1. More About the Markets Abhijan Khosla (Director of Mentorship)

2. Who Am I? GTSF Investments Committee2

3. NO MENTORSHIP THURSDAY TEST IS TEUSDAY OCTOBER 1 st ! GTSF Investments Committee3

4. A quick review GTSF Investments Committee4 ● There are two kinds of markets ○ Primary ○ Secondary ● Securities can be listed in two ways ○ Listed ○ OTC ● The Efficient Market Hypothesis has 3 “levels” ○ Strong ○ Semi-strong ○ Weak

5. A quick review GTSF Investments Committee5 ● The 3 main styles of investing ○ Value ○ Growth ○ Momentum ● What is the difference between going long and short? How do we “short” a stock? ● Different levels of market cap ○ Large ○ Mid ○ Small ● What does “liquidity” mean and why is it so important?

6. What we’re doing today GTSF Investments Committee6 ● We use statistics to measure risk ● Some basic concepts ● Properties of data sets ○ Mean ○ Median - “middle number” ○ Mode - occurs most often ● Normal Distributions ● Standard Deviations

7. Normal or “Gaussian” Distributions GTSF Investments Committee7

8. Measuring Risk in Markets GTSF Investments Committee8 ● Name some major risks people lending money may face ● How do we measure the risk of a stock? ● We use the Standard Deviation of returns to compare similarly performing companies ● Standard Deviation formula

9. Risk Practice Problems GTSF Investments Committee9 ● You are thinking about investing in 2 companies. One of them (let’s call it ABC) following monthly returns ○ 4% ○ 2% ○ 3% ○ 1% ○ -8% ● What is this stocks average return and standard deviation?

10. Risk Practice Problems GTSF Investments Committee10 ● The next company (DEF) has the following returns; ○ 1% ○ 2% ○ 1% ○ 3% ○ 2% ● What is this stocks average return and standard deviation? ● Which stock would you most likely invest in? ● What other factors should influence your decision?

11. Risk and Return GTSF Investments Committee11 ● The basic assumption about financial markets is that greater risk is met with greater return ● If you invest in a risky security you expect to be compensated with a greater return ● The risk/return relationship is central to determining if securities are mispriced in the market

12. More Risk! GTSF Investments Committee12 ● Standard deviation is a good measure of risk for an individual securities ● What about a stock’s sensitivity to the market? ● When the broader market is down individual company stocks are often down, why is that? ● Traders use stocks as a way to express their views on the market, often movements in stocks are not due to company news but market news

13. More Risk! GTSF Investments Committee13 ● The most common way to see how a stock moves in relation to the broader market (represented by the S&P 500) is Beta ● Beta (or market risk) is a measure of a securities relative volatility as compared to the broader market ● Beta > 1 means the stock is more volatile than the market ● Beta < 1 means the stock is less volatile than the market

14. Beta GTSF Investments Committee14

15. Beta Practice GTSF Investments Committee15 ● Consider the following security beta’s; a. 1.3 b. 1.4 c..6 d..4 e..35 f. 1.9 ● If the market rose 10% by how much would you expect each of the securities to rise?

16. Using Beta to determine return GTSF Investments Committee16 ● We previously calculated expected return by taking the average of past returns ● With Beta we know how a security compares to the market return ● Using this information we can calculate the E(r) of a security without knowing its previous returns ● E(r) = Risk Free Rate + Beta (Market Risk Premium) ○ Market risk premium = market return - risk free rate

17. CAPM GTSF Investments Committee17 ● The use of Beta, Market Return and the Risk Free Rate to determine expected return is called the Capital Asset Pricing Model or CAPM ● What do you think we use for the risk free rate? ● If a stock’s beta is 1.2 and the market has returned 10% on average while the risk free is 2% what is the stock’s expected return?

18. GTSF Investments Committee18

19. Alpha GTSF Investments Committee19 ● If everything perfectly followed CAPM then we would be able to very accurately predict what a given stock would return ● If this was true then we would not need actively managed funds to gain outsized returns ● Alpha is the portion of returns associated with a given security or set of securities ● Alpha represents a greater return for lower risk

20. Risk/Return Payoff GTSF Investments Committee20 ● Which portfolio manager did a better job last year and why? Bill - 25% return Carl - 20% return ● What does the information above NOT tell us about the returns of the portfolios in question?

21. The Risk Return Payoff GTSF Investments Committee21 ● RISK! ● We haven’t accounted for the risk each manager took so we don’t know if they got those returns by picking smart investments or simply taking a lot of risk

22. Risk Adjusted Returns GTSF Investments Committee22 ● Let’s take another look at those returns Bill – (25% return, stdev of 20%) Carl – (20% return, stdev of 25%)

23. What does the Sharpe Ratio Tell Us? GTSF Investments Committee23 ● A sharpe ratio tells us how much return the portfolio gets for every “unit” of risk it takes ● A sharpe ratio of > 1 means for every unit of risk we get more than 1 unit of return ● A sharpe ratio of > 2 means that we are getting double the return for every unit of risk we take

24. Where does “risk” come from? GTSF Investments Committee24 ● Beta measures risk compared to markets ● Alpha measures risk of individual assets ● If we hold multiple securities at the same time can we increase/decrease our risk? ● Correlation - the degree to which two things move together ● If we have a portfolio of highly correlated stocks then our entire portfolio will rise and fall at the same time

25. Correlation GTSF Investments Committee25  Correlation - a measure of how closely two things move together

26. Why We Care About Correlation GTSF Investments Committee26

27. Diversification GTSF Investments Committee27 ● We can increase our portfolio’s risk/return relationship by diversifying ● If we hold non-correlated assets then they will move separately eliminating moves cause by correlations ● Say you have a portfolio of only Tech stocks (GOOG, APPL, MSFT) how would you diversify your holdings so a drop in the tech sector wouldn’t bankrupt you?

28. Diversification GTSF Investments Committee28

29. Quiz Time! What is Beta? 1.Security Risk 2.Market Risk 3.Treasury Risk 4.Interest Rate Risk

30. Quiz Time! What is Beta? 1.Security Risk 2.Market Risk 3.Treasury Risk 4.Interest Rate Risk

31. Quiz Time! How many low correlation stocks do we need to achieve the diversification benefit 1.5 2.20 3.30 4.33

32. Quiz Time! How many low correlation stocks do we need to achieve the diversification benefit 1.5 2.20 3.30 4.33

33. Quiz Time! What is NOT a component of CAPM 1.Market Risk 2.Risk Free Rate 3.Beta 4.Market Return

34. Quiz Time! What is NOT a component of CAPM 1.Market Risk 2.Risk Free Rate 3.Beta 4.Market Return