Nivine Richie, Ph.D., CFA is an Associate Professor of Finance at the University of North Carolina Wilmington. She teaches courses in corporate financial management, derivatives, fixed income, and commercial bank management. Her research interests include cost of capital, banking, and derivatives. She has published studies in the Journal of Economics and Finance, Journal of Futures Markets, Review of Futures Markets, and Journal of Trading, among others.
The U.S. central bank or Federal Reserve was established in 1913 despite criticism. Today, the Fed continues, again despite criticism.
Why was there resistance to the Fed at its inception?
The housing market has been bouncing back, but not for everyone. For some markets, prices have not bounced back enough. In this video, we see the story of one family that fell on hard times just as the credit crisis hit the nation. They fell behind on their mortgage, but could not sell the house as the value of their home was below the price they paid for it.
In real estate, what is a short sale? When would a homeowner want to do a short sale?
This report from the CBOE describes how at the money calls on Apple stock are active. Other options are described, but one of the interesting parts of this report is that straddles on Costco shares are active.
Calls are contracts that give the holder the right to buy the underlying asset at the strike price on or before expiration. In this video, we hear that calls with strike prices near the current market price of Apple (i.e. "at the money") are active, indicating that investors are optimistic that share prices may rise before expiration.
Straddles, on the other hand, are a combination of options. More specifically, an investor goes long a straddle by buying a call and buying a put (which is the right to SELL the underlying asset at the strike price). In the case of a straddle, the worst thing that can happen is that nothing happens. In other words, if the stock goes up, the call gives the holder the right to buy at the original low strike price. And if the stock falls, the put gives the holder the right to sell shares at the original high strike price. But if the stock neither goes up nor down, then the holder paid the premium on both the call and the put to no avail.
What market outlook must the holder of a call option have? How about the holder of a put option?
What market outlook must the buyer of a straddle have? Why would anyone ever sell a straddle?
"If you get the opportunity, don't turn it down" is the advice that Myron Scholes gives to anyone who asks what it's like to win the Nobel Prize.
From the press release at the announcement of the Nobel Prize in Economics in 1997:
Robert C. Merton and Myron S. Scholes have, in collaboration with the late Fischer Black, developed a pioneering formula for the valuation of stock options. Their methodology has paved the way for economic valuations in many areas. It has also generated new types of financial instruments and facilitated more efficient risk management in society.
(Read more here)
What was so groundbreaking about the discovery by Black, Scholes, and Merton?
In what ways did this formula change the financial markets?
The real GDP that was released last month for the 2nd Quarter of 2015 showed that the economy grew at an annualized rate of 3.7%, following an increase of 0.6% in the first quarter.
This infographic gives us a picture of the U.S. economy and its level of globalization as of 2014.
Source: Principles of Economics and Business
This sneaker collection contains over 3,000 pairs and is worth $750,000.
It begs the question: how does one determine the value of a sneaker collection?
If we use the same methods we use to value any investment, we can list several ways:
What are the benefits and limitations of each of the valuation methods described above?
This Bloomberg video gives us a glimpse of the chart to watch this coming week: the Chinese manufacturing sector performance. The Fed decided not to raise rates this week, and it cited global economic weakness as the reason. Therefore, this chart is important because if it gives an indication that the global economy is strengthening, then we can expect the Fed to react by beginning the slow climb out of expansionary monetary policy.
This Fed decision tells us that the Fed is setting U.S. monetary policy with more than just the U.S. economy in mind. Now the Fed is taking the global economy into consideration as it chooses whether the raise interest rates. The interconnectedness of global financial markets suggests that Chinese markets and U.S. markets cannot be easily separated.
What happened to the U.S. stock market after the Fed announcement? Why do you think that happened?
In a move that surprised financial markets, the Federal Reserve chose to leave rates unchanged at near zero this week. Markets were expecting an increase in interest rates and an end to the expansionary monetary policy that has dominated financial markets for so long. From the Federal Reserve press release:
To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate. In determining how long to maintain this target range, the Committee will assess progress--both realized and expected--toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen some further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term.
A look at the current yield curve shows a zero short term rate with an upward sloping curve, suggesting that the market expects rates to rise in the future.
To see a dynamic view of the changing yield curve over the last 15 years, click here and then select "animate" on the tab below the charts.
What is the "term structure of interest rates?" What is the definition of the "yield curve?"Use the three different theories of the term structure of interest rates to explain why the curve is shaped the way it is today.
We all know that when rates rise, bond prices fall, and when rates fall, bond prices rise. That's because the price or "intrinsic value" of a bond is simply the sum of the present values of all expected cash flows.
The same is true for any investment. The price or intrinsic value of any investment asset is the sum of the present value of all future cash flows. So again, when rates rise, values fall.
Or maybe not.
The market has been expecting rates to rise for some time now. The arguments have been that the Fed has to raise rates sometime and can't hold interest rates at near zero forever. So if rates have been expected to rise, it stands to reason then that investors have already built those expected future rates into their valuation models, and prices of assets have already fallen. So indeed, if rates rise, values will fall, but only if rates rise more than expected.
The question, then, is how can we determine what the market expects interest rates to be in the future. Theory offers us several ways to answer this question.
First: Pure Expectation Theory
According to the pure expectation hypothesis, the yield curve is the shape we see today because investors have built in the shape for tomorrow. If rates are expected to rise, then today's yield curve will be upwardly sloping. In fact, we can determine just how much we expect interest rates to rise by examining the relationship between today's short term rates and today's longer term rates. For example, if today's 1-year rate is 1% and today's 2-year rate is 2%, then we can assume that the 1-year rate one year from now will be approximately 3%. The reason, according to this theory, is that investors who have a 2-year investment horizon will be indifferent between investing in today's 2-year rate at 2% for two years, or investing in today's 1-year rate earning 1% and then rolling over into next year's 1-year rate of 3%. In the end, they will have earned 2% per year, on average. Therefore the rate "implied" in today's curve is the 3% next year.
Second: Liquidity Preference Theory
This theory says that investors must be paid a premium to part with their money. In other words, liquidity--that is, the ability to convert investments into cash at market value quickly--is valuable. To invest in long-term bond is to give up liquidity, and therefore investors must be compensated in the form of a premium. According to this theory, long-term rates are most often higher than short-term rates because of the liquidity premium built into the yield curve.
Third: Market Segmentation Theory
According to market segmentation, the rates on short-term investments are determined by the interaction of supply and demand for short term investments, and this market for short-term investments operates separately from the market for long-term investments, i.e. the markets are segmented. According to this theory, the different rates along the yield curve are driven by the preferences and behaviors of different market participants, and nothing more.
This Bloomberg video discusses the impact of an expected Fed interest rate hike.
Based on this video, which of the three theories is being used to explain the impact of a potential Fed interest rate hike?
Despite the scandals and bad press, the NFL is a money machine and revenue continues to pour in.
Because, according to this Wall Street Journal interview, the NFL Commissioner "is the CEO of a corporation that is making its directors...a tremendous amount of money."
What is the goal of the firm? In what ways is this "firm" achieving or not achieving it's goals?
According to this infographic, the average American spends a lifetime in debt. Read more below:
See the original infographic here
What are the different types debt that the average American takes on?
What are some tips you can offer an individual who is in a large amount of debt?
The debate continues. Should the Fed raise rates? What will happen if they do? What will happen if they don't.
This video shows the debate in 80 seconds.
How does the Fed control interest rates in the economy?
What are they hoping to achieve with such low rates? What would they be hoping to achieve if they raise rates?
Unlike investors in financial assets, art investors are collectors, and collectors aren't sellers. Art is worth more than the dollar price of the investment, so selling the art involves more than simply how much the piece is worth.
Why is it more difficult to sell art than to sell stocks or bonds?
What factors does an art collector need to consider when determining the right time to sell?
This video from the Chicago Board Options Exchange (CBOE) describes options and VIX trading after the release of anticipated economic data. After the release of jobs data the markets saw buying in puts and one investor sold calls and bought straddles.
What are calls? What are puts?
Why does volatility affect the value of options contracts like calls and puts?
What must an investor be anticipating for him/her to sell calls and buy a straddle?
An investment generates a return, and that return can arrive in one of two ways: (1) dividends or interest, and (2) capital gains. The dividends or interest is the annual payout generated by the investment. The capital gains, on the other hand, is the return that is due to an increase in the value of the investment over time.
The infographic below describes "What Are Capital Gains" and distinguishes between short-term and long-term capital gains. It also describes when a change in the value of an investment is NOT a capital gain or loss.
Filed at Infographicsposters.com in Business Infographics
Why might an investor prefer capital gains over dividends or interest?
This interview describes the potential connection between stock markets and economic data, and answers questions such as;
Mr. Theo Kalomirakis owns more than 15,000 movies. He spends nearly $15,000-20,000 per year on his hobby, and now he owns one of the larges collections in the world, if not the largest.
When you consider the value of an asset like this, here are some question to think about: