“Warren Buffett is the world’s most successful investor. In a letter he wrote to his wife, advising her how to invest after he dies, he offers some clear advice: put almost everything into “a very low-cost S&P 500 index fund”. Index funds passively track the market as a whole by buying a little of everything, rather than trying to beat the market with clever stock picks – the kind of clever stock picks that Warren Buffett himself has been making for more than half a century. Index funds now seem completely natural. But as recently as 1976 they didn’t exist. And, as Tim Harford explains, they have become very important indeed – and not only to Mrs Buffett.”
From November 2016 through October 2017, Financial Times writer Tim Harford presented an economic history documentary radio and podcast series called 50 Things That Made the Modern Economy. This same information is available in book form under the title “Fifty Inventions That Shaped the Modern Economy“. While I recommend listening to the entire series of podcasts (as well as reading the book), I would like to call your attention to Mr. Harford’s episode on the topic of insurance, which I link below. This 9-minute long podcast lays out the history of the development of the various institutions which exist today for the sharing and trading of risk, including markets for financial derivatives as well as for insurance.
“Legally and culturally, there’s a clear distinction between gambling and insurance. Economically, the difference is not so easy to see. Both the gambler and the insurer agree that money will change hands depending on what transpires in some unknowable future. Today the biggest insurance market of all – financial derivatives – blurs the line between insuring and gambling more than ever. Tim Harford tells the story of insurance; an idea as old as gambling but one which is fundamental to the way the modern economy works.”
I highly recommend John Cochrane’s January 2019 article entitled “Volatility, now the whole thing” which builds and expands upon yesterday’s implied volatility topic in Finance 4335. Dr. Cochrane is a senior fellow at Stanford University’s Hoover Institution and was formerly a finance professor at Univ. of Chicago. Cochrane’s article provides a broader framework for thinking critically about the implications of volatility for future states of the overall economy. This article is well worth everyone’s time and attention, so I highly encourage y’all to read it!
The CFA Institute grants “Affiliated Schools” such as Baylor several scholarships per year in accordance with Official Scholarships Rules. Scholarship awards reduce the CFA Program enrollment and exam registration fees to $350, which includes the eBook curriculum.
Candidates should (1) submit the application form on the CFA Institute website and (2) email Brandon_Troegle@baylor.edu prior to January 30, 2019, though earlier applications are encouraged. In the body of the email, please include:
• A summary statement on why you should be considered for the scholarship. This statement should include what you hope to achieve by pursuing the CFA charter, your career goals, and you can discuss academic achievements/performance including GPA information in you wish.
• Expected graduation date
• Did you apply for the Access Scholarship (the other scholarship)? If not, why not?
• Any other information you believe will aid in the scholarship decision
What is the evaluation process and criteria?
Awards will be made based on a combination of factors including interest in and rationale for pursuing the CFA charter, academic accomplishments, and other personal characteristics that indicate the applicant is a strong scholarship candidate.
“Companies on the S&P 500 have poured more than $5.3 trillion into repurchasing their own shares since 2010. WSJ explains how stock buybacks work, and why there’s debate over whether or not they’re good for the economy.”
Besides going over the course syllabus during the first day of class on Tuesday, January 14, we will also discuss a particularly important “real world” example of financial risk. Specifically, we will look at the relationship between stock market returns (as indicated by daily percentage changes in the SP500 stock market index) and stock market volatility (as indicated by daily percentage changes in the CBOE Volatility Index (VIX)):
As indicated by this graph from page 21 of the lecture note for the first day of class, daily percentage changes on closing prices for VIX (which is the x-axis variable) and the SP500 (which is the y-axis variable) are strongly negatively correlated. The blue points represent 7,557 daily observations on these two variables, spanning the time period from January 3, 1990 through December 27, 2019. When we fit a regression line through this scatter diagram, we obtain the following equation:
where corresponds to the daily return on the SP500 index and corresponds to the daily return on the VIX index. The slope of this line (-0.1126) indicates that on average, daily VIX returns during this time period were inversely related to the contemporaneous daily return on the SP500; i.e., when volatility as measured by VIX went down (up), then the stock market return as indicated by SP500 typically went up (down). Nearly half of the variation in the stock market return during this time period (specifically, 48.91%) can be statistically “explained” by changes in volatility, and the correlation between and comes out to -0.7. While a correlation of -0.7 does not imply that and always move in opposite directions, it does suggest that this will be the case more often than not. Indeed, closing daily returns on and during this period moved inversely 78.44% of the time.
Throughout the semester, I will often reference specific WSJ articles on the course blog and in class. Finance 4335 topics (as well as topics in many of your other business school courses) come to life in the world outside the Baylor bubble when you read make a habit of reading the WSJ on a regular basis. Furthermore, if you expect to interview for jobs or internships anytime soon, reading the WSJ will give you a leg up on the competition, since you will be better informed and have more compelling ideas and insights to share with recruiters.
In closing, the following (2 minute) video provides a helpful introduction to the WSJ, providing time-saving tips to help you get the most from WSJ and succeed not only in Finance 4335 but also your other courses and careers: