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Welcome
to
ECO358!
Financial
Economics
I
Lecture
1.1:
Introduction
September
15,
2015
Course
Resources
Instructors:
Professor
Katya
Malinova
katya.malinova@utoronto.ca;
Max
Gluskin
House
211.
Default
Weights:
course
grade
=
30%
x
test
1
+
30%
x
test
2
+
40%
x
nal.
ExcepVon:
the
nal
counts
for
70%
and
your
best
term
test
counts
for
30%
if
both
of
the
following
condiVons
are
saVsed:
your
nal
grade
your
worst
midterm
grade,
AND
your
lowest
term
test
grade
is
30%.
weight
from
the
missed
term
test
may
be
shifed
to
the
nal;
please
see
the
syllabus
for
details.
Course
Logistics
Regular
Lectures
and
Occasional
TA-led
Tutorials
Problem
sets
will
be
posted
on
Blackboard
to
provide
you
with
an
idea
of
how
test/exam
quesVons
will
look
like.
Please
consult
Blackboard
for
the
lecture
and
tutorial
schedule
(to
be
posted
within
a
week)
will be announced.
Chapter
numbers
will
be
provided
to
you,
but
you
are
responsible
for
nding
the
relevant
subsecVons
within
each
Chapter
based
on
the
material
presented
on
the
slides.
The
Law
of
One
Price
&
the
Absence
of
Arbitrage
(Ch.
3).
The
Time
Value
of
Money
&
Interest
Rates
(Ch.4-5).
Basic
ValuaVon:
Valuing
Bonds
(Ch.
6).
Basics
of
Financial
Statements
(Ch.
2).
Valuing
Stocks
(Ch.
7).
15-09-14
Only
trade
with
the
company
the
rst
Vme
these
assets
are
issued
(primary
market)
(or
when
the
company
repurchases
them,
e.g.,
b/c
it
has
excess
capital).
Historical Returns
15-09-14
Debt
An
I
owe
you.
Equity.
DerivaVves.
Features:
Short-term:
30,
60,
90
days,
maximally
1
year.
No
interim
payments
(i.e.,
receive
a
single
payment
``at
maturity'').
Examples:
Examples:
T-bill
(government)
Commercial
Paper
(corporaVons).
Repo
(repurchase
agreement):
a
form
of
very
short,
typically
to
hold
Vll
tomorrow;
tomorrow
I
repay
you
your
money
with
interest
and
you
return
my
bond
to
me.
Equity
Equity
is
a
stock
or
any
other
security
represenVng
an
ownership
interest.
interchangeably.
Typically:
shares
is
countable
(e.g.,
you
own
stock
of
Apple
Inc.
or
100
shares
of
Apple
Inc.)
Also:
stock
is
ofen
more
general
(=
equity).
I
own
stocks
means
I
own
equity
of
some
companies.
I
own
shares
prompts
a
quesVon
in
what
company?
Equity
(contd)
CorporaVons
raise
funds
for
their
investments
by
issuing
stock
or
bonds.
If
you
buy
bonds,
you
make
a
loan
to
the
company.
If
you
buy
stocks,
you
own
a
fracVon
of
a
company
assets
of
company
(afer
the
debt
holders
have
been
paid
o).
Note:
stockholders
in
a
corporaVon
have
limited
liability
(cannot
lose
more
than
your
investment).
15-09-14
Derivatives
A
derivaVve:
A
contract
between
two
or
more
parVes
whose
value
is
based
on
an
agreed-upon
underlying
nancial
asset,
index
or
security.
Example:
OpVons.
Terms:
exercise
or
strike
price,
expiraVon
date,
underlying
assets.
Call
OpVon
=
a
right
to
buy
the
underlying
asset
at
the
strike
on
(or
prior
to,
depending
on
the
opVon
type)
the
expiraVon
date
Financial
Markets
Primary
versus
Secondary
Markets:
Primary
Market
When
a
corporaVon
issues
securiVes,
cash
ows
from
investors
to
the
rm.
Usually
an
underwriter
is
involved.
Any
costs
that
are
associated
with
issuance
are
paid
by
the
rm
=>
need
to
understand
the
mechanisms
&
costs
for
security
issuance
(will
touch
upon
these
in
ECO359).
Secondary
Markets
Afer
the
iniVal
transacVon
in
the
primary
market,
the
shares
conVnue
to
Trading
Costs
The stock market provides liquidity to shareholders.
Liquidity (extremely loosely):
The ability to easily sell (and buy) an asset.
low transaction costs
easy to find somebody to trade with
15-09-14
orders.
Unclear
whether
bid-ask
spread
remains
a
good
measure
for
transacVon
costs.
where
both
bid
and
ask
prices
move
very
fast
(so
that
the
bid-
ask
spread
remains
low).
PotenVal
problems:
may
not
be
able
to
nd
a
match
in
the
dark
pool
(nobody
knows
that
you
are
interested
in
buying/selling).
if
the
price
discovery
aected
if
traders
are
able
to
hide
their
trading
intenVons?