1. Workshop in Financial Engineering “The Stock Game” Dr. J. René Villalobos, Joel Polanco and Marco A. Gutierrez Industrial Engineering Dept. Arizona State University

2. Introduction F This game was prepared for the IIE regional student chapter conference F We will use it to start the discussion on stock selection

3. Objective F Through hands-on exercises show the use of classical Industrial Engineering tools in devising Investment Strategies (Financial Engineering)

4. Financial Engineering F Financial Engineering is becoming a very “hot” topic in Industrial Engineering Programs F It has been established as a specialization area in programs such as: Georgia Tech, Columbia and Michigan

5. What is Financial Engineering? F Combining or carving up existing instruments to create new financial products. (http://www.duke.edu/~charvey/Classes/wpg/glossary.htm) F Financial engineering is the application of mathematical tools commonly used in physics and engineering to financial problems, especially the pricing and hedging of derivative instruments. (from Neil D. Pearson, Assoc. Prof. UIUC) F Financial engineering is the use of financial instruments such as forwards, futures, swaps, options, and related products to restructure or rearrange cash flows in order to achieve particular financial goals, particularly the management of financial risk. (www.stanford.edu/~japrimbs/00-Intro.ppt)

6. Investment Game F You will be given $100,000 of virtual money to invest in 7 stocks and a “risk-free” alternative which yields an interest of 2% per year F You can divide up the money any way you want among the 7 stocks and the risk-free investment F You will have the opportunity to change your original investment up to 3 times before the end of the game F Assume that you borrowed the original $100,000 and that you have to repay it by making two payments of $55,000 at the end of rounds 2 and 3. F Your job is to apply the IE tools that you know and your intuition to maximize the value of your investment when the game is over. F If you can’t meet the scheduled payments your company goes bankrupt and the game is over for your team

7. Example F First Round: You are given in Excel the daily closing quote for two stocks for around two years.The information looks like:

8. Example F From the previous information, the closing price for stocks A (the stock in blue) and B (the stock in pink) at May 31, 2001 are: $8.55 and $25.64 respectively. F Based on the information provided we make our investment allocation decision as $50,000 in stock A and $50,000 in Stock B, which corresponds to 5848 shares of Stock A and 1950 shares of stock B. F Then you will be given information for the second period

9. Example

10. F Your previous investment is now worth ($153,441.00, $76374 for Stock A and $77067 for stock B). F Since stock B performed better than Stock A you decide to sell 4211 of your shares of stock A and use the proceedings to pay the $55,000 loan payment F Now you are left with 1636 shares of stock A and 1950 of stock B and an investment value of $98,441.00 F The information for the next period looks as follows

11. Example

12. F The value of your stock of 1636 shares of stock A and 1950 of stock B is now $66223 F Since you almost lost your shirt in the last period because of Stock B you now sell ALL your shares of this stock and 974 shares of stock A to pay your final loan payment. F You are left only with 662 shares of stock A and none of stock B with a total market value of $11223 F The information for the last period looks as follows

13. Example

14. F Final Value  Shares of Stock A= 662, Price = $19.14 Total = $12673  Shares of Stock B= 0, Price = $24.4 Total = $0 F We made $12,673 but almost when bankrupt in the process

15. Your Turn to play