Stock market presentation

STOCK  MARKETS2007 FINANCIAL MESS: REASONS

• US. And European housing market bubble:‐ Interest rates too lowL k f b ki l i i h• Lack of banking regulations in the:‐ Hedge funds and Investment banks;‐ Derivative markets (Credit‐default‐swaps) and;Derivative markets (Credit default swaps) and;Asset‐back securities.

• Home‐ownership obsession:‐ Crazy lending (subprime);‐ Tax subsidizing.

i i l i fl f hi• Massive Capital inflows from China• Rational markets –speculation‐• US fiscal policy tax cutting and enormously war spendingUS fiscal policy, tax cutting and enormously war spending• Credit Agencies:• ‐ High rating to untested new securities such

as the Collateral Debt Obligations (CDOs).• Lehman Brothers bankruptcy

STOCK  MARKETS

KEY  STOCK MARKET INDEX:

STOCK  MARKETS

01/02/2011 30/09/2011 % change

DOW                          11.891          11.154             ( 6.20)

NASDAQ                      2.276            2.139             ( 6.02)

S & P 500                     1.286            1.131            (12.05)

DAX 7 077 5 502 (22 25)DAX                               7.077             5.502           (22.25)

STOXX50E                    2.954             2.180           (26.20)

KEY EU BANKS STOCK´s PERFORMANCE SINCE 01/02/2011

STOCK  MARKETSKEY EU BANKS STOCK s PERFORMANCE SINCE 01/02/2011

• DEXIA                                                    (59.08 %)

• SOCIÉTÉ GÉNÉRALE                            (55.15 %)

• UNICREDIT                                           (52.03 %)

• CRÉDIT AGRÍCOLE                              (50.53 %)

BNP (43 91 %)• BNP                                                       (43.91 %)

• INTESA                                                  (41.86 %)

• DEUTSCHE BANK (36.99 %)DEUTSCHE BANK                                (36.99 %)

• ING                                                        (32.47 %)

• SANTANDER                                        (25.40 %)

• BBVA                                                     (22.00 %)       

KEY USA BANKS STOCK´s PERFORMANCE SINCE 01/02/2011

STOCK  MARKETSKEY USA BANKS STOCK s PERFORMANCE SINCE 01/02/2011

• BANK of AMERICA                                      (56.75 %)

• J.P MORGAN CHASE                                   (31.37 %)

• CITIGROUP  (after the June split 1:10)   (32.78 %)

WELLS FARGO (24 42 %)• WELLS  FARGO                                             (24.42 %)

• B. of NY MELLON                                         (58.53 %)

WHY EUROPEAN STOCK MARKETS FALL?

STOCK  MARKETS

WHY EUROPEAN STOCK MARKETS FALL?

• Sovereign debt, bond yield spreads and CDS:

Fears of a sovereign debt crisis of some European states members, Greece,Fears of a sovereign debt crisis of some European states members, Greece,Portugal, Ireland, and Spain (called PIGS). In the EU, in countries wheresovereign debts have increased sharply due to bank bailouts, a crisis ofconfidence has emerged with the widening of bond yield spreads and riskconfidence has emerged with the widening of bond yield spreads and riskinsurance on credit default swaps (CDS) between these countries andGermany.

• Toxic Assets:

Held in EU banking Assets such as: Greek debt mortgages and loans toHeld in EU banking Assets such as: Greek debt, mortgages and loans tosubprime borrowers, and foreclose mortgage‘s properties valued muchhigher than the market value.

• European countries and USA double deep recession fears:

Europe GDP growth forecast for 2011 at 1 5 %; USA: 2 5 %Europe GDP growth forecast for 2011 at 1.5 %; USA: 2,5 %

• Greece:STOCK  MARKETS

‐Deficit from 10.5 % of GDP in 2010 to  8.5 % in 2011‐Will miss target deficit in 2011and 2012‐Public debt: 142.8 % of GDP.

• Banking stocks are the biggest fallers in EU, on concernsabout their exposure to Greek government debt Greeceabout their exposure to Greek government debt . Greeceneeds the 8bn Euro' installment to avoid going bankruptthis month, October 2011.

• Bankruptcy would put severe pressure on the eurozone,damage EU bank finances and possibly have a serious knock‐damage EU bank finances and possibly have a serious knockon effect on the world economy.

• Portugal might be the next: Spain:

STOCK  MARKETSPortugal  might be the next:                   Spain: ‐Deficit: 9.1 % of GDP                                   ‐Deficit: 9.2% of GDP‐Public debt: 93 % of GDP                            ‐Public debt: 60.1 % of GDP 

• Germany: Italy:• Germany:                                             Italy:‐Deficit: 5 % of GDP                                       ‐Deficit: 6  % of GDP                          ‐Public debt:  83.2 % of GDP                        ‐Public debt:  120 % of GDPF UK• France:                                                  UK:‐Deficit: 8.5 % of GDP                                    ‐Deficit 6 % of GDP‐Public debt:  81.7 % of GDP                        ‐Public debt: 80 % of GDP

• USA:‐Federal Deficit: 10 % of GDP‐Federal debt:  92 % of GDP

Note: All deficit and public debt are related to 2010EU TARGETS for 2011: Debt not higher than 60 % of GDP,EU TARGETS for 2011: Debt not higher than 60 % of GDP,

Deficit not higher than 3% of GDP, andInflation not higher than 1.5 % above German inflation

• Stock market or equity market: is a concept of the mechanism that

STOCK  MARKETSq y p

enables the trading of company stocks, the world‐wide size: ~$ 52trillions, and other securities such as bonds and derivatives, theseare securities listed and traded in the stock exchange.are securities listed and traded in the stock exchange.

• Bonds are traded in the OTC (over‐the‐counter) bonds market, the size is~ $ 46 trillions. Commodities are traded in the commodities markets.

• Derivative instrument: A security or contract whose value is derived• Derivative instrument: A security or contract whose value is derivedor dependent from the value of some other underlying asset. The mainclasses of derivatives are: forwards, futures, options, and swaps.Th d i ti t t i diti itiThere are derivative contracts on currencies, commodities, equities,interest rates and others. Futures are traded on specific exchangemarkets such as: Chicago Board of Trade (CBT), EUREX, LIFFE, MATIF,and others.

• Trading: Participants in the stock market can range from individual

STOCK  MARKETSg p g

stock investors to large hedge fund traders. Some exchanges arephysical locations where transaction are carried out on a trading floor bya method known as an open outcry (stocks and commodity exchanges)a method known as an open outcry (stocks and commodity exchanges)the other method is via computer terminals. Actual trades are based onan auction market, where potential buyer bids a specific price for astock and potential seller asks a specific price for the stock Buying orstock and potential seller asks a specific price for the stock. Buying orselling at market means you will accept any ask price or bid for thestock respectively.

• Function : Stock market is one of the most important sources forcompanies to raise money, this allows business to go public andcompanies to raise money, this allows business to go public andraise additional capital for expansion.

• The Liquidity that  an exchange  market provides affords  investors  the ability  to quickly and easily sell a securities  as  compared to  less liquid investment as real state.

Capital markets:

STOCK  MARKETSCapital markets:

• Are the corporate stock markets including: common stocks, preferred stocks,convertibles securities, warrants etc. and long‐term‐debt markets such as theBond markets.

Primary markets:Primary markets:

• Are the markets in which corporations raise new capital.

The IPO markets:

• The initial public offering market is a subset of the Primary market. Here firms“ bli ” b ff i h t th bli f th fi t ti“go public” by offering shares to the public for the first time.

DEFINITIONS and KEY RATIOS STOCK  MARKETS

Market price :                                 EPS x PER

EPS (Earnings per share):    Net Income –Preferred Stock  dividendsNumber of shares outstanding

PER (a multiple):                      Share Price / EPS  

Market CAP:                    Market Price x nº Shares outstanding  

Price / Book:                                 Stock Price  Book Value  per share

Book Value:              Total Assets – Intangible Assets – Liabilities

STOCK MARKET

E t i V l M k t CAP P f d St k D bt C h• Enterprise Value:            Market CAP +Preferred Stock + Debt – Cash or Cash equivalent (Marketable securities)

• Enterprise Value / Revenues:         Enterprise ValueTotal Revenues

• Enterprise Value / EBITDA:              Enterprise ValueEBITDA

EBITDA:     Earnings before Interest, Taxes, Depreciation and Amortization

• Profit Margin (ROS): Net Income• Profit Margin (ROS):                            Net IncomeTotal Sales 

• Operating Margin:                                    EBIT   .T t l S lTotal  Sales 

• ROE:                                                         Net IncomeTotal Equity

EBIT:        Earnings before  Interest and taxes

Securities: Stocks and debt securities (bonds debentures)

STOCK  MARKETSSecurities:      Stocks and  debt securities (bonds, debentures)

Indexes:          NYSE,  Nasdaq,  STOXX50E, DAX,  FTSE, IBEX, Nikkei..

ll k k i d iBull market:   Average stock indexes are going up

Bear market:   The opposite of bull market

Rally:                 Temporary appreciation in value of stocks or  bonds

Correction:      Temporary depreciation in value of stocks or bonds  

Sell off:             Temporary correction of stocks  or  bonds

Fly to quality: Sell stocks and purchase Government bondsFly to quality:  Sell stocks and purchase Government bonds

Overpriced:      Current market prices are above acceptable P/E ratio.

U d i d Th i f i dUnderpriced:   The opposite of overpriced

Sell short:          Selling a stock without owing the stock (borrowed). Not allowed in some European countries.Not allowed in some European countries.

STOCK  MARKETS

TO WATCH

• S&P Futures:        Indication on how the market will open (webs: CNN‐Money, p ( y,Bloomberg)

• GDP, CPI, PPI:       Gross Domestic Product, Consumer Price Index and Production Price IndexPrice Index 

• Commodities:       Follow the price of  crude oil and copperIF the crude oil is going up the US $ will weaken against the €g g p g

• Reports:                 Consumer confidence and unemployment reports

• Recession: Two or more consecutives quarters of negative GDP• Recession:             Two or more consecutives quarters of negative GDP

• Stagnation:            No growth in terms of GDP and low inflation

• Higher inflation:   Interest rates will be moving up 

• Interest rates up:  Stocks prices  down and  Yield bonds up, then the bond priceswill go downwill go down

• Lower inflation:    The opposite of above

TECHNICAL ANALYSISSTOCK  MARKETS

CORRELATION:

• Is the relationship between two variables, the stock and the associatedpIndex, for example IBM versus NYSE Index.

• Stocks with a reduce correlation helps to minimize the RISK in theStocks with a reduce correlation helps to minimize the RISK in theportfolio. Stocks highly correlated to the Index will perform similarly tothe Index. Correlation moves between ‐1 and 1.

• When correlation figures are close to ‐1, it means the the stock and theIndex moves in opposite way (negative correlation).

• Correlation close to 1, it means that the stock and the Index move inthe same direction. Close to zero both the stocks and Index move indifferent direction.

VOLATILITY:

It is calculated by comparing the standard deviation of the stock´s monthly returto its appropriated Index.

STOCK  MARKETS

HOW COMMON STOCKS ARE VALUED

Cash payoff to owners of Common stocks comes in two

fforms:

• Cash dividends   and Capital gains or losses   

Rate of Return:Rate of Return:

The return that investors expect from this stock over next year is

defined as the expected Dividend per share DIV1 plus the expected

price appreciation of the stock (P1–P0) divided by the purchase

price P0.

1) M k t C it li ti t DIV1+ ( P1 P0)1) Market Capitalization rate:   r =    DIV1+ ( P1 – P0)

Po

2) r = DIV1 + g (Dividend growth)2)                                                      r      DIV1  g (Dividend growth)

P0

STOCK  MARKETS

PRICE OF THE STOCK:

If investors have the forecast on Dividends and

the Market Capitalization rate the Price of thethe Market Capitalization rate, the Price of the

stock P0 would be: 

1)     Price P0 =   DIV1 + P1 2) Price P0 =   DIV1) )1 + r                                      r – g

3)     Price P0 =  EPS1 / (r +PVGO)  ‐General formula‐

k i li ir: Market capitalization Rate

g: Dividend growth

PV GO : PV of growth opportunities = NPV1 / r ‐ gPV GO : PV of growth opportunities = NPV1 / r  g

STOCK  MARKETS

Lessons of Market Efficiency

• Market have no memoryMarket have no memory• Trust market prices• There are no financial illusions such as: stock splits and dividends, and

accounting changesaccounting changes.• Corporate finance alternatives, such  as: issue debt or common stock.• Fair return for its risk, in which the demand for one company’s stock

h ld b l ti if ti i k i i l l ti tshould be very elastic, if a prospective risk premium is lower relative toits risk than other stocks, nobody will want to hold that stock.. If itis higher, everybody will want to hold it.

EFFICIENT CAPITAL MARKETS

STOCK  MARKETSEFFICIENT  CAPITAL MARKETS

• If Capital Markets are efficient, then purchase or sale of any security at theili k t i i NPV t ti i ll l t dprevailing market price is a zero‐NPV transaction, since all relevant and

ascertainable information is already reflected in security prices.

NPV =    ‐ P0 (stock price)  +  DIV1 + (P1 ‐ P0) =  zero

11 + r   

RETURNS and RISK PREMIUMS: STOCK  MARKETS

( Risk)Average annual      Risk           StandardgRate of Return Premium Deviation

(σ)1. Common stocks (S&P 50) 11.3 8.8 22.4 %1. Common stocks (S&P 50)      11.3               8.8                 22.4  %2. Corporate bonds                        4.2               1.7                   5.63. Government bonds                   3.5                1.0                  5.74 Treasury bills (T bs) 2 5 0 2 14. Treasury bills (T‐bs)                   2.5                0                      2.1

‐Average Returns since 1929 University of Chicago.

Example:       Probability Distribution in businessSTOCK  MARKETS

Economic MeanOutcome Probab.x Invest.(1) ER% ERR(2) (1‐2)   Squared x Probab.=Variancestrong 0 3 40 % 12 10 30 900 0 3 270strong           0.3           40 %        12        10       30        900             0,3          270normal          0.4           25            10        10       15        225             0,4            90week             0.3  ‐40           ‐12 10      ‐50       2500            0,3          750

1 0 10% 1 1101.0 10%                                                              1.110

ER                                            =   Average Expected Return               ERR = Expected Rate of Return (mean)ERR                                               Expected Rate of Return (mean)VARIANCE  =   1.110

STANDARD DEVIATION (σ ) =      √  1.100      =  33.32 %( )

CV: (Coefficient of  Variation) =3,33  (Standard Deviation / ERR)

STOCK MARKET ALTERNATIVES:STOCK  MARKETS

• Investing in Stock, bonds or Treasury Bills (T‐bs)

• Investing in Investment/Mutual funds

• Investing in Stock OptionsInvesting in Stock Options

• Investing in Futures to HEDGE Long position in Stocks

Investing in Stocks: Highest Return, Risk and Risk PremiumSTOCK  MARKETS

Analyze:

• Market Prices and its Index, if you invest in top European companies iny p p p€, the Index would be the EUROXX50E. Beta 1 means same return asthe index.

• 52‐week high and 52 week low (buy low and sell high) and key returnsand statistics (web: Yahoo finance USA or local).

• Look into the Futures market in USA for the expected opening S&P,NASDAQ and NYSE (webs: CNN‐Money, Bloomberg, and Barchart).

• If the USA’s stocks trend is up European stock will follow or vise‐versaNYSE, NASDAQ, S&P 52‐week high and low.(if markets are at 52‐week high, these may have a correction).

To make money invest in November and sell in April (statistics).However, In a recession scenarios do not invest in stocks.,

Investing in Bonds/ T‐bills Lowest Return, Risk and Risk PremiumSTOCK  MARKETS

Analyze:

• The trend in interest rates since higher Yields means lower Prices• The trend in interest rates, since higher Yields means lower Prices

• For bonds , the Coupon is fixed up to Redemption date ( if the bond isll bl ) i hi h i b d id i knot callable). Invest in a higher rating bonds to avoid risk. AAA or AA

rating.

In a recession  scenarios invest in Bonds / T‐bills or cash.

Investing in Investment/Mutual Funds STOCK  MARKETS

Medium Return, Risk and Risk Premium

Analyze :• Lower risk than investing in individual stocks• Diversification and liquidity• Select the top market funds.

INVESTMENT FUNDS / MUTUAL FUNDS

STOCK  MARKETS

• Is a type of a company that brings together a group of investors andinvests their money in stocks, bonds, and other securities. Each investorowns shares (Mutual) or participations (Investment funds) which represent aowns shares (Mutual) or participations (Investment funds), which represent aportion of the holdings of the fund.

• Investors purchase funds because they don’t have the time or the expertiseInvestors purchase funds because they don t have the time or the expertiseto manage their own portfolios. It is relatively inexpensive for a smallinvestor.

Th i i i d h l l f RISK h h i i illi k• The investments is suited to the level of RISK that the investor is willing to take.

• DiversificationRISK is spread outRISK is spread‐out.

• Economies of scale:Its transaction costs are lower that what any individual would pay forIts transaction costs are lower that what any individual would pay forsecurities transactions.

• Liquidityq yIf you decide to sale the holdings, the cash value will be credited into youraccount in 48+ hours.

I ti i St k O ti

STOCK  MARKETS

Investing in Stock Options:

• Option Definition: A contract that grants the Holder the right (not thebli ti ) t BUY (C ll O ti ) SALE (P t O ti ) STOCK t ifi iobligation) to BUY (Call Option) or SALE (Put Option) a STOCK at specific price

(striking price) for specific period of time, for a PREMIUM payable up front.

B B k S llBuyer                                                   Banks    Seller HOLDERS OTC market                               WRITERS

(over‐the‐counter)Buyer of a CALL (Long Call)                             Seller of a CALL (Short Call)Risk Cost   Expectation Risk  Income ExpectationNon     Premium       up                                          Limited       Premium    down

(if owns the stock)Unlimited(if naked or uncovered)( )

Buyer of a PUT (Long Put)                                 Seller of a PUT (Short Put)Risk Cost Expectation Risk Income ExpectationRisk Cost  Expectation Risk  Income ExpectationNon    Premium      down                                      Unlimited  Premium     up

STOCK  MARKETS

Who can EXERCISE an OPTION ?

• ONLY the HOLDER who pays a PREMIUM up front to the WRITER• ONLY the HOLDER, who pays a PREMIUM up front to the WRITER,through a bank‐OTC‐market, the Premium cost is the maximum loss forthe Holder.

• IF a CALL Option is exercised by the Holder, the Writer has to sell thestock at striking price.

• IF a PUT Option is exercised by the Holder, the Writer has to buy thestock at striking price.

• A CALL Option will be exercised if the striking price < Market price

• A PUT Option will be exercised if the striking price > Market price• A PUT Option will be exercised if the striking price > Market price

• If a CALL or PUT Option is not exercised the Option is worthless

For a Call Option:

STOCK  MARKETSFor a Call Option:

IF  striking price is  <  than market price  =  In‐the‐money **

IF  striking price is  =  than market price  =  At‐the‐money

IF iki i i h k i O f hIF  striking price is  >  than market price  =  Out‐of‐the‐money

** the Call Option will be exercised at  “In‐the‐money”

For a PUT Options:STOCK  MARKETS

IF striking price is > than the  market price  = In‐the‐money **

IF striking price is = than the market price   = At‐the‐money

IF striking price is < than the market price = Out‐of‐the‐moneyIF striking price is < than the market price     Out of the money 

** the PUT Option will be exercised  at “ In‐the‐money “

Invest in the Futures marketSTOCK  MARKETS

• Futures markets are used by institutional investors, pension funds,investment/mutual funds and investors to HEDGE their Long portfolio

iti i t k itiposition in stocks or securities.

• If a portfolio manager fears that a bear market is imminent and wishest HEDGE hi tf li i t th t ibilit t t ld bto HEDGE his portfolio against that possibility, one strategy would beto liquidate the portfolio and place the proceeds into short‐term debtinstruments, however, the transaction cost would be quite high. Suchplan is infeasible.plan is infeasible.

• The European manager, however, could use the STOXX50E Index futurescontract in the EUREX market. By SELLING future contracts (Shortcontract in the EUREX market. By SELLING future contracts (ShortHedge) the manager could be able to offset the effect of the bearmarket on the portfolio by generating gains in the future markets.

• Futures markets are not OTC (over‐the‐counter) markets, the Futuresk t t li d i ifi h t d d k t h

STOCK  MARKETS

markets are centralized in specific exchange traded markets such as:EUREX (Zurich, Frankfurt), CBT (Chicago Board of Trade),LIFFE London International Financial Futures),LCE (London Commodity Exchange) ,NYFE (NY Futures Exchange),IPE‐ICE (International Petroleum Exchange) . . .( g )

• The Margins required and daily mark‐to‐market settlements are keyrequirements in the Futures markets.

• HEDGER: Is the trader that enters the Futures markets in order to reducea pre‐existing risk.

• ESPECULATOR: Is a trader who enters the Futures markets in search of aprofit and, by so doing, willingly accepts increased risk.