Level: Why does the price jump around?
© 2020 Patrick J. Kelly 5
0
1000
2000
3000
4000
5000
6000
7000
8000
1
9
9
2
1
9
9
3
1
9
9
4
1
9
9
5
1
9
9
6
1
9
9
7
1
9
9
8
1
9
9
9
2
0
0
0
2
0
0
1
2
0
0
2
2
0
0
3
2
0
0
4
2
0
0
5
2
0
0
6
2
0
0
7
2
0
0
8
2
0
0
9
2
0
1
0
2
0
1
1
2
0
1
2
2
0
1
3
2
0
1
4
2
0
1
5
2
0
1
6
2
0
1
7
2
0
1
8
2
0
1
9
2
0
2
0
A
S
X
2
0
0
I
n
d
ex
L
ev
el
Source: https://www.marketindex.com.au/data-downloads
The Price is Right
• What is a correct price?
• Correct price: the price conforms to a model we believe in.
© 2020 Patrick J. Kelly 6
0 =
=1
∞
1 +
Note: the equity cost of
capital is constant for
all investment horizons.
This is the same as
what you saw in
Principles of Finance.
See BKM 13.3 for a more in-depth discussion
The Price is Right
• What is a correct price?
• Correct price: the price conforms to a model we believe in.
© 2020 Patrick J. Kelly 7
0 =
=1
∞
෪
1 + ǁ
CF= Cash flow
෩ on top means the
variable comes from a
random distribution.
stands for investor “Expectations”
about what’s inside the brackets.
The cost of capital is annualized, but we
allow it to vary by the investment horizon.
Important Assumption in this Subject
• In this subject we will usually assume that prices are correct.
– A fairly realistic assumption to make
• Implication of correct pricing:
Smart Investing is HARD
… and EASY
© 2020 Patrick J. Kelly 8
0 =
=1
∞
෪
1 + ǁ
If the price is right, then…
• It is very hard to make investments that perform unusually well.
• We will discuss in future lectures what “unusually well” means.
• If anyone is going to do particularly well, one might think it should
be professional investors.
• Let’s look at a real-life example.
© 2020 Patrick J. Kelly 9
The Hard Part: Are Investors Smart or Just Lucky?
© 2020 Patrick J. Kelly 10
9.27% vs. 4.27% (ASX 200)
On 12/07/2020: https://www.canstar.com.au/compare/managed-funds/?profile=Australian+Shares+%E2%80%93+Large+Cap&amount=25000
Superficially, these managers seem smart
• 9.27% is a lot better than 4.27%
– But we don’t know how risky the fund was.
– It is hard to tell if it could have just been luck.
• Let’s look at the distribution of a reported 5-year returns for all
managed funds in Australia that report their returns to
Morningstar.com.au
© 2020 Patrick J. Kelly 11
Distribution of 5-Year Managed Fund Return
© 2020 Patrick J. Kelly 12
1
501
1001
1501
2001
2501
3001
3501
4001
-15 to -12 -12 to -9 -9 to -6 -6 to -3 -3 to 0 0 to 3 3 to 6 6 to 9 9 to 12 12 to 15 15 to 18 18 to 21 21 to 24 24 to 27 27 to 30
C
o
u
n
t
o
f
F
u
n
d
s
Count of Managed Funds Coin Toss
9.27%
The yellow bars:
If beating the market were a simple
coin toss (50%-50% bet), how much
of the time (x-axis) would the number
of funds (y-axis) beat the market?
The histogram suggests….
• Even if a professional manager performs well, it is really hard to
tell whether it is any better than luck.
– And if it is just luck, why do I need to pay them?
• So what do we do, if even the pros have a hard time?
© 2020 Patrick J. Kelly 13
The Easy Part
• Easier anyway….
• Correct Pricing is good.
– It means that prices reflect a fair compensation for the risks we face.
• If prices are correct, the best we can do is:
– Be cognizant of the risks that we can get compensated for
– Minimize the risks we do not get compensated for.
© 2020 Patrick J. Kelly 14
The major concepts of this subject
• Prices of traded assets are always correct (almost)
• Diversification we can
– minimize risk and
– maximize our reward for taking risk.
• The only risks we should expect to earn a return for is risk that is
undiversifiable.
– Anything else is just luck.
• Or at least indistinguishable from luck.
© 2020 Patrick J. Kelly 15
16
The Subject Guide: Admin Details
Reading is important! Note about the textbook
• Essentials of Investments (12th edition)
– by Bodie, Kane and Marcus, 2022
– www.booktopia.com.au
– www.mheducation.com.au
• Very, very, very similar texts
– Principles of Investments (1st edition)
• by Bodie, Drew, Basu, Kane and Marcus, 2013
– Investments (12th edition)
• by Bodie, Kane and Marcus, 2021
– Essentials of Investments (11th edition)
• by Bodie, Kane and Marcus, 2019
17
Marking System
• Tutorial assignments 10%
– Weeks 1 & 6: no tutorial assignments, no tutorial
– Weeks 2 & 3: tutorial assignment, but not marked
– Weeks 4, 5 & 7-12: tutorial assignment marked
• You get to miss one for free
• Mid-semester exam (Week 6) 20%
– On-line, open-book multiple choice exam through the Canvas LMS.
– You MUST sit the mid-sem during the lecture in which you are enrolled
• Final 70%
– Sometime during the exam period from 31 October to 18 November
– On-line, open-book exam through the Canvas LMS both long answer and
multiple choice.
18
Tutorials and tutorial assignments: marking
• Tutorial Attendance is not mandatory,
but you would be foolish not to attend.
In tutorial you review assignments and address questions
• Tutorial Assignments are due at 10:00am on the Monday before
your tutorial in weeks 4, 5, and 7-12.
19
Tutorials and tutorial assignments: marking
• If you are sick or something horrible happens
– File for special consideration
• There is a new rule about formally requesting extensions on time
to complete.
– We don’t do extensions.
– Unfair to other students
• If something happens that doesn’t qualify for special consideration
– We replace your lowest tutorial assignment with 1.25 marks
20
ALL Content-Related Questions
• During:
– lectures,
– tutorials and
– consultation hours with me or tutors
• Through the “Discussions” board on the LMS
– Questions get posted to a searchable FAQ
• Good way to learn from the questions of others
• Levels the playing field across students
– I have instructed tutors to direct any and all content questions not during
tutorials to the on-line tutor.
21
Subject Coordinator Consultation Hours
• My consultation hours via Zoom:
– Tuesday 3:15pm to 4:15pm via Zoom
• Link is on the LMS under “Zoom”
• Meeting ID: 882 3868 8961
• Password: Investment
22
Contact for non-content questions: Admin and other….
• Please put FNCE30001 in the subject line
• Lecturer in charge: Dr Patrick J Kelly
patrick.kelly@unimelb.edu.au
– Please contact me, if
• You see errors in the slides
• All content questions must go through the “Discussions” board
– OR – ask in tutorial, or come to consultation hours, whether mine or
another tutor’s.
23
Academic Honesty
• Unless specifically instructed, all work in this subject is to be your
own. Representing someone else’s work as your own is unethical.
– although group discussion prior writing up a tutorial assignment is fine.
• If you are caught representing someone else’s work as your own,
you will be punished to the full extent of the university’s rules.
24
Outline of Topic in Investments
(Mostly) Stock Investing
• Why we invest?
• How should we invest?
– Types of Assets and Asset Classes
– Details of Trading (margin purchases and short sales)
– Measuring risk and reward (return)
– Portfolio theory
– Managed Funds
– Index Models
• Asset Pricing (Pricing Risk)
• The mid-semester exam (Week 6)
© 2020 Patrick J. Kelly 26
Technical
details
The important stuff, but
mostly a repeat from
Principles of Finance
Adding Risky Debt
• More Asset Pricing and Forecasting
• Bond pricing
• Term Structure of Interest Rates
• Duration and Bond portfolio management
Bringing it all together
• Performance evaluation
• Market Efficiency
© 2020 Patrick J. Kelly 27
Similar to Principles, but introducing risk
Types of Investment Assets
Calculating Return
Why invest?
Why do we invest?
• In order to
Increase consumption and/or
smooth our consumption
– Life cycle planning
– Hedging
• Why do people save for retirement?
• Why do most people buy houses or cars with loans?
© 2020 Patrick J. Kelly 29BKM 1.3
Why do we get (demand) a return from investing?
1. “Time value of money”
2. Risk
• “Consumption timing” is important and we need to be
compensated for
– not consuming now and for
– the risk we may not be able to consume later
© 2020 Patrick J. Kelly 30BKM 1.3
© 2020 Patrick J. Kelly 31
Examples of Investments
• Stocks
– Common, Preferred and Depository Receipts
• Bonds
– Treasury Notes and Bonds, Certificates of Deposit, and more
• Derivatives: Calls, Puts, Futures
• Health Insurance, Life Insurance
• A company’s purchase of a factory
• Education
• Real Estate ?
• Children ?
BKM 1.1, 2.1-2.7
Real Assets
Financial
Assets
Real vs. Financial Assets
• Real Assets:
– The stuff used in the production of goods and services
• Financial Assets:
– Claims to real assets and their income
• One Key distinction:
– With real assets, there is no debtor
– With financial assets one person’s asset is another’s liability
© 2020 Patrick J. Kelly 32BKM 1.1
© 2020 Patrick J. Kelly 33
What is an investment?
• Anything that gives us return (or any benefit), in exchange for
some cost and, usually, some risk
• Return in this subject it is profit as a percentage of the initial
investment
Return =
Revenue− Cost
Cost
Realized or Historic Return
ǁ+1 =
෫Revenue+1 −
Expected Return
BKM 1.Intro
© 2020 Patrick J. Kelly 34
You’ve seen this before
• This
• Is the same as, something you might have seen in Principles
• It is just more general.
Return =
Revenue− Cost
Cost
= 0 =
1 − 0 + 1
0
BKM 5.1
Holding Period Return=
Trading Stocks
The plan
• Raising Capital: The Primary Market
– You need to know this – but it is covered more completely in the textbook.
• Trading stocks: The Secondary Market
– Details of trading
• Costs of Trading
• Limit order book
• Types of orders
– Margin trades
– Short sales
© 2020 Patrick J. Kelly 36BKM Chpt. 3
Raising Equity Capital
• There is only one time in the life of a stock that the firm actually
gets the proceeds of the sale of a stock.
– The Initial Public Offering (IPO) – the first time a stock is issued to the
public.
– Seasoned Equity Offering (SEO) – any issuance of new stock after the
initial offering.
• Both occur on the Primary Market and are intermediated by
Investment Banks.
– The Primary Market is not a physical location, but just reference to the
market for new shares that (usually) investment banks help create.
– Investment banks act as brokers, like real estate agents, helping find
buyers for the new issue of stock.
© 2020 Patrick J. Kelly 37BKM 3.1
Secondary Markets
• Once has stock has been sold to the initial investors, it can trade
on a secondary market.
• Typically there are two forms of secondary markets:
– Auction markets
• Usually a continuous and simultaneous double auction where there is bidding on both
the buy and the sell side.
• Example: ASX
– Dealer markets:
• A dealer is a firm that keeps an inventory of an asset and makes that asset available
to sell and stands ready to buy.
• OTC markets (Over the Counter) are dealer markets. NASDAQ in the US is a dealer
market.
© 2020 Patrick J. Kelly 38BKM 3.2
© 2019 Patrick J. Kelly 39
Costs of Trading (on secondary markets)
• Commission: fee paid to broker for making the transaction
• Spread: cost of trading with a dealer or exchange
– Ask (Offer): price dealer will sell to you
– Bid: price dealer will buy from you
– Spread: ask – bid
• Price Impact: the temporary change in price that occurs as the
result of placing a relatively large order.
§3.5BKM 3.2 and 3.7
© 2020 Patrick J. Kelly 40
The Limit Order Book
Source: http://finance.yahoo.com/q/ecn?s=MSFT
The dealer or
other investors are
offering $26.12 to
buy up to 24,595
shares
The dealer or
other investors are
asking $26.14 to
sell up to 30,363
shares
BKM 3.2
© 2020 Patrick J. Kelly 41
Bid-Ask Spread
Source: http://finance.yahoo.com/q/ecn?s=MSFT
The Bid-Ask Spread is $0.02
$26.14 - $26.12 = $0.02
Ask - Bid = Bid-Ask Spread
BKM 3.2
© 2020 Patrick J. Kelly 42
Types of Orders
• Market Order
• Limit Order
– Buy when price falls below limit
– Sell when price goes above limit
• Stop Loss Order
– Sell when the price goes below a limit
– Buy when the price goes above a limit
• (often accompanying short sales)
Instructions to the brokers on how to complete the order
BKM 3.2
© 2020 Patrick J. Kelly 43
Market order
• Market buy occurs at the Ask (Offer)
• Market sell occurs at the Bid
BKM 3.2
© 2020 Patrick J. Kelly 44
The Limit Order Book
Source: http://finance.yahoo.com/q/ecn?s=MSFT
The last trade
occurred at the
bid, $26.12
BKM 3.2
© 2020 Patrick J. Kelly 45
The Limit Order Book
Source: http://finance.yahoo.com/q/ecn?s=MSFT
What price?
A market buy order for 500 shares
A market sell order for 3000 shares
A market buy order for 35,000 shares
What if a market buy and sell for 400 shares came in at the
same time?
BKM 3.2
© 2020 Patrick J. Kelly 46
The Limit Order
Source: http://finance.yahoo.com/q/ecn?s=MSFT
You place a limit buy order for $26.10 for 200 shares
You place a limit sell order for $26.17 for 100 shares
BKM 3.2
© 2020 Patrick J. Kelly 47
Why Limit Orders?
1. To buy on a dip or sell on a rise
2. To avoid paying the spread
3. In the form of stop orders to prevent loss or lock in a gain
(more shortly)
§3.2BKM 3.2
Question
• Before the market opens, you place a limit sell order on Rio Tinto
(RIO) to sell 1000 shares for $100.
• At the start of trading RIO
– opens at $95 per share.
• During the day
– the lowest price was $90
– The highest price was $105
– The stock closed at $97 per share
• You made no changes to your order during the day.
© 2020 Patrick J. Kelly 48
Fun fact
• What happens if you put in a limit sell for $100, but the bid-ask
spread is
– Ask= $102
– Bid = $101
• Answer: $101
– Limit orders are executed at the best price or better.
© 2020 Patrick J. Kelly 52
Margin Trading
© 2020 Patrick J. Kelly 54
Why buy stock on margin?
Buying on margin = borrowing money to buy stock
Suppose you wish to invest $2000 in MSFT and you finance your
purchase with $1000 of your own money and $1000 from a margin
loan from your broker.
• What is your return on investment if MSFT increases in value by
10% during the next year, if your broker charges you 4% interest?
=
−
BKM 3.8
Cost?
Invest $2000 in MSFT grows by 10%
with $1000 -- own money (this is called margin)
and $1000 -- margin loan at 4% interest rate
• Answer: $1000
© 2019 Patrick J. Kelly 55BKM 3.8
Revenue?
Invest $2000 in MSFT grows by 10%
with $1000 -- own money
and $1000 -- margin loan at 4% interest rate
• Revenue
– MSFT grows by 10%
– But you have to pay back your 4% loan of $1000 first
= $2000 × 1.10 − $1000 × 1.04
= $2200 − $1040
= $1160
© 2019 Patrick J. Kelly 56BKM 3.8
© 2020 Patrick J. Kelly 57
Why buy stock on margin?
Suppose you wish to invest $2000 in MSFT and you finance your
purchase with $1000 of your own money and $1000 from a margin
loan from your broker.
• What is your return on investment if MSFT increases in value by
10% during the next year, if your broker charges you 4% interest?
=
−
=
$1160 − $1000
$1000
= 16%
BKM 3.8
© 2019 Patrick J. Kelly 58
Margin Percent (also often confusingly called just “Margin”)
=
ℎ
=
−
=
= 1 −
BKM 3.8
Margin Trading: Examples
© 2020 Patrick J. Kelly 60
Margin Trading - Initial Conditions
X Corp $70
1000 Shares Purchased
50% Initial Margin
40% Maintenance Margin
Initial Position
Stock $70,000
Equity $35,000
Borrowed $35,000
BKM 3.8
Initial margin is the minimum
amount of your own money
you must invest. Often set by
law.
Maintenance margin: minimum
amount equity your account can
have before additional funds must
be put into the account
Margin call: notification from
the broker that you must put
up additional funds or assets
will be sold.
© 2020 Patrick J. Kelly 61
Margin Trading - Maintenance Margin
Stock price suddenly falls to $60 per share
New Position
Stock 1000 x $60 = $60,000
Call Loan is still $35,000
What is our Margin Percent?
=
−
=
60,000 − 35,000
60,000
=
25,000
60,000
= 41.67%
BKM 3.8
© 2020 Patrick J. Kelly 62
Margin Trading - Margin Call
How far can the stock price fall before a
margin call?
=
−
0.40 =
1000 − 35,000
1000
400 = 1000 − 35,000
35000 = 600
= $58.33
BKM 3.8
© 2020 Patrick J. Kelly 63
Your Turn
Y Corp $20
60% Initial Margin
40% Maintenance Margin
1000 Shares Purchased
Initial Position
Stock Equity
Borrowed
______
______
______
BKM 3.8
© 2020 Patrick J. Kelly 64
Your Turn
Y Corp $20
60% Initial Margin
40% Maintenance Margin
1000 Shares Purchased
Initial Position
Stock Equity
Borrowed
$20,000
$8,000
$12,000
BKM 3.8
© 2020 Patrick J. Kelly 65
Your Turn
Stock price falls to $15 per share
New Position
Stock Borrowed $8,000
Equity
Margin % =
______
_____
_____________
BKM 3.8
© 2020 Patrick J. Kelly 66
Your Turn
Stock price falls to $15 per share
New Position
Stock Borrowed $8,000
Equity
Margin % =
$15,000
7,000
$7,000/$15,000 = 46.67%
BKM 3.8
© 2020 Patrick J. Kelly 67
Your Turn
How far can the stock price fall before a
margin call?
P =______
BKM 3.8
© 2020 Patrick J. Kelly 68
Your Turn
How far can the stock price fall before a
margin call?
(1000P - $8,000) / 1000P = 40%
$13.33
BKM 3.8
“Investment Loans”
© 2019 Patrick J. Kelly 69
https://www.anz.com.au/personal/investing-super/investment-loans/
BKM 3.8
Loan to Value, but Still Margin Calls
• List of stocks and the maximum loan to value
• Margin calls occur when price 5% higher than maximum loan to
value
© 2019 Patrick J. Kelly 70https://www.anz.com.au/content/dam/anzcomau/documents/pdf/anz-investment-lending-approved-stocks.pdf
Try this example
• Suppose you purchased 1000 shares of BLD at $4.96 per share
on Friday, 23 Aug. 2019. You decided to buy on margin with a
60% Loan to Value using an Investment Loan from a local bank.
– The bank will make a margin call if the loan to value increases to 5%
over the maximum loan to value of 70%.
– At what price will the bank make a margin call?
© 2019 Patrick J. Kelly 71BKM 3.8
At what price will the bank make a margin call?
• Suppose you purchased 1000 shares of BLD at $4.96 per share
on Friday, 23 Aug. 2019. You decided to buy on margin with a
60% Loan to Value using an Investment Loan from a local bank.
– The bank will make a margin call if the loan to value increases to 5% over
the maximum loan to value of 70%.
=
= 1 −
0.75 =
.60 × 1000 × $4.96
1000
750 = $2976
= $3.97
© 2019 Patrick J. Kelly 72BKM 3.8
