1. Introduction, Financial Terms and Concepts

1. Introduction, Financial Terms and Concepts

Introduction (00:03:00)

  • The aim is to provide basic knowledge about financial markets and terminologies
  • Majority of attendees are undergraduate students (80%) and graduate students (20%)
  • Audience background varies from finance, math, engineering, and other majors, including attendees from other universities
  • The professor encourages communication through emails and office visits for feedback on class pace and content clarity
  • A personal story is shared highlighting the evolution of finance from a non-quantitative field to one dominated by professionals with strong mathematical and computer science backgrounds
  • Concepts in finance are to be understood as rapidly evolving over the past 30 years rather than being definitive truths
  • Financial markets began with the exchange of goods, leading to centralized stock exchanges and OTC (over-the-counter) trading
  • It is emphasized that currency is also traded, with different countries having specialized exchanges for local products

Trading Stocks (00:13:52)

  • Stocks can be traded individually or as part of baskets called stock indices
  • The process of a company going public is through an IPO (Initial Public Offering), representing a transition from a private to a public company

Primary Listing (00:14:20)

  • Secondary trading occurs after a stock is listed on an exchange.
  • Financial products include equities, loans, bonds, and commodities.
  • Bonds are issued by governments and corporates for various financing needs.
  • Commodities are traded mostly as futures, with physical handling like warehousing.
  • Asset-backed securities use assets to issue debt, important in the 2008 financial crisis.
  • Derivative products like swaps and options are complex and tailored for specific needs.
  • Banks, following the Glass-Steagall repeal, consist of commercial banks and investment banks, which are involved in various financial services.
  • Investment banks are structured into fixed income, equities, and the Investment Banking Division (IBD).
  • Asset managers are major financial market participants.
  • Financial markets can be viewed as a zero-sum game with winners and losers based on trades and markets.

Why We Need the Financial Markets (00:20:44) & Market Participants (00:22:21) & What Is Market Making (00:22:28)

  • Financial markets exist to connect lenders with borrowers for capital access.
  • Investment leads to potential higher returns compared to basic savings.
  • Market participants include banks, dealers, brokers, and various types of investors.
  • Dealers facilitate market making by providing liquidity and taking the opposite side of trades as principal risk.
  • Brokers match buyers and sellers to earn commissions without taking principal risk.
  • Mutual funds, insurance companies, pension funds, and sovereign wealth funds invest capital for returns.
  • Hedge funds look for profit opportunities through various strategies.

Hedge Funds (00:24:37) & Market Maker (00:27:33)

  • Hedge funds employ different strategies to capitalize on market inefficiencies.
  • Private equity invests in companies for operational improvements and profitability.
  • Governments influence markets through policy and interest rates.
  • Corporations hedge against market changes via financial instruments.
  • Trading types include hedging existing exposures, market making for bid-offer profit, and proprietary trading, which is restricted under new regulations.

Proprietary Trader the Risk Taker (00:28:19)

  • Hedge funds and portfolio managers focus on generating returns and controlling risks using alpha and beta metrics.
  • Beta represents the correlated movement with a benchmark index, while alpha denotes the return above the benchmark.
  • Hedging strategies, such as currency hedging, are used to lock in costs or returns and mitigate risk.
  • Examples include borrowing in a currency with a lower interest rate (Japan) and investing in a currency with a higher rate (Australia), while hedging against potential currency fluctuations.
  • Entities like corporations and banks must manage risks including currency exposure, interest rates, and assets vs liabilities on balance sheets.

Trading Strategies (00:42:44)

  • Market making provides liquidity and involves managing risk by balancing 'Greeks' like delta, gamma, theta, and vega, which describe various sensitivities in a trading portfolio.
  • VaR (Value at Risk) and capital usage are important concepts for evaluating risk and financial stability.
  • Various trading strategies include directional trading, arbitrage, value trading, systematic trading, and high-frequency trading.
  • Fundamental analysis, special situations, and private equity are other approaches.
  • Mathematics plays a crucial role in financial markets in areas like pricing models, risk management, and developing trading strategies.
  • Perpetual profit-making trading strategies do not exist; strategies require constant research and adjustment to remain effective.

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