Yale University

Week 1: Lesson 2
Var in finance means two things, Variance and Value at risk. But when the middle “a” is not
capitalized, it means Value at Risk. VaR (not VAR) appeared after Stock Market Crash in
1987. Value at Risk is usually quoted within $ for specific probability and time horizon. If VaR
is 1% on $10 million, then it means that there is a 1% probability to lose $10 million from
portfolio. Used to quantify risk.
Another measure of risk is known as Stress Test. It is based on the Cardiovascular Test
conducted for testing the stress bearing ability of heart. This risk came into being after
Financial Crisis in 2008-09. OFHEO started testing the firm’s ability to withstand economic
crisis before 2008. Test conducted on Freddie Mac and Fannie Mac. Method of assessing
risk to firm. Ordered by govt. to test the firm withstanding the crisis. Dodd Frank Act
requires Federal Reserve to do Annual Stress Test. Dodd Frank Act came on 21 July 2010 as
response for Financial Crisis in 2007-08. This test is criticized because of underestimating a
financial crisis. Stress Test is conducted by Office of Federal Housing Enterprise Oversight.
OFHEO don’t looks at the historical return but at the portfolio and determine for the
vulnerabilities. This test was done for mitigating any unforeseen future financial crisis.
S&P 500 stands for Standard and Poor 500 Index used as a benchmark for return. Showcase
the average of around 500 stocks. It takes into account the Stock Price and Shares for
showcasing the performance of 500 Stocks. Therefore, it is preferred among the
Institutional Investors.
Beta is the numeric value which measure the fluctuation of the stock in relation to the
aggregate Stock Market. It is regression slope coefficient. Slope Beta tells you how a
particular Stock moves with the Stock Market and is a measure of Stock Systematic Risk.
Suppose we take Apple’s Stock, so we have particular relation in algebra that is
Y = mx + B
Here Y is return on Apple’s Stock, x as the return on market, m as Slope Beta and B as
constant Alpha. If Beta is 1, then the movement of Stock is equal to the Aggregate Market. If
the Beta is more than 1, the stock is more volatile than the Aggregate Market. If it is less
than 1, the stock is less volatile than the Aggregate Market.
Market Risk is the risk to overall Stock Market. Idiosyncratic Risk is the risk related to a
specific class of share or security (uncertainties, problem unique to specific class of
security.). Idiosyncratic Risk is the risk related to specific class of shares of a particular
company not to industries dealing in specific securities.
Normal distribution with same mean and standard deviation has the probability of 20% drop
equal to 3 * 10^7. Despite such unfathomable fall, US Stock Market crashed in 1929 with a
drop 0f 20.50% (approx.) in just one day.

.
Covariance determines the risk.
Lesson 3
Insurance is based on the theory of risk pooling. Risk Pooling is the source of all value in
insurance.

Fundamental Insurance Principals and Issues.

1) Risk Pooling is the source of all value in insurance.
2) Moral Hazard: When people know that their property is insured, so they tend to
take more risk
3) Selection Bias: Sometimes, an insurance company might not be able to see all the
parameters of the risks as compared to customers who may see more risk. In such
case, insurance companies take exams to screen out such people. For ex- in health
Insurance, a person may know that he/she is going to be sick so they sign up for
insurance. Thus, insurance company demands a medical exam and if founds out that
the people are going to be sick, they screen out.
Insurance dates back to ancient Rome era. True Insurance policies appeared in 14 th century
Italy. The development of Actuarial Theory gave an impetus to Insurance Companies.
Normally, probabilities of death in every age group would be scribed on a stone tablet. So,
people would look at the stone tablet and comprehend the death probability in different
age group and on that basis, they would buy life insurance.
Morris Robinson, in 1840 revolutionized the Insurance business when he transpired that
people have to persuaded to buy Insurance. So, he appointed numbers of salesmen who
would go door to door selling Insurance. Consequently, it worked.
Lesson 4
Portfolio Diversification has some principals:
1) All that should matter to an investor is the entire portfolio.
2) Mean and Variance of the Portfolio matters.
3) Law of Large Numbers means spreading over many assets, reducing risks on the
overall portfolio.

Investment Companies that provided services for Portfolio diversification for small
investors
1) Investment Trusts (before 1940)
2) Mutual Funds
3) Closed End Investment Companies
4) Unit Investment trust
All these institutions can help small investors overcome the problem of transaction cost and
diversify Portfolio.

Investors focus more on Beta of the asset as compared to Idiosyncratic Risk of that
particular class of securities. In a portfolio one should include securities with negative Beta
(less than 1) as it is able to sustain some amount of recession and shocks. For example, Gold
is a security with a negative Beta. It may not ensure very high returns but can withstand
shocks and recession up to some extent as compared to securities with positive Beta thus
saving the overall portfolio of the investor up to some extent.
Capital Asset Pricing Model was developed by Financial Economist William Sharpe in his
book Portfolio Theory and Capital Management. According to him, diversification in
portfolio would never reduce the Market Risk (Which affects the entirety of the Market).
Therefore, he charted out a formula that would measure Systematic Risk / Market Risk.

3
4 2
1 2

The above formula states the relationship between the expected rate of return on asset and
its Beta.

Risk Free Rate refers to the interest that an investor would get from an absolutely risk-free
investment over a specified period of time. It is a theoretical rate of return from a risk-free
investment. Government securities are known as the Risk free investment as they are
assured by the Government.
Week 2 : Lesson 5
Short Sale – Under this, a seller borrows stock from an investor and sells the borrowed stock
to another person with an anticipation of fall in the price of stocks in the future. If in the
future the price of that stocks falls, the seller buys back the sold stock from the buyer to
incur profit. Suppose a seller borrows 100 mil worth of stock and sells it for 100 mil to
another person. Now in the future the price of that stock falls now it costs 40 mil. The seller
buys back the stocks. Here the SP of stock is 100 mil and CP of stock is 40 mil for the seller.
Additional 60 mil becomes the profit.
Levering Up to A Hilt – is a technique that sometimes allow you to get 100% return on your
investment. But for this, concept of Short Sale should be clear. Let’s say we have 1$ to invest in two
assets – Risky Asset with 20% return and Riskless Asset with 10% return with no risk. Borrow aka
Short 8$ from the risk-free market (we take 8$ from the risk-free market because the Beta is below
1 meaning less fluctuation in the value). Now we have 9$. Invest all 9$ in the risky asset. At the end
we’ll get a total of $10.80 in our portfolio. Give back 8$ along with interest of $0.8. We are left with
$2 which is double of $1. The Leverage Ratio would be 8:1. But this technique is risky as it can also
get you bankrupt in some cases.

Efficient Portfolio Frontier / Optimal Portfolio – refers to that portfolio that which can provide the
highest return on a given level of risk.

Expected Rate of Return - Expected return measures the mean, or expected value, of the
probability distribution of investment returns. The expected return of a portfolio
is calculated by multiplying the weight of each asset by its expected return and adding the
values for each investment.

For example, a portfolio has three investments with weights of 35% in asset A, 25% in asset
B, and 40% in asset C. The expected return of asset A is 6%, the expected return of asset B
is 7%, and the expected return of asset C is 10%.

Asse
Weight  Expected Return
t
A 35% 6%
B 25% 7%
C 40% 10%
Therefore, the expected return of the portfolio is

[(35% * 6%) + (25% * 7%) + (40% * 10%)] = 7.85%

Lesson 6

Random Walk Hypothesis was given by Karl Pearson. It states the process of change in such a way
that each change is independent of its previous change. We don’t know how today’s statistic will
change tomorrow. Stock Market is governed by this theory. We cannot forecast the change.

Before the invention of telegraph, there was a man named Reuter who was curious as to how he
could supply up-to-date information to the Stock Markets for efficient investing. So, he set up a
pigeon business in major cities of Europe. As soon as some information was to be sent, he would tie
the information paper on pigeon’s leg and make it fly to the desired city. Now, that sort of
information transfer took maximum of 6 hours. (Telegraph was invented by Samuel FB Morse in
1840. Before that, there was pigeon business). Then came the telegraph and beepers which were
used to send the info. at light speed.

Efficient Market Hypothesis is a hypothesis (a principle proved through little evidence) that states
that the price of the Share reflects all the information and that generating Alpha is impossible. It
states that the Stocks are traded at the fair price and that it is impossible to outperform the overall
the market through smart stock selection or buying undervalued stock and selling it at inflated price.
If there is a new information, then the Stock price is updated instantaneously.

Lesson 7

Prospect Theory – The Theory comes under the Behavioural Economics. It states that the losses and
gains are valued differently and investors will tend towards the offer with gain instead of the offer
with loss. In other words, if two equal offers are presented before an individual but in terms of Gain
and other in terms of Losses, the offer with the gain will be chosen. Proposed by 2 psychologists
Tversky and Kahneman, the theory says that the losses have greater impact on an individual’s brain
compared to an equivalent gain hedging it. Prospect Theory also replace the traditional Utility
Theory which states that the preference of a consumer for a good will depend upon its utility and
that consumers focuses on utility Maximisation. But modern prospect theory suggests “NO”. The
consumers will also take into account the losses and gains given that the consumers are irrational .
The second part of this theory is the Weightage Function. And it states that people excessive
weightage to low probabilities and less weightage to higher probabilities.

Limited Liability – I realised that earlier, I did not have sufficient understanding of limited liability.
So, I included this topic. The concept of limited liability dates back to 1811. Before 1811, if a
company commits mistake the management would go to the shareholders to pay for the company’s
debt. This concept changed when New York State passed a law for limited liability. Now the
shareholders will be liable for any unpaid value of shares when Company goes bankrupt. This model
was welcomed with critics, scepticism and praise. Now all the business went to New York State and
the state became the mecca for business. Slowly, all the state adopted the limited liability concept.
India too, adopted the limited liability concept which was amended in Companies Act 2013.

Psychological Theories – Consist of various inferences drawn by psychologists which often reflects
the behaviour of the market.

● Mental Compartment – This theory that at most suggest that people have two sides of
portfolio – the risky side and the riskless side. People don’t want to take chances with the riskless
side as it gives them security. But people choose to have fun with risky side for gain earning motive.

● Attention Anomalies – states that people cannot pay attention to everything. And the
attention is often influenced by social environment. For ex – in a market full of crowd, if suddenly a
man points his finger at the sky and yell “What’s that?”, all the people will look up. Same applies in
Finance. If a group of investors is paying attention to one stock, chances are other people too will
focus on the same stock. That will get the Stock overpriced.

● Anchoring – is the tendency in an ambiguous situation to allow one’s decision to be

influenced by some anchor. For example – Wheel of fortune experiment by Kahneman and Tversky.

● Overconfidence – is the tendency of people of overestimating the probabilities that they

want to happen or like to happen. Also known as the Wishful Thinking Bias. (Theory is somewhat
related to exaggeration)
Week 3 : Lesson 8

Overnight Market is the component of the money market involving shortest term loan. The lenders
agree to lend the money to the borrower overnight. The borrower must repay the loan along with
the interest rate next business day. Basically, a market which gives loan for one day.

Overnight Interest Rate is the interest rate at which the lender lends money to the borrower in the
Overnight Market.

Negative Interest Rate – happens when the interest rate falls below 0. It means that – in contrast to
nominal interest rate (positive rate) – banks have to pay the Central Bank for keeping their money as
reserve. Example would European OverNight Index Average (EONIA). Switzerland adopted the
negative interest rate in mid-2020 that was -0.75% and Japan also adopted the same model with
rate of -0.1%. These are imposed because it increases the cost of storing money in banks.

Coupon Bonds are the bonds that are issued by the company which pays coupon (interest) to the
bondholder. These are issued at Par.

Discount Bonds – These are the bonds that are issued at a discount rate and no coupon is paid to
the bondholder. Instead at the maturity, the increased in the price of that Bond act as a source of
income for the Discount Bondholder. The following formula is used to determine the Price of the
bond.

Consol Bonds are the Perpetual Bonds that have no maturity period and ensure a steady source of
income forever. They are more similar to equity as compared to debt. However, Consol Bonds are
not traded actively because in the market there are very few institution that are safe enough for the
investors to invest in a bond where principal amount will never be repaid. It was issued by the British
Treasury for World War 1 and the South Sea Bubble in 1720.

Forward Rate refers to the rate at which a financial transaction will take place in the future. It is
decided by the parties involving in the transaction. Irrespective of the current situation, the buyer
and seller have to observe that the transaction is carried out at the rate decided. If a seller is willing
to sell $ 10mil into rupees to an Indian buyer at a rate of 1$ = 75R in the future then the party has to
conduct transaction on 1$ = 75 R rate irrespective of then rate in the future. It was developed by Sir
John Hicks, British Economist.

Nominal Rate of Interest – refers to the interest rate which is computed before taking into account
the Inflation rate (Consumer Price Index). To avoid the Purchasing Power Erosion due to Inflation,
investors tend to look at the Real rate instead of Nominal Rate. These rate are often influenced by
the

● Demand and Supply of Money in the Economy

● International Forces

● Action of the Federal Government

Real Interest Rate – refers to the interest which is adjusted to remove the effect of Inflation to
reflect the real yield to the investors and real cost of borrowing to the borrowers. It is calculated by
subtracting the Nominal Rate and Inflation Rate. The Real Rate reflects the purchasing power of the
return earned on investment. It was created or developed by John Bates Clarke in 1895 in a journal.

Index-Linked Bonds – refers to the bonds whose return is linked with some Inflation indicator. The
return on these Bonds adjusted as per the Inflation Rate to help mitigate the impact of Inflation.

Lesson 9

Corporation has been derived from the Latin word “Corpus” meaning “Body”.

In ancient Rome there were Publicani(s), which were corporation. And in ancient Rome, there was a
Stock Market but it was just 1% of what we have as a Stock Market today. People used to buy the
Stocks of these Publicani(s). These market were located on the streets in front of one of the temples
in Roman Forum.

Corporation are also known as the Shareholder’s democracy because the Shareholders get to select
the Board of Directors. Each vote of shareholders has value.

Non-Profit Organisation don’t have to pay the corporate tax because they don’t earn profit so the
concept of corporate tax cannot apply in this case.

Non-profit corporation do earn their revenue but their objective is not to distribute the revenue
among the owners as in the case of Profit organisation. Non-profit organisation has to be set up with
a definite purpose and if the corporation has earned some revenue, they have to channelise it for
that purpose instead distributing it among the owners. Earlier, people created NPO to mobilise
hoard of money to get rich. It was an unfair use of NPO provisions. Example would be Shaker Church.
This was a Christian church which accumulated lot of wealth for the community of Shakers. But
there are no Shakers left in the world and nobody knows what happened with all of that money
which was accumulated for NPO motive.

Corporation Charters – are the documents drafted and filed by the Promoter of the Company to get
the Company incorporated. These Corporation Charter includes Memorandum of Association
(MOA) and Article of Association (AOA). These documents define the constitution of the company.
Small states of a country provide incentive for incorporating the companies because big states
already have high numbers of corporation.
Missing a Dividend payment and how it affects the Investors and the Business – There are some
companies who boast about the timely payment of dividend (brainchild of Steve Jobs 😉). If a
company misses the payment of dividend, then the investors lose the confidence in the company.
They may withdraw their investment (as non-payment of dividend reflects Financial problems) which
will cause a freefall in the Company’s Share Price. So, to avoid such lose in confidence, companies
have to pay dividend timely.

Introduction of Proxy – A company may have millions of shareholders who have agreed to buy the
Shares of the company and act as a partial owner. But the board of directors have to take voting of
all these Shareholders to take necessary decision for the Company. And taking vote from millions of
Shareholders is grueling and tedious process. That’s where Proxy comes in. Proxy refers to the right
to act on the behalf of other shareholder in decision-making process. So, now the Shareholders who
are not interested in Company’s Management can just give their proxy to other Active Shareholders
to take decision on their behalf.

Class A Shares are those shares which have Voting Right and Class B Shares are those shares which
do not have a voting right or have less voting right. Berkshire Hathaway has both Class A and Class B
shares. Class A shares are generally offered by companies to those individual or companies who
want an active role as Shareholder.

Stuart Myers Pecking Order Theory – Stuart Myers agreed with Karl Marx and said that initially
Company issues a lot of Shares to mobilize capital. But as the Company grow their retained earnings
increases. Now if the Company wants to expand, they don’t usually issue new share as it may dilute
the voting power of the Shareholders neither they opt for Debt capital as it is very risky. But they go
with Retained Earnings for expansion. Most firm in the world have not issued new shares for the last
20 years. When asked, the companies respond that they do not even contemplate on issuing new
shares. So, all the shares that are traded in the Stock Market are most likely issued some 20 years
ago. And these Shares have been circulating in the Stock Market for 20 years galloping from one
owner to the other.

Share Repurchase – A company may resort to Share repurchase (Buy back of Shares). In that case,
the opposite of Dilution takes place. It’s also another mode of Dividend payment. The company
instead of issuing a Dividend letter issues different letter stating that “Here is your money for 1% of
your Share that Company just purchased from you”. But it also depends upon you whether you want
to sell your Share or not. Share Repurchase gives Shareholder tax benefits. When the Shareholder
gets dividend, he/she has to pay the tax. But when the money is paid for Repurchase Agreement,
shareholders are not required to pay the tax because they are not selling their Shares. They may
never sell their Shares continue to get dividend in the form of Repurchase Agreement and avoiding
Tax.

Why do Company pay dividend – To prove the Public that they are really worth something
(Signaling Effect – Proving other that you can do something). And other is to maintain the confidence
among the investors.
Week 4 : Lesson 10

Mortgage - Oxford English Dictionary states that the word Mortgage was derived from Latin word
“Mortuus Vadium” which means “Death Pledge”. Mortgage means Death (Mort) Pledge(Gage).
Mortgage existed during the time of Tsang Dynasty and a lot of traders used to mortgage some
security to trade in the Silk Road. In 19 th century, Germany came up with the GrundBuch (Land
Registration) which was a book that recorded the ownership of all the lands and buildings in
Germany. So, when a land was sold, papers had to be given to the GrundBuch authorities to make
changes in the ownership.

Real Estate Investment Trust (REIT) – are corporations that allow small investors to invest their
money in the Real Estate. Earlier, investing in Real Estate was restricted only for the rich people
because of the risk and higher financial requirement. This created a hinderance for small investors
for investment. So, REIT was created to allow not just rich but also small investors to invest in the
Real Estate. In India there are 3 REITS – Embassy Office Park, Mindspace Business Park, Brookfield
India Real Estate Trust.

Types of Mortgages

1) Conventional Mortgage – Simple Mortgage where a borrower borrows money giving his
property as a security.
2) Adjustable-Rate Mortgage – These mortgages have fixed interest rate for a certain period
and after the expiry of that period, the rate of the mortgage is adjusted based on some
benchmark or index. Interest rate applied on the outstanding amount varies through the
mortgage period. In India it is known as the Dual Rate Loan.
3) Price Level Adjusted Mortgage (PLAM) – In this type of mortgage, the interest rate remains
fixed but the principal amount changes with respect to Inflation. The lender receives the
principal amount, fixed interest rate and an additional amount for covering the cost of
inflation. These are not suitable for borrowers living on fixed income.
4) Shared Appreciation Mortgage – This is similar to the conventional mortgage. But when
there is an appreciation in the value of the house the borrower has to share the gain arising
out of appreciation with the lender. In this mortgage, the rate of interest is lower than the
market because the real income arises out of the appreciated value. This type of mortgage is
offered by the institution when it is aware of the fact that in the future, there will be a
bubble in the real estate business.

Insurance of Mortgages – In US, there is FHA, Federal Housing Administration provide insurance
against Mortgages. Insurance is provided in case there is a Deflation or sudden drop in the demand
for Real Estate. These events reduce the value of the mortgaged property. In India, HDFC Life, ICICI
Prudential, Max Life, LIC Housing Finance and Bajaj Alliance provide Mortgage Insurance.

Collateralized Debt Obligation (CDO) – It refers to a financial product backed by loans and debts. An
investment banking company may collect loan and debt given to the people and aggregate them to
make a Collateralized Debt Obligation. This is then sold to a group of investors. Now, when the
people who had initially taken the loan makes the periodical payment along with interest, the
amount is given to those group of investors who have purchased the loan from bank. If the loan is
default, then the investors are handed the collateral for the settlement of debt. The CDO is divided
into tranches or part. The senior tranches are the safest because in case of default these have the
first claim on asset but these tranches have lower returns. Small tranches are the riskiest but has the
highest return to encourage investors.
Foreclosure – refers to the settlement of a default loan done by the lender by taking the ownership
of the mortgaged property and selling it to recover the due amount lent.

Private Mortgage Insurance (PMI) – When a person mortgages his/her property for borrowing
money, the lender may ask for 20% down payment based on the home’s purchasing price. If the
borrower is not able to pay the down payment, the lender senses the danger in lending and
therefore asks the borrower to get the Private Mortgage Insurance. The PMI protects the lender
from the event default loan and the mortgage property going under Foreclosure.

Collateralized Mortgage Obligation (CMO) – refers to the security which is backed by the pool of
mortgages. This pool of mortgages is aggregated to create an investment instrument which is then
sold to an investor or group of investors. The borrowers who have taken debt in exchange for
mortgages repays money which is given to the investors. If there is default, then the mortgaged
property is given to the investors for the settlement of debt. Now, CMO and CDO are same but the
former is backed by only estates mortgage while the latter is backed by mortgage of various
securities and not just property.

Excess Reserves – Every Central Bank of the country specifies certain amount which must be kept by
the Commercial Banks as reserves. When the banks maintain reserves, which is more than the
specified amount or rate, then that excess amount is known as the Excess Reserve. Now, why would
a Bank keep excess reserve instead of utilizing it for lending purposes. Well banks typically maintain
excess reserves when economy is in recession.

Lesson 11

Phishing for Phools – Phishing means some sort of Manipulation while Phools are those people who
are not aware that they are being manipulated. It was coined by Robert Shiller. It says that in a
market, there are lot manipulation and people are not even aware that they are being manipulated.
Most of the time markets are driven by constraints. Business tends to do something which is done by
most of the other businesses. For example – when we go to a store and see a product with a price
tag of $9.99, we ask ourself that why don’t businesses just round the price value to $10 instead of
$9.99. It’s because all the business does it so others do as well. And prices like $9.99 also
manipulates us as we like good products attached to a lesser number value. So, a typical consumer
would go more towards $9 instead of $10.

Robert Shiller wants 5 level of regulations

1) Within Firm Regulations – These regulations are done by the Board of Directors. The BOD
appoints and fires the President of the company. Most of the time these directors have a
sense of their personality and they don’t want to lose it. So, if someone says “let’s do a
devious trick”, the directors sensing their reputation would deny and even resign.
a. Tunneling refers to the devious tricks to obtain money from the company which
often against the interest of the company. According to La Porta, tunneling is more
common in Civil Law Country as compared to Common Law Country. It is because
Civil Law country has more private and family-owned companies. And tunneling in
this kind of companies is easy. Common Law Country refers to the country where
law is made by Legislative but also have separate Judiciary for making laws. For
example, India is a common law country as here both, the government as well as
courts are entitled to make laws. But in Civil Law Country, most of the law is made
by the Legislative with no precedent to the courts. Civil law is mostly seen in the
European countries such as France. In Common Law Country, courts make decisions
 and laws on specific cases, especially in disputes. So, it allows the courts to better
connect with the current panorama of various disputes in the country and helps
them to connect with the Human Issues. And it also deals with tunneling more
comprehensively because tunneling is a specific case and the courts in the Common
Law Country are specialized in dealing with specific cases. It is because of this aspect
of dealing with country’s specific cases that makes Common Law better than the
Civil Law. Tunneling is achieved via –
i. Dilutive Share Issue
ii. Insider Trading
iii. Excessive Executive Remuneration
iv. Asset Sales to cronies
v. Contracts ; excessive price paid for inputs or other things

2) Trade Groups – Different Trade Groups can also employ certain regulations for the
companies. For example, Stock Market can list some regulations that companies dealing in
buying and selling of securities should follow.

3) Local Regulations – These includes regulations amended by the State government. Various
local regulations vary across state to state. But the regulation of one state cannot be
imposed on the other state until the other state itself decides to adopt similar regulations.

4) National Regulations – These includes regulations that are amended by government or

Supreme Court which is applicable throughout the country. For example – Companies Act
2013 was passed by the Parliament which includes several regulations, restrictions and rules
which all the companies registered under this Act has to follow. Other example would be
Securities and Exchange Board of India (SEBI) which establishes regulations and code of
conducts for all the parties involved in the securities trading. Almost all the companies start
as a Private Company but there comes a time when they realize that they have to go for IPO.
Generally, most of the companies don’t prefer to stay as public because they have to file
information about the companies which is disclosed to the public. That makes it difficult for
a public company to maintain their secrecy.

In Hedge funds (which is for accredited investors only), there are 3c1 and 3c7. Under
3c1, investment companies can have only 99 accredited investors who must have an
income of $200,000 and or investible asset of $1,000,000. Under 3c7, investment
company can have 500 accredited investors with net-worth of $5,000,000 or
institutions with net-worth of $ 25 million.

Some people like Hayne Leland (Economist) believes that Insider Trading is not that
bad as after an inside information is known, the insider parties will compete against
each other and soon all the information will be disclosed. But the general idea is that
Insider trading is bad because it creates a bad impression in the general trading
public which results in the loss of confidence from investment.

Front-Running – It refers to trading of stocks or other assets on the basis of secret

information of related to the future transactions which will affect the price of the
asset in the future. It’s illegal and is considered as Insider Trading.
 Decimalization – refers to representing the price of the security in terms of
decimals. For example – $30.03. Other function is the Fraction function in which the
price of security is represented in terms of fraction. For example - $ 30.1/4 instead
of $ 30.25.

5) International Regulations – The Bank for International Settlement is a central bank for all
the central bank of the countries. It was set up in 1930. It has 60 members central banks.
India too is a part of BIS. It is located in Basel, Switzerland. It is the world’s oldest
international financial institution (World Bank was formed in 1944). Till now, this bank has
released three international regulatory accord (agreement) naming, Basel 1, Basel 2 and
Basel 3 for the central Banks of its member countries. These Basel are just
recommendations, propounded policies and set of actions that is recommended for each
member country and the BIS is in no position to impose these regulations on any country’s
Central Bank.
Then there is G20 which is a Group of Finance Ministers and Central Banks from 20 different
countries who get together and discuss about regulations and make some amendments at
the end of the meeting. G20 approved the Basel 3. India is one of the members of G20.
Then there is Financial Stability Board. It was created by G20 which is responsible for giving
recommendations regarding financial proposals and regulations to the G20 countries.
Robert Shiller’s final thought is that the regulations has continuously change with the rapidly
changing technology. International regulation is needed as more and more firms start
expanding their business across several countries.
Week 5 : Lesson 12

The concept of Forward Market, Forward/Future Contracts started in Dojima through grain business
where farmers made a promise to the warehouse holder that they would sell their grains (mostly
rice) to the warehouse holder in the future at certain price. So, there was used to be future rice
exchange contracts. That’s why Dojima in Japan is typically for Grain Exchange.

Forward Market refers to the market involving future agreement or contract where the delivery of
goods or services or the payment for the goods and services is done in the future.

Future Exchange refers to the market or exchange where future contacts are bought and sold. These
future contracts may include sale or purchase of an asset or security at a pre-determined rate with a
pre-determined quantity in the future.

Future Contract refers to the agreement made by the buyer and seller to buy and sell the asset in
the future at a predetermined rate. One key feature that separates Future Contracts from the
Forward Contracts is that Future Contracts can be traded in the in the Future Exchange while
Forward Market cannot. So, if there is a default, you can sell the Future Contracts by renewing the
terms. One more thing is that in Future Contracts, the buyer and seller interacts through Future
Exchange. So, Future Exchange is more like a middle man. The seller lists out his/her future contracts
and one interested in buying can do so from the Future Exchanges. So, it mitigates the risk involved
in the Forward Contracts where transactions take place directly between the buyer and seller.

How Future Contract is better as compared to Forward Market – In Forward Market, there is no
guarantee or confidence or trust among the counterparties. They may strike a future deal and fail to
fulfill it in the future. But the Future Contracts mitigates such risk. Firstly, there is an intermediary
(Future Exchange) between the Buyer and Seller. Secondly, the buyer has to open a Margin account,
and deposit money into the account. With passage of time, the amount will be automatically
deducted from the Buyer’s Margin Account. Should he fail to observe the deal in the future, the
Future Exchange as an intermediary will reduce the amount of Buyer’s Margin Account close to zero
(but not complete zero).

Advantages of Future Contracts or Forward Contracts – Future/Forward Contracts are taken by the
investors and brokers to protect themselves against the risk of Price Movement in the Asset.

Forex Forward trade is like a Zero-Coupon Bonds.

Margin Account – refers to the account in which the Brokers lend cash to other people for
purchasing stocks and other securities. The loan is collateralized by the stocks and securities
purchased using the lent money. Because the customer is using debt, it could be considered as ana
example of Leverage which will either maximize the profit or loss. The investor may also add some of
his/her money to buy the securities.
Surprisingly, the world’s first Futures Contract Market too came in Osaka (Japan), or a small part of
Osaka called Dojima. So Dojima was the place where both the Forward and Future Contracts Market
concept was transpired. But the concept of Future/Forward Market was soon displaced to Chicago.

s = percent of the value of the commodity that warehouser would cost you to store commodity for
one year

r = is the interest rate for the same interval of time

For example -

Contango refers to the situation in which the future price of a commodity or goods or securities is
higher than the current / spot price of the same. The Contango is usually represented by an upward
sloping forward curve.

Arbitrage refers to the purchase of asset or securities in one market and selling it in another market
to attain profit from the price difference between two markets.

Chicago Mercantile Exchange purchased New York Mercantile Exchange which was used to be an
important future market for crude oils. Crude oils throughout the world are not traded at the Spot
Price but the Future Price. It’s because most of the oil suppliers in the world sell oils at long-term
contracts which may exceed 4 to 5 years. Such Future Contracts of selling crude oils for more than 5
years are agreed upon based on Future Price.

Organization for Petroleum Exporting Countries (OPEC) was founded in 1960 by Iran, Iraq, Kuwait,
Saudi Arabia and Venezuela. It was joined by some other countries as well. Recently, OPEC has
become weak because of conflict in middle east, hence low oil price. Venezuela is the country which
has the highest oil reserve in the world followed by Saudi Arabia and Canada. The OPEC countries
recently decided to limit the oil barrel supply to keep the price up.

Lesson 13

Call Option refers to a financial contract which gives right but not obligation to a buyer to buy stock,
bond or commodity at a specified price at a specified time. Unlike future contracts, the buyer is not
bound to purchase the underlying assets. He/she may agree to buy the underlying asset and then
change the mind in future. That’s why it is known as the Options.

Put Option refers to the financial contract which give seller the right but not obligation to sell stock,
bond or commodity at a specified price at a specified time. Unlike future contracts, the seller is not
bound to sell the underlying assets. He/she may agree to sell the asset and change the mid in future.
That’s why it is known as the Options.
In both, Call Option and Put Option, the price at which the buyer agrees to buy the asset or the price
at which the seller agrees to sell the asset is known as the Strike Price. Also, in the both of the
options, the time at which the buyer and seller agrees to buy and sell the asset is known as the
Maturity or Expiration.

Underlying Asset refers to the asset which give Derivatives, their value. These assets give derivatives
their value. Underlying Assets are mostly stocks, bonds and commodities and give the investor Put or
Call options in terms of these assets.

Dutch East India Company

The first written and well-documented case of Options comes from a written-descriptions from a
Dutch book which was around 1600. Dutch were financially advanced in 1600 and even in 1700.
Some economist claims that the concept of IPO came from Dutch East India Company. The company
aimed at employing hundreds of ships to carry out voyages and trade around the world. But such a
large operation required strong and enormous finance. So, they went to investors and the rich public
and proposed a deal to give money to the company for carrying out this huge voyage operation and
earn a share of profit from the company. Once voyage operation began, this Share proposal was
given to many other rich public in different continents.

Ticker is an abbreviation of the Company’s name which is used in the Financial Reporting. For
example, the ticker for Intel Corporations. Is INTC. This is the abbreviation used in the Stock
Exchange when the Company’s Share is listed.

Recourse Loan – These loans primarily favor lenders. In this loan, the money is given to the borrower
by the lender against some collateral. In case of default, the lender takes up the collateral to recover
the lent money. However, if some amount is still due even after the acquisition of collateral, then
the lender has the right to acquire the personal assets of the borrower to settle the due amount. It’s
like a loan with unlimited liability.

Non-Recourse Loan – refers to the loan which favors the borrowers. In this loan, money is lent by
the lender to the borrower against some collateral. In default, the lender can only acquire the
collateral. If there is a due amount even after the acquisition of collateral, then the lender has no
right to acquire the personal asset of the borrower. So, it’s the loan with limited liability.

Benefits of Options Market – Options Market overcomes the limitations of Future Market in the
same way as Future Market overcomes the problem of Forward Market. First of all, the contract of
buying and selling in the future is not bounding. If the seller or buyer does not want to sell or buy in
the future then their deal will simply expire with no charges of Contract Breach on either of the
party. Option Market also allows the parties to earn profit or avoid losses. Since the contract is not
bounding, the seller may not sell the Underlying Asset if the Strike Price falls below the then market
price for that asset. He/she may reject the deal and sell the asset at the higher market price to incur
profit as compared to what he/she could’ve got by selling at the strike price.
Options are present everywhere and not just in Stock, Bond and Commodities. Options are also
available on mortgages and properties.

Stop-Loss Order – refers to the deal placed with the broker to buy or sell the security when the price
falls or rise below a certain level. The Broker will not charge any cost in conducting the Stop-Loss
Order as its just transactions. This method is a great tool for risk management. Investors looking for
the market price to increase in the future will opt for Sell-Stop Strategy. Investor looking for the
market price to decrease in the future will opt for Buy-Stop Strategy.

To predict the Future Price of the Shares according to Put-Call Parity Relationship

Predicted Share Price = Call Price + PDV Dividend + PDV Strike Price – Put Price ;

 PDV Dividend is the dividend offered on 1 Share for 1 year

 PDV Strike Price is the Strike Price from the Option
Week 6 : Lesson 14

Underwriting – To underwrite the security is to manage the process of issuing new shares for the
company or the new debt for the company.

Underwriter Syndicate – refers to the band or group of Investment banks and the brokers who
collectively undertakes the responsibility of issuing new shares on behalf of some company. Usually,
this syndicate is formed when the issue of shares or debt is too large for one Broker or Investment
Bank to handle. So, they form a syndicate or group, buy all the shares from the company and sell it
to the investors and public at a different price. Their earning is in the form of Underwriting Spread,
which is the difference between the price at which the Syndicate purchased the Shares from the
company and the price at which the Syndicate sold it to the general investors and the public.

Bulge Bracket is a slang term used to describe those multi-national investment companies that have
issued a large number of shares for the other company. It includes Citi Investment Bank, Goldman
Sachs, Morgan Stanley, Barclay’s Capital, JP Morgan’s Chase, Swiss Bank – Credit Suisse etc. In
layman’s language, the term is used to denote big investment banks.

Investment Bank refers to those banks which specializes not just in Investment but also in
Underwriting Services, Consulting and Investment Risk Management.

Blue Chip Companies refers to the financially strong, stable and well-established companies that
deal in popular and highly accepted products. These companies are able to weather downturns and
operate profitably even in the adverse economic conditions which contributes to their stability and
long growth. Example – Reliance Industries, Tata Consultancy Services, Hindustan Unilever, Infosys
ltd.

Seasoned Offer – refers to the additional issue of shares of those companies whose initially issued
share are already traded in the Secondary Market.

Offers by Investment Bank – The investment banks give two kinds of offer.

 Bought Deal – The bank will purchase all the shares from the company at some price and sell
it in the market for a higher price on the behalf of the company to earn profit.

 Best Effort – Under this offer, the Bank takes the share of the company and try to sell it at
the market at a determined price. If the stocks are sold at the fixed price, then the deal is
considered successful. If the stocks are not sold, then the deal collapses there is no issue of
shares to the public or other investors.
 Underwriting Process 1

 Prefiling Order
 Advise issuer about the choice of issue
 Agreement among the underwriter to form a syndicate because the underwriting is
mammoth task and cannot be handled by just one Underwriter.
 Filing of Registration with SEBI
 Distribution of Preliminary Prospectus such as Red-Herring Prospectus

Underwriting Process 2

 After the issue of Red-Herring Prospectus, the underwriters call for the clients interested in
subscribing for additional fund
 Due Diligence Meeting between the Underwriters and Corporations
 Deciding the Offering Price
 Underwriting Agreement between Corporation and the Underwriters
 Dealer Agreement that the dealer has purchased from the Underwriters

How Underwriters protect their reputation – When a company offers IPO to the public, all the
general investors and the public is charged with the same amount for the Shares. But after the issue
when the shares enter the market, their value fluctuates due to Demand and Supply. If the company
has made IPO through Underwriters and after some days the value of shares start to fall, then the
Public and the Investors start doubting the Underwriters who had initially issued the shares. So, to
stabilize the falling price of the Shares and protect the reputation, Underwriters buys a large
proportion of the Company’s Share. This again increases the value of Shares in the Market and
consequently, their reputation. It’s called Stabilization.

Price Pop in the beginning of IPO – When a Company offers IPO through the Underwriters, the
underwriters genuinely assign lower price value to the Shares. When the Shares are underpriced, lot
of investors and general public align to buy the new Shares. But on the first day, underwriters don’t
sell the Shares to anybody because they know that by deliberately underpricing the shares, there
will be an excess demand and the excess demand will push the Share’s price up. So, the next day the
price of the Shares increases and the underwriters open their windows for selling purposes. This
increases their profit and the ultimately the Underwriting Spread. It is considered as an example of
legal Market Manipulation.

What Investment Banking is all about – According to Robert Shiller, “Investment Banking is all about
connecting with clients and building relationship and prestige and not just money.” Typical example
would be Goldman Sachs. Before the Financial Crisis in 2007 – 08, Goldman Sachs was the most
esteemed Investment Bank in the world. It had 3 main principals – 1) Make Money and only money
2) Absolute loyalty to the firm 3) Personal Anonymity. All these 3 principals lacked any sentiments
towards the clients and customers. But the bank was hit hard by 2008 crisis and its reputation and
efficiency fell into an abyss. Then came, John Whitehead as the Chairman. He introduced new
principals that brought back the Company’s reputation and efficiency. These were – 1) Client’s
interest should come first. 2) Real asset for the company is the people. 3) Achieving Excellence. 4)
Stress on creativity and imagination.

Moody – John L Moody established the first rating agency called Moody. This company is
responsible for grading other companies on the basis of ranks such as A, B, C, D. The best rating that
Moody can give is AAA rating which is based on Company’s integrity, principals, work culture etc.
Ultimately, these ratings have a significant effect on the Company’s Share Price. In 2017, Moody
rated India’s Sovereign Bond (Government Bond).

The Glass Steagall Act of 1933 (USA) created the modern concept of Investment Banking when it
separated Investment Bank, Commercial Bank and Insurance Companies from each other. And this
concept was accepted all around the world. The prime reason of separating the three was because
commercial banks with its inefficient investment and banking operation contributed to the Stock
Market fall in 1929. It is because it was believed that banks with both Commercial and Investment
operations had inside knowledge and were indulged in the Insider Trading. It is because of Glass
Steagall Act 1933, that Morgan Stanley (Commercial Bank) and JP Morgan (Investment Bank)were
separated into two autonomous bodies. But in 1999, Gramm Leach Act signed by President Clinton
ended the Glass Steagall Act. After that, Chase Manhattan Bank acquired JP Morgan which is now
known as the JP Morgan Chase.

In USA, total assets held by the HOUSEHOLDS is $101 trillion. If we divide that by population, it gives
the ratio of $270,000 : 1 (approx..). This means that in US, 1 household holds $270,000 (around 1
crore in Rupees) worth of asset. And this data is of 2015. So, by now it must have increased
approximately by two-fold. (One of the reasons why one should consider US to be an advanced
county.). But that’s average household. The Median in this case would be much lower.

Financial Advisor

In the United Kingdom, there is Citizen Advice Bureaus which provide financial advices to poor
people for free of cost.

Open-End Funds – It refers to the funds in which the money invested can be redeemed anytime as
per the demand of investors. Example would be Mutual Funds. Investors invest their money in this
fund and can withdraw it anytime they want.

Mutual Funds – The first mutual fund appeared in Holland in 1770 known as “Eendraght Maakt
Macht”. It was created by Dutch (one of the reasons why Dutch were considered Financially
powerful in 1600s and 1700s). These are also known as the Open-End Funds because you can pull
out your money or deposit additional money anytime you want.

Closed-End Funds – refers to the fund in which the money invested cannot be redeemed. Once an
investor pays his/her money for investment in the Closed-End Funds, he/she is entitled to receive
the dividend but the principal amount is not returned. Example would be Consol Bonds and Stocks
(Equity). The only way, an investor can reclaim his/her money back is by selling all the securities.

Exchange Traded Funds – The first ETF was for S&P 500. The first ETF was SPDR – Standard and Poor
Depository Receipt.
Lesson 15

Broker – To define a Broker, we can use BOAC. Broker acts on behalf of Other as their Agent for
which they earn Commission. Broker is different from Dealer. The Dealer is the person who acts for
Himself. In other words, as a Principal in the transactions for which he makes Markup. Dealers
secure their source of profit from the difference between the Markup Price and the Selling Price.
While Brokers earn their profit from the commission earned by securing profit on the sale of
securities on the behalf of their client. Brokers are dedicated to their Clients while dealers may not
have any client, so they conduct trade for personal gains (mostly).

An Inter-Dealer Broker refers to the broker which facilitate the transactions between the dealers.

A firm dealing with both Brokers and Dealers have to register themselves with the Securities and
Exchange Board.

Bad behaviors of Stock Brokers – We know that Stock Brokers charge commission whenever they
sell the securities on the behalf of their client. So, they may resort to a cynical action which is known
as Churning. Under this, Stock brokers will call you and notify that there is a new hot investment deal
that you should enter into by selling your previous securities. Thus, the stock broker is persuading
their client to sell their securities just to earn commission. And they may do it frequently.

Churning – refers to excessive selling of client’s securities by Stock Broker to earn commission and
then buying the sold securities back to avoid suspicion from the client. It is an unethical and immoral
activity against the Laws of Securities and Exchange Board. One way, you as a client can prevent your
stock broker from Churning is by maintaining a strict control over your Trading Account instead of
giving its full access to your Stock Broker.

In United States, the first Stock Exchange was New York Stock Exchange (NYSE). In India, the first
Stock Exchange was set up in Bombay in 1875 as Bombay Stock Exchange (BSE).
People mostly resort to invest in locally listed companies because they are familiar with the local
news and local information.

High Frequency Trading – is the result of use of computers for automating the task of trading. With
the automated software loaded in computer, trade can take place in millisecond. In such
transactions taking place at the speed of light, the speed of transmission matters. Fully automated
market is taking over the un-automated market like NYSE, NSE etc.

Limit Order – refers to buying or selling of securities once the market price reaches a specific value
or above/below the value. Under this, the order is executed at specific price. It’s different from the
Stop Loss Order. In Limit Order, investor sells or buy the asset when the market price reaches a
specific price, while in Stop-Loss Order, assets are bought or sold once the market price crosses a
specific price. The former is related to earning profit while the latter is related to hedging or
mitigating the risk associated with Price Fluctuation.

Lesson 16

Public Finance – It is related from the Finance of the Government.

Repudiation – It refers to the situation when the government declares that it will not pay back the
public debts. But government rarely repudiate or default any loan or public debt. When the
government default any loan, then there is restructuring of Government’s Debt and the government
pays back less amount than initially liable. For example – Greece in 2015 defaulted on loan and then
there was Restructuring of Debt.

Odious Debt – It refers to the situation when the government declares that it will not pay back the
public debts taken by the previous government party as that party was perceived to be corrupt or
inefficient.

Government default are not rare but Government seldom Repudiate. It is because there is an apt
difference between Default and Repudiation. In case of Repudiation, the government completely
denies paying back its Public Debt. But when the Government Defaults, they usually restructure their
Debt Portfolio and makes the Payment. For example – Suppose the Government has debt of $100
million. In case of Repudiation, the government will not pay back the debt. In case of default, there
will restructuring, say 50% deduction. So, now the government will pay only $50 million.
Government rarely repudiates because they want to maintain the investors confidence otherwise
nobody will lend them in the future.

In Capitalist Countries, there is a notion that government stays away from the corporate and
business sector. But that’s wrong. First of all, government regulates businesses and second, they can
own shares of the private company. And Private Business can be nationalized in the future.

Revenue Bond – refers to the bond issued by the municipalities for some specific projects like
buildings, dam, city constructions etc. and promises to pay the coupon from the revenue arising out
of the specific project. This bond allows the government to finance a particular project without
raising taxes or using State Government Treasury.

Negative Tax – I never knew that there can be a concept of Negative Tax. So, in negative tax which is
applicable for very low-income group, is one in which government instead of taking taxes, pay the
money to very low-income groups. It is somewhat similar to subsidy. USA provide the Negative Tax.
In Germany, there is Unemployment Insurance known as Arbeitslosengeld. So, Lloyd George, former
Prime Minister of United Kingdom went to Germany, he realised that there were almost no hobos on
the road as compared to UK because most of the people had taken Unemployment Insurance.

Week 7 : Lesson 17

Currently, there are 1.5 million NPOs in the USA. India has 1.2 million NPOs with 19.2 million people
employed. And the number is expected to grow.

The first Cooperative society was the Rochdale Society of Equitable Pioneers, 1844. They dealt in
Grocery Stores.

Alternative for NPO and For-Profit Organisations – USA came up with an alternative from NPO and
For-Profit Organisations known as the Benefit Corporation (Also Known as the B Corp). This type of
Corporation exists between the Non-Profit and For-Profit Organisations. It was first created in
Maryland 2010. The Company’s Charter must state the purpose for establishing such corporation and
must pursue that purpose along with making profit. Example – Grower’s Secret. An existing NPO or
Profit Company can turn into the Benefit Corporation by making a new Charter meeting the
requirements of the Benefit Corporation. So, this Corporation has Dual Objectives –

1) To make Profit
2) To pursue a Social Cause and create benefits like NPO

In India, there is a B Corp known as the eKutir which is the India’s first certified B Corp.
 eKutir

eKutir is the India’s first B Corp situated in New Delhi. Its inception took place in 2009. It is a For-
Profit Organisations focusing job creation, prosperity and livelihood for India’s Poorest Communities.
The company’s main focus is on the Farming Sector. It addresses the small farm holders by working in
the field partners to replace their old techniques with a better one.

It is saddening to see that there is only 1 dormant B Corp in India as compared to 3,500 + in USA. It is
because these Corporation bridges the gap created by the Non-Profit and For-Profit Organisations. B
Corp can focus on both – Profit Making as well as Creating Societal Benefits. The first objective can
satisfy the money-making appetite of present India’s Youth and the second objective can give an
opportunity to the philanthropists to work for greater good. Therefore, it can hit two birds with one
stone.

Lesson 18

According to Adair Turner (British Businessman) said that Debt is like a corporate pollution and it
must be taxed. It means that companies have accumulated wealth yet they use debt for business
capital to avoid taxes. For example – after the death of Steve Jobs, Apple started mobilising debt
instead of using the earning the company accumulated under the leadership of Steve Jobs, just to
save tax.

According to Robert Shiller, there has been democratization (introduction of democracy in particular
field) in finance and it will democratize further in the future. What he means by democratization is
that finance benefiting all the people and not just some chosen few people like rich.

Crowd Funding - refers to mobilising of funds at large from people for a project or venture directly
via internet. For example, CrowdCube is a website through which business people can present their
business ideas to the public and gather funds.
Need of Financial Advice – The US government realised the needs and importance of Financial
Advisors. Earlier, many companies established their factories in rural area that would provide cheap
labour. The labourers were given housing accommodations near the factories along with wages. But
once the company realised that they could get cheaper labour in other area, they would scrap the
factory and as a result thousands of labourers would lose their wages along with their house. In that
case, Financial Advisors could have advised them to not to buy the house near the factory instead,
taking rent. But poor people cannot avail the services of Financial Advisors because those are
expensive. So, US Government to mitigate this up to some extent provided a provision whereby any
people can avail the services of Financial Advisor and meet the expense from their Income Tax
payment.