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And I called Kappa in the last 17 years. But you will hear people calling it a Vega. Obviously, probably more people calling it a Vega. But anyway, so that's my first day at Morgan Stanley. But why did I tell you this story? What point did I try to make? 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Someone needs to borrow money. So that's loan. Loan is really a private agreement between two counterparties, so multiple counterparties. When you securitize them, they become bonds. And when you look at bonds, every government issue large sovereign debt. 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They borrow money when they need to build a new factory or expand. Universities borrow money. When MIT needs to build a new building, some of the money will come from the endowment support. Some will come from some other form of research budget. Or some will come from debt financing, just borrow from the public. 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This has a lot to do with the real estate market, the mortgages, and asset-backed securities. And so I'm not trying to give you all the definition, dumping the information on you, but I like at least you're hearing it once today, then you have more interest you can read on the side. So asset-backed securities is when you have an asset"},{"chunks":[{"end":1020.44,"start":1020.0,"text":"You"},{"end":1022.04,"start":1020.44,"text":"basically"},{"end":1022.4,"start":1022.04,"text":"issue"},{"end":1022.44,"start":1022.4,"text":"a"},{"end":1023.6,"start":1022.44,"text":"debt"},{"end":1023.8,"start":1023.6,"text":"with"},{"end":1023.96,"start":1023.8,"text":"the"},{"end":1025.04,"start":1023.96,"text":"asset"},{"end":1026.16,"start":1025.04,"text":"backing"},{"end":1026.6,"start":1026.16,"text":"it."},{"end":1027.16,"start":1026.6,"text":"And"},{"end":1027.8,"start":1027.16,"text":"how"},{"end":1028.04,"start":1027.8,"text":"do"},{"end":1028.24,"start":1028.04,"text":"you"},{"end":1028.48,"start":1028.24,"text":"rate"},{"end":1028.88,"start":1028.48,"text":"the"},{"end":1030.0,"start":1028.88,"text":"asset's"},{"end":1030.4,"start":1030.0,"text":"risk"},{"end":1031.16,"start":1030.4,"text":"level?"},{"end":1031.28,"start":1031.16,"text":"And"},{"end":1031.64,"start":1031.28,"text":"what's"},{"end":1031.72,"start":1031.64,"text":"the"},{"end":1032.12,"start":1031.72,"text":"income"},{"end":1032.52,"start":1032.12,"text":"stream,"},{"end":1034.28,"start":1032.52,"text":"cash"},{"end":1035.4,"start":1034.28,"text":"flow?"},{"end":1035.92,"start":1035.4,"text":"And"},{"end":1036.48,"start":1035.92,"text":"before"},{"end":1037.56,"start":1036.48,"text":"2008"},{"end":1037.96,"start":1037.56,"text":"financial"},{"end":1039.08,"start":1037.96,"text":"crisis,"},{"end":1039.24,"start":1039.08,"text":"as"},{"end":1039.4,"start":1039.24,"text":"you"},{"end":1040.08,"start":1039.4,"text":"heard,"},{"end":1040.56,"start":1040.08,"text":"large"},{"end":1040.88,"start":1040.56,"text":"amount"},{"end":1041.4,"start":1040.88,"text":"of"},{"end":1043.0,"start":1041.4,"text":"CMBS,"},{"end":1045.2,"start":1043.0,"text":"basically"},{"end":1045.6,"start":1045.2,"text":"it's"},{"end":1046.56,"start":1045.6,"text":"commercial"},{"end":1046.96,"start":1046.56,"text":"real"},{"end":1047.44,"start":1046.96,"text":"estate"},{"end":1049.36,"start":1047.44,"text":"backed"},{"end":1049.96,"start":1049.36,"text":"securities."}],"text":" You basically issue a debt with the asset backing it. And how do you rate the asset's risk level? And what's the income stream, cash flow? 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And further, of all these, you heard probably a lot about the derivative products. So that started with swaps, options, and the structured products. It could become more tailor-made for either investors or borrowers to structure the products in a way to suit their needs. 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So that's how banks are organized. Outside banks, other players, basically the asset managers, are obviously a very big force in the financial markets. So the question a lot of people ask is, is this a zero-sum game? 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That's really coming down to the essential relationship. So investors who have money need to have better yield or better return, better interest. In the current environment, when you have a savings account, you know you don't really earn much at all. And so you would have to take more risk to generate more return. 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So when you or some end user go to the market, wants to buy or sell, typically if there's no market, you don't really find the match. And some of the products you want to buy or sell may not necessarily be liquid. So the dealers step in the middle, make you a price. Say, OK, you want to buy or sell? I can tell you this stock. 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So that's the price I'm willing to buy or sell. But the result of the trade, the dealer actually takes the other side of your trade. So they take principal risk in this case. So that's the difference between dealers and the brokers. 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Or your corporate has a large income coming from Europe. So you have euros coming in, but you're not sure if euro will trade stronger to the US dollar in the future or trade weaker. If you think it will be stronger, you just leave it. 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So let me just go in details of how each type of trade actually occurs. So when we talk about hedging, I mentioned the currency example. Let me give you another example. A lot of people issue bonds or issue debt. 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So typically, people like to borrow money in Japan because you pay smaller interest. And then invested in Australia, you earn higher interest rate. So let me ask you a question. 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Then that interest rate, I'm giving you an example of a difference is about 3 and 1 half percent for the 10 year, roughly, 10 year swap rates. Why don't, yeah, go ahead. You can exchange the exchange rate back. Right. Because you invest in the Australian Aussie, right, Australian dollar. The Australian dollar may become weaker to the yen. 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So let's say you think that's the right time to do it. But then at one time you wake up, you say, huh, I think too many people are doing this. I want to hedge myself. So what do you do? . Yep. So you try to lock in, right? 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On the interest rate terms, you say you basically pay the Australian dollar in the swap leg and receive yen. So this involves foreign exchange trade, interest rate swap, and the cross-currency swap. 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Even if you are not a finance guy, you work in a corporate, you just do input, export, or building a factory, you have to know actually what exposure is. So risk management nowadays becomes pretty widespread responsibility. It's not just the corporate treasuries responsibility. So that's on the hedging side. 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Stat op, finding statistical relationship among large number of stocks, then trade at higher frequency. And fundamental analysis, you really try to understand what's going on in the world. What is the trade balance? What is the earning potential of a company? 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What does it mean when Federal Reserve announced they're going to taper the quantitative easing? Why the stock market sold off in the last couple of months? Especially why stocks in India, Brazil, Indonesia sold out more? Why is that? So you have to go through those fundamental analysis. And there are special situations. 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So there are firms out there. You probably heard Bain Capital and many others. They focus on these private equity and special situation opportunities. So what have all these to do with mathematics? Where does math come in? How do you use math?"},{"chunks":[{"end":2460.4,"start":2460.0,"text":"I"},{"end":2460.76,"start":2460.4,"text":"want"},{"end":2460.76,"start":2460.76,"text":"to"},{"end":2460.8,"start":2460.76,"text":"give"},{"end":2461.2,"start":2460.8,"text":"you"},{"end":2461.48,"start":2461.2,"text":"some"},{"end":2461.92,"start":2461.48,"text":"aspects"},{"end":2462.08,"start":2461.92,"text":"of"},{"end":2462.28,"start":2462.08,"text":"that."},{"end":2462.92,"start":2462.28,"text":"So"},{"end":2463.6,"start":2462.92,"text":"from"},{"end":2463.96,"start":2463.6,"text":"my"},{"end":2464.44,"start":2463.96,"text":"personal"},{"end":2465.84,"start":2464.44,"text":"experience,"},{"end":2466.16,"start":2465.84,"text":"I"},{"end":2466.44,"start":2466.16,"text":"joined"},{"end":2466.64,"start":2466.44,"text":"the"},{"end":2467.28,"start":2466.64,"text":"market"},{"end":2467.6,"start":2467.28,"text":"really"},{"end":2468.08,"start":2467.6,"text":"started"},{"end":2468.4,"start":2468.08,"text":"working"},{"end":2468.48,"start":2468.4,"text":"on"},{"end":2468.96,"start":2468.48,"text":"pricing"},{"end":2469.28,"start":2468.96,"text":"models."},{"end":2469.84,"start":2469.28,"text":"So"},{"end":2470.16,"start":2469.84,"text":"that's"},{"end":2470.28,"start":2470.16,"text":"the"},{"end":2470.64,"start":2470.28,"text":"first"},{"end":2471.52,"start":2470.64,"text":"area."},{"end":2471.68,"start":2471.52,"text":"So"},{"end":2472.44,"start":2471.68,"text":"math"},{"end":2472.64,"start":2472.44,"text":"is"},{"end":2473.0,"start":2472.64,"text":"very"},{"end":2473.48,"start":2473.0,"text":"effective"},{"end":2473.92,"start":2473.48,"text":"because"},{"end":2475.56,"start":2473.92,"text":"when"},{"end":2476.0,"start":2475.56,"text":"you're"},{"end":2476.24,"start":2476.0,"text":"a"},{"end":2476.68,"start":2476.24,"text":"bank"},{"end":2477.04,"start":2476.68,"text":"or"},{"end":2477.56,"start":2477.04,"text":"you're"},{"end":2477.56,"start":2477.56,"text":"a"},{"end":2478.36,"start":2477.56,"text":"corporate,"},{"end":2478.92,"start":2478.36,"text":"you"},{"end":2479.28,"start":2478.92,"text":"want"},{"end":2479.56,"start":2479.28,"text":"to"},{"end":2479.84,"start":2479.56,"text":"buy"},{"end":2480.16,"start":2479.84,"text":"some"},{"end":2481.08,"start":2480.16,"text":"financial"},{"end":2481.76,"start":2481.08,"text":"instruments."},{"end":2481.76,"start":2481.76,"text":"You"},{"end":2482.08,"start":2481.76,"text":"have"},{"end":2482.16,"start":2482.08,"text":"to"},{"end":2483.68,"start":2482.16,"text":"know"},{"end":2483.88,"start":2483.68,"text":"where"},{"end":2484.28,"start":2483.88,"text":"is"},{"end":2484.44,"start":2484.28,"text":"the"},{"end":2485.52,"start":2484.44,"text":"price."},{"end":2485.92,"start":2485.52,"text":"It's"},{"end":2486.16,"start":2485.92,"text":"easy"},{"end":2486.24,"start":2486.16,"text":"to"},{"end":2486.8,"start":2486.24,"text":"observe"},{"end":2486.96,"start":2486.8,"text":"a"},{"end":2487.56,"start":2486.96,"text":"stock"},{"end":2487.6,"start":2487.56,"text":"in"},{"end":2487.72,"start":2487.6,"text":"the"},{"end":2488.08,"start":2487.72,"text":"market,"},{"end":2488.28,"start":2488.08,"text":"but"},{"end":2488.72,"start":2488.28,"text":"when"},{"end":2488.72,"start":2488.72,"text":"it"},{"end":2489.36,"start":2488.72,"text":"comes"},{"end":2489.96,"start":2489.36,"text":"to"}],"text":" I want to give you some aspects of that. So from my personal experience, I joined the market really started working on pricing models. So that's the first area. So math is very effective because when you're a bank or you're a corporate, you want to buy some financial instruments. You have to know where is the price. 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When you go to the market, you buy a stock. When the stock goes up, makes a bit of money, the natural tendency for especially someone who is new to the market is to, let's take profit. Let's sell. Oh, I made $1,000. I made $500. Let's go have a nice meal or whatever. Buy an iPad. 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I mean, the last day of the class, hopefully we have much deeper discussion on this. It's not unique. The answer, OK, I think it can go either way. 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And largely, often, this is art than science. So keep that in mind, even though we're talking about mathematics in finance. Math is very powerful and useful in finance. So learn the math, learn the finance first. But keep those questions along the way when you are learning during this class. 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And basically what we had, we had the noise observation of broker data. And it was coming on at different non-uniform times, basically at random times. 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Just to remind, the website is fully functional. We put syllables there, a short list of literature. We will be posting a lot of materials there. Probably most lectures will be published there. Jake's slides are there already. 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So we like to get you emails so we can put you on the website for the further announcements. But you can also add yourself, I believe. But it's probably easier if you put your email on the sign-up sheet. Yeah, but please visit and sign up here because there will be announcements to the class. All right. Thank you very much."}]}} |