1. Fintech Chapter 8: Equities, Efficient Markets, Exchanges

2. Equities Ownership interest in a company Claim on profits
Junior to creditors
Not liable
Voting rights
Preferred stock

3. Equities Risk, Return, Diversification Mutual Funds, ETFs
Modern Portfolio Theory

4. MPT Investors are risk averse Efficient portfolios Optimal portfolio
Minimize risk for given return
Maximize return for given risk
Efficient portfolios
Optimal portfolio
Expected value of portfolio return is weighted average of individual returns
Variance of individual stock
Covariance of all pairs

5. MPT Limiting assumptions:
Massive computation would be required to calculate all covariances
Expected return and var are not the whole story: fat tails, Black Swans
Risk appetite varies among investors
Differences in market expectations
Time horizon: one period vs longer time

6. MPT Practical applications Diversification by asset class
Age-related investment horizon and risk
Tax efficient rebalancing

7. MPT Minimize risk: Minimize covariance or correlation among assets
Uncorrelated or diversified assets
When some assets are down, others are unchanged or even up

8. Capital Asset Pricing Model
Theoretical value of assets given their expected return
RA= RF + βA(RM – RF)
Where:
RA= the return required of stock A
RF= the rate of return on the risk-free asset
RM= the market rate of return
ΒA= beta, or the volatility of Stock A compared to the volatility of the market

9. CAPM
What the model says is that the expected return from an asset should be equal to a risk-free rate plus a premium which reflects the relative volatility in that asset’s return, as compared to the market return.
Extensions of CAPM

10. Efficient Market Hypothesis: Assumptions
Perfect Information
Investors act rationally
No edge, no market outperformance (flip a coin)
Investor can only earn market rate of return, unless they take on more risk
There appear to be some investors who consistently outperform the market: Warren Buffet?

11. Random Walk
next period value is a random step, not dependent on the current value.
If market is currently efficiently priced then next change in price is equally likely to be positive or negative
traders will act to buy assets which are underpriced relative to risk and return, and they will sell assets which are overpriced
This theory strains to explain bubbles and crashes

12. Equity Indexes DJIA NYSE Composite Nasdaq Composite S&P 500
Wilshire 5000
Russell 1000

13. Equity Indexes TOPIX Nikkei 225 Hang Seng Index FTSE 100 DAX CAC 40
Swiss Performance Index
S&P/TSX
MSCI World Index

14. Investment Styles Individual (retail) buys specific stock/fund
Institutional managers of large pools of capital:
Pension funds, insurance companies, hedge funds, sovereign wealth, others
Active vs. passive (benchmark)
Industries
Market cap
Fund fees: active (2/20), passive ( bp?)
Fund of funds
Buffet Challenge

15. Figure 8.1 Performance of S&P Index Fund vs. Six Managed Funds
Source: Berkshire Hathaway

16. Mutual Fund Diversification Lower contracting costs
Information efficient
Lower execution fees
Many flavors

17. ETFs Similar to Mutual Funds, but
ETFs are securities. Buyers own shares of the ETF vs. Mutual fund buyers have fractional ownership in the underlying stocks or bonds
ETF NAV priced continuously vs end of session
ETF’s can be bought or sold continuously vs end of session
Less exposure to adverse tax events

18. Types of Orders Market Limit Stop Open only Close only Fill or Kill
Good till Canceled
Blocks
Baskets
HFT

19. Equity Trading Venues NYSE Nasdaq ATS Lit ECNs Dark Bloomberg LavaFlow
Broker dealer
Agency
Bats

20. Regulation SEC FINRA State-blue sky laws Exchange rulebooks
Division of Corporate Finance
Division of Enforcement
Division of Economic and Risk Analysis
Division of Investment Management
Division of Trading and Markets
FINRA
State-blue sky laws
Exchange rulebooks

21. Fintech Applications AI Prop trading ETF Manager’s Trust
White label platforms
Regtech

22. Fintech Applications Exchange technology Incumbents Borsa Italiana
Nasdaq
NYSE

23. Robo-advisors Wealth tech On-line, automated investing
Little or no physical presence, human interaction
Low fees
Customer identifies risk preferences
Algorithm selects portfolio, often ETFs
Automated rebalancing, tax optimization

24. Robo-Advisors
Wealthfront
Betterment
Schwab
Fidelity
Vanguard