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Topic 02 - Investors, Assets and Markets
Topic 02 - Investors, Assets and Markets
Paul Geertsema
1
Contents
3 Market participants 9
4 Investable assets 22
5 Markets 24
8 A list of books... 40
2 FINANCE 361 Class Notes – University of Auckland – Copyright (C) Dr Paul Geertsema, 2022
1 Reading (before class)
3 FINANCE 361 Class Notes – University of Auckland – Copyright (C) Dr Paul Geertsema, 2022
Reading (before class) (cont.)
4 FINANCE 361 Class Notes – University of Auckland – Copyright (C) Dr Paul Geertsema, 2022
Reading (before class) (cont.)
5 FINANCE 361 Class Notes – University of Auckland – Copyright (C) Dr Paul Geertsema, 2022
Reading (before class) (cont.)
• You might not get the previous joke if you don’t know about the
GameStop episode – see en.wikipedia.org/wiki/GameStop_short_squeeze
for background)
Source: https://www.reddit.com/r/dataisbeautiful/comments/lkz1wm/oc_timeline_of_the_rise_and_fall_of_gme_stock/
6 FINANCE 361 Class Notes – University of Auckland – Copyright (C) Dr Paul Geertsema, 2022
2 What are we doing today
7 FINANCE 361 Class Notes – University of Auckland – Copyright (C) Dr Paul Geertsema, 2022
What are we doing today (cont.)
8 FINANCE 361 Class Notes – University of Auckland – Copyright (C) Dr Paul Geertsema, 2022
3 Market participants
9 FINANCE 361 Class Notes – University of Auckland – Copyright (C) Dr Paul Geertsema, 2022
Market participants (cont.)
10 FINANCE 361 Class Notes – University of Auckland – Copyright (C) Dr Paul Geertsema, 2022
Market participants (cont.)
11 FINANCE 361 Class Notes – University of Auckland – Copyright (C) Dr Paul Geertsema, 2022
Market participants (cont.)
13 FINANCE 361 Class Notes – University of Auckland – Copyright (C) Dr Paul Geertsema, 2022
Market participants (cont.)
• Banks
– Commercial banks (eg CBA/ASB)
◦ What they really want
· Loyal depositors that will fund them cheaply
· Careful borrowers that will repay their money in full and
on time
◦ Constraints
· Regulations, public perception (do you love your bank?),
keeping up with technology, hackers
14 FINANCE 361 Class Notes – University of Auckland – Copyright (C) Dr Paul Geertsema, 2022
Market participants (cont.)
15 FINANCE 361 Class Notes – University of Auckland – Copyright (C) Dr Paul Geertsema, 2022
Market participants (cont.)
• Hedge funds
– Big (D.E. Shaw, Citadel, Renaissance Technologies, etc.)
– Others
– What they really want
◦ Lots of rich investors that believe it is possible to beat the
market, if only you are smart enough (the second part is not
a problem for your typical HF guy)
◦ Beating the benchmark by miles so they can take the 20 part
of their “2 and 20” fee
– Constraints
◦ So hard to borrow money
◦ Investors pulling out money just when it is a good time to
buy
◦ Irrational markets that make no sense
◦ Not really as unregulated as they used to be (SEC, Madoff
scandal)
16 FINANCE 361 Class Notes – University of Auckland – Copyright (C) Dr Paul Geertsema, 2022
Market participants (cont.)
17 FINANCE 361 Class Notes – University of Auckland – Copyright (C) Dr Paul Geertsema, 2022
Market participants (cont.)
• Large corporates
– Investing surplus cash (Apple)
– Funding their customers (GE Capital)
– Hedging risk (ie FX hedging)
◦ FX = Foreign Exchange
– What they really want
◦ Not to be fleeced
◦ Expertise (investments are usually not their core business)
– Constraints
◦ Shareholders
◦ Lenders
◦ Understanding markets, products
◦ Not their day job, they have a real business to run
18 FINANCE 361 Class Notes – University of Auckland – Copyright (C) Dr Paul Geertsema, 2022
Market participants (cont.)
• Central banks
– Manage the currency for sovereign states
– Issue debt on behalf of the state
– Inflation targeting
– Often have some regulatory role as well
– Big beasts with a lot of power
◦ Can make rules
◦ Can print money (aka Quantitative Easing)
◦ Sets the interest rate
◦ “Don’t fight the fed”
19 FINANCE 361 Class Notes – University of Auckland – Copyright (C) Dr Paul Geertsema, 2022
Market participants (cont.)
20 FINANCE 361 Class Notes – University of Auckland – Copyright (C) Dr Paul Geertsema, 2022
Market participants (cont.)
• Governments
– Nation states (Australia)
– States (Texas, or Western Australia)
– Local (Auckland City Council)
• Individuals
– “Retail” - current & savings account, credit cards
– “Mass Affluent” - own a house or two, some cars; a bit of money
saved up
– “High Net Worth” if their liquid assets (ie excluding properties,
paintings and pets) is a million or more
• Family office
– If your family has serious money (say $100mn or more)
– Essentially set up your own fund management company to man-
age your assets
– Your employees are often “High Net Worth” themselves
21 FINANCE 361 Class Notes – University of Auckland – Copyright (C) Dr Paul Geertsema, 2022
4 Investable assets
22 FINANCE 361 Class Notes – University of Auckland – Copyright (C) Dr Paul Geertsema, 2022
Investable assets (cont.)
• Structure
– Cash aka underlying
– Derivatives
– Structured products
– Funds, ETFs
23 FINANCE 361 Class Notes – University of Auckland – Copyright (C) Dr Paul Geertsema, 2022
5 Markets
24 FINANCE 361 Class Notes – University of Auckland – Copyright (C) Dr Paul Geertsema, 2022
Markets (cont.)
• “By appointment”
– You have to go and find buyers (or sellers) yourself
– Property, bespoke structured products
• Dark pools / Block trading / Algorithmic trading / High frequency
trading
• Important dimensions
– Liquidity (the cost of moving in and out of a position)
– Depth (amount you can trade before you move the price)
– Transparency (availability of price data)
– Access (who can trade)
– Speed (of execution)
25 FINANCE 361 Class Notes – University of Auckland – Copyright (C) Dr Paul Geertsema, 2022
6 How banks work
• Most people have only a hazy idea of what large banking institutions
do and how they are organised
• In this section I aim to give you an “X-ray” view of these organisa-
tions (with an Investment Bank focus)
• It is important to understand how banks work
– If you are planning a career in finance, you will either work for
them or work with them at some point
– They are intimately involved in the creation and trading of most
types of financial assets
26 FINANCE 361 Class Notes – University of Auckland – Copyright (C) Dr Paul Geertsema, 2022
How banks work (cont.)
• I’ll show you the different ways in which a bank is commonly “cut
and diced”
– So you can go from:
◦ “I think she works for a bank”
– to:
◦ “She is an IBD Associate in the Financial Institutions Group
for Deutsche Bank in London”
◦ or
◦ “She is a Director in Product Control responsible for Interest
Rate Exotics at Bank of America in New York”
• Lets get to work
27 FINANCE 361 Class Notes – University of Auckland – Copyright (C) Dr Paul Geertsema, 2022
How banks work (cont.)
28 FINANCE 361 Class Notes – University of Auckland – Copyright (C) Dr Paul Geertsema, 2022
How banks work (cont.)
• Rank
– Like most large organisations (Military, Health Care, Civil Ser-
vice), banks have a fairly well established seniority structure
– From bottom to top...
– Analyst
– Associate
– Manager
– Vice-President (VP) / Associate Director (AD)
– Director (Can sign on behalf of the firm)
– Managing Director (MD)
– Executive Committee
– CEO
29 FINANCE 361 Class Notes – University of Auckland – Copyright (C) Dr Paul Geertsema, 2022
How banks work (cont.)
• Office
– Historically, banks have categorised their people into different
“Offices”
– Front Office
◦ Deal directly with clients of the bank
◦ Some direct involvement in making money
◦ Investment banking, capital markets, trading, sales, research
◦ Most risk, most upside, hard to get in
– Middle Office
◦ Control functions
◦ Check that front office are within risk limits and not stealing
money or breaking rules
◦ Product control, Risk, [Accounting, Tax, Compliance]
30 FINANCE 361 Class Notes – University of Auckland – Copyright (C) Dr Paul Geertsema, 2022
How banks work (cont.)
– Back Office
◦ Narrow definition: Operations [Ops]
· Confirmations
· Clearing / payments
· Regulatory reporting
◦ Wider definition: includes support functions
· Legal
· IT
· Operations
· Facilities
· HR
31 FINANCE 361 Class Notes – University of Auckland – Copyright (C) Dr Paul Geertsema, 2022
How banks work (cont.)
• Role
– This is what you actually do
– Will obviously have some overlap with Office
– Really applies to front office roles
– Often split into primary and secondary
• Primary (creation of new securities)
– IBD (Investment Banking Division)
◦ Coverage/Origination
◦ Execution
◦ Structuring
◦ Debt Capital Markets (DCM) / Equity Capital Markets (ECM)
◦ Syndicate
32 FINANCE 361 Class Notes – University of Auckland – Copyright (C) Dr Paul Geertsema, 2022
How banks work (cont.)
33 FINANCE 361 Class Notes – University of Auckland – Copyright (C) Dr Paul Geertsema, 2022
How banks work (cont.)
• Product
– More commonly applied to the Secondary business
◦ Traders need to understand the product they trade
– Equities
– Fixed Income
◦ Credit
◦ Interest Rates
– FX
– Commodities
– Can overlay adjectives like
◦ Derivatives
◦ Structured
◦ Exotic
◦ Flow
34 FINANCE 361 Class Notes – University of Auckland – Copyright (C) Dr Paul Geertsema, 2022
How banks work (cont.)
• Client base
– More commonly applied to the Primary business
◦ Investment bankers need to understand their clients
– Consumer goods / Retail
– Oil & gas / Energy
– Technology
– Mining & minerals
– Manufacturing
– Defence
– Healthcare / Pharma
35 FINANCE 361 Class Notes – University of Auckland – Copyright (C) Dr Paul Geertsema, 2022
7 The business of fund management
36 FINANCE 361 Class Notes – University of Auckland – Copyright (C) Dr Paul Geertsema, 2022
The business of fund management (cont.)
37 FINANCE 361 Class Notes – University of Auckland – Copyright (C) Dr Paul Geertsema, 2022
The business of fund management (cont.)
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The business of fund management (cont.)
39 FINANCE 361 Class Notes – University of Auckland – Copyright (C) Dr Paul Geertsema, 2022
8 A list of books...
– https://www.quantnet.com/threads/master-reading-list-for-quants-
mfe-financial-engineering-students.535/
• Some more serious books
– A random walk down wall street (Malkiel)
– Thinking, slow and fast [behavioural] (Kahneman)
– Thinking strategically [game theory] (Dixit, Nalebuff)
• PhD level stuff
– Asset Pricing (Cochrane)
– Dynamic Asset Pricing (Duffie)
– Econometrics of Financial Markets (Cambell, Lo, MacKinlay)
41 FINANCE 361 Class Notes – University of Auckland – Copyright (C) Dr Paul Geertsema, 2022