Return and Volatility

Notes on module 2.

Readings: Money and Debt: The Public Role of Banks

• Link

• Debates after financial crisis (2007-09) about fundemental reform of the financial-monetary system.

• Debt and money are scant attention in economics before crisis.

• Prosoal for an alternative system:

  • Most money is not created by gov or central banks, but by private banks through frant loans.
  • Money is destroyed when loans are repaid.
  • Creation of money is linked to creation of debt!

What is Money?

• Agreement between people, a social construct.
• Origins?
  • Inefficiencies of barter trade?
  • Debt relationship, when promissory notes dissociate from issuer and recipient?
  • Taxes collected by state and religion authorities?
• Economics focus on functions of money:
  • mean of payment
  • store of value
  • accounting unit
  • value stability -> mean of saving
  • liquid that other assets
• Money aggregates:
  • M0: cash in circulation
  • M1: M0 + demand deposits
  • M2: M1 + short-term deposits
  • M3: M2 + long-term deposits, money market funds, repurchase agreements

What is Debt?

• Enables the borrower to anticipate future income.

The important of Trust

The Dynamism of the Financial Monetary System

Introducing Stocks and Cryptocurrencies

• fractional ownership in a corporation: stockholder / shareholder.
• stocks = equities
• Assets = liabilities (borrowing debts) + equity

Types:

• Value stock: remains stable over time
• Growth stocks.
• Income stock, offer regular and steady income
• Dividend aristocrats, just companies in S&P 500 that increased their dividends annually for the nearest 25 yeats.

Markets:

• Primary Market, IPO (initial public offering)
• Secondary Market, exchanges.

Benefits of Stock

1. Capitial appreciation (資本增值), (increased in value)
2. Dividend patment
3. Voting rights
4. Ease of Trading
5. Extra income through securities lending
6. Centralized depositories

Raise capital for company

1. Issue bonds
2. Issue stocks

Disadvantages

• realized loss
• dividend may not occur
• Activist investor, buy significant shares, imporve performance or quit.

Value a stock

1. Discount Cash Flow model (DCF), need to know the company very well.
2. Dividend discount models (DDM), e.g. GGM

Gordon Growth Model (GGM)

• special DDM

• Stocks present day price is worth the sum of all it futures dvd when discounted back to its present value (Fair value)

• Two input

  • Dvd $D_1$ and dvd growth rate $g$
  • Discount factor $k$

Value of the stock is thus:

$$P_0 = \frac{D_1}{k-g}$$

We may calculate the expected dvd by current dvd $D_0$ and growth rate $g$:

$$D_1 = D_0 (1+g)$$

Limitations

• only for companies that pay dvd
• only for companies with stable growth rate
• assume company exist forever
• ignore external factors

Multistage Gordon Growth Model (mGGM)

Allow fast growth and a period of stable growth, requires multiple inputs:

1. current dvd $D_0$, or expected dvd $D_1$
2. fast gwoth rate $g_H$
3. Number of years of fast growth period $n$
4. stable growth rate $g_L$
5. cost of equity capital $k$

Value of stock is thus:

$$P_0 = \sum_{t=1}^{n} \frac{D_0 (1+g_H)^t}{(1+k)^t} + \frac{D_0 (1+g_H)^n (1+g_L)}{(k-g_L)(1+k)^n}$$

• Noted that the model can extend to more than two stages.

Multistage Gordon Growth Model with Linearly Declining Growth Rate (H model)

Same as mGGM, but $g_H$ stablizes linearly to $g_L$ over $H$ years.

1. 1 period of high growth rate $g_H$
2. $H$ periods of linearly declining growth rate to $g_L$
3. stable growth rate $g_L$, from $H+1$.

Stock vs Bonds

An Analysis of Bitcoin’s Price Dynamics

Reading link

There's More Than Meets the Eye: Looking at Art as an Alternative Investment

Author: Levenkron, Hannah (2011)

Thesis: Abstract of link

Summary:

• Art is a highest return asset in 1960-2010 period
• Annual return 12%, but low sharpe ratio and high std, very risky.
• beta of 0.79, correlation of 13.9%, hence not attractive alternative.
• Autoregression show art leads S&P 500 and recover faster, probably it is a group predictor?.