This document provides an overview of an introduction to financial economics class, including quizzes on foreign exchange rates and the Philippine stock market. Key points covered include definitions of exchange rates, the Philippine dealing system for currency trading, methods for valuing stocks, and diversification as a strategy to reduce risk. The document concludes with computations and homework assignments related to the course material.

1. INTRODUCTION TO FINANCIAL ECONOMICS May 18, 2011

2. QUIZ Use a size 2 Will start at exactly 7:31am Part 1 – 5 minutes Part 2 – 10 minutes

3. QUIZ PART 1: IDENTIFICATION 1. How much you’re willing to pay for $1. 2. When a bid and an offer is equal, trade happens. This is called a ____. 3. Buying money at low price, selling it at a high price. 4. Clearing house for the Phil. Forex Mkt. 5. If your impaired capital is $425M, what is the max amount you can trade?

4. QUIZ PART 2: EFFECTIVE EXCHANGE RATE Given the ff hypothetical data, compute and interpret the effective exchange rate. Show all solutions (weight, index, EER).

5. BONUS Using P43.36/$ as reference rate Place a bid and an offer Any two people with matching bids and offers will get 2 points each DON’T COLLUDE.

6. Intro to the ForEx Market Foreign Exchange Market – market in which individuals, firms and financial institutions buy and sell foreign currency

7. Intro to the ForEx Market Types: End users – Banks Bank – bank (bulk) Bank – Central Bank (BSP)

8. Philippine Dealing System Online 9:00am-4:00pm Weighted average Volume Clearing house at Citibank Traders are anonymous Lower is high

9. 16 Nov 2010: P46.90/$ Open: P46.9/$ $100 (volume) Close: P47.9/$ $100 (volume) $200 Always look at volume Weighted ave today is reference rate tomorrow

10. BID/OFFER Each trader places a bid/offer Bid – how much you’re willing to pay for $1 Offer – how much you’re willing to sell $1 Max bid < Max offer

11. BID/OFFER

12. Currency Arbitrage Buy low, sell high Make money by shuffling money

13. RULES Each trader deposits PHP and USD in Citibank (clearing house) Impaired Capital Each trader can only buy/sell a maximum of minimum, either ($50M or 20% of impaired capital)

14. RULES Whatever is smallerbetween $50M or 20% of impaired capital is your trading limit. Bank A $500M, $50M, $100M (20%) Bank B $200M, $50M, $40M (20%)

15. 2% - 1% - 1% bands If exchange rate reaches +/- 2%, trading stops for two hours Someone might be speculating/panic Dirty flexible exchange rate Creates sort of stability Avoids speculation

16. FOREX SUPPLY AND DEMAND Exchange rate – price of domestic currency per unit of foreign currency Phil – US: P/$ Phil – Japan: P/Y

17. FOREX SUPPLY AND DEMAND Flexible/floating exchange rate Exchange rate that is market determined Depreciation Appreciation

18. FOREX SUPPLY AND DEMAND Fixed Exchange Rate Exchange rate that is artificially determined Devaluation Revaluation

19. EFFECTIVE EXCHANGE RATE Measure of overall performance of domestic currency Able to figure out if Peso is weak or $ is strong

20. EFFECTIVE EXCHANGE RATE Measure the weight/importance of each Index the forex rates by dividing current year rate by base year rate Multiply weight and index If EER goes down, P appreciates

21. INTRO TO FINANCIAL ECO Securities and equities Bonds, stocks, T-bills Investment, market value, dividends

22. STOCK MARKET Stocks – part ownership of a firm Stockowners are part owners Primary Market – stocks are sold to market for the first time (IPO) Secondary Market – where stocks (IPOs, SOs) are sold again NYSE, PSE, NASDAQ

23. PRIMARY MARKET Initial Public Offering (IPO) – initial stocks signed in with SEC Seasoned Offerings – new pieces of paper sold by listed companies

24. SECONDARY MARKETS New York Stock Exchange (NYSE) Dow Jones Industrial Average $18B/day NASDAQ – online NASDAQ Composite Index $14B/day Before 2001 financial crisis, bigger than NYSE

25. SECONDARY MARKETS London Stock Exchange FTSE – “footsie” $7B/day Philippine Stock Exchange Composite Index 30 biggest listed representatives of major industries P5B/day = $113M

26. PHILIPPINE STOCK EXCHANGE Relatively a young and small market Opens at 9:00am, closes at 12:00nn Two floors: Makati, Manila

27. DIVIDENDS Periodic payment from the firm to its shareholders Cash dividend Stock dividend

28. VALUATION OF STOCKS BOOK VALUE Equity divided by the number of shares Accountant’s value * given (exogenous), can’t be changed Example Assets = P100M*, Debt = P25M*, Equity P75M* Outstanding shares = 50M* pieces

29. VALUATION OF STOCKS LIQUIDATION VALUE Net proceeds that would be realized by selling the firm’s assets and paying off it creditors Once the firm is sold, it is no longer the firm, value is now market determined

30. VALUATION OF STOCKS LIQUIDATION VALUE Example: Assets = P110M Debt = P25M* Outstanding shares = 50M* pieces Solve for equity, price per share

31. VALUATION OF STOCKS MARKET VALUE Amount that investors are willing to pay for the shares Open market Investors place a value on your stock

32. VALUATION OF STOCKS MARKET VALUE Example: Price per share = P2 Outstanding shares = 50M* pieces Debt = P25M* Solve for equity, solve for assets

33. HOW DO INVESTORS VALUATE A STOCK? Compute for a rate of return Use this to compute for Price Price = present value of all future stream of income from that stock Present value = value today

34. HOW DO INVESTORS VALUATE A STOCK? Problem: define P0 by P1 Price today is defined by price tom Defining it by itself Solution: Efficient Valuation of Stocks by Robert Lucas

35. PAYOUT RATIO Dividend divided by earnings per share (EPS) Percentage of that you receive Ex: Stock worth P10, with EPS = P1, dividend = P0.25

36. PLOWBACK RATIO Retained earnings divided by EPS Percentage that is kept in the firm Plowback ratio = 1-payout ratio Ex: P10 stock, EPS = P1, Payout = P0.25

37. RETURN ON EQUITY (ROE) Growth of firm per peso of retained earnings Every peso of retained earnings is reinvested and adds to growth of firm

38. DIVERSIFICATION Strategy designed to reduce risk by spreading portfolio across many investments Each investment has risk GOAL: Minimize risk σ = risk

39. DIVERSIFICATION Risk is eliminated Risk is not changed Risk is halved Risk is reduced but rate of return reduced

40. TECHNICAL TRADING RULES Rules followed by traders to buy, sell or hold cash Depend on historical patterns

41. HOW TO PROFIT IN THE STOCK MARKET Buy low, sell high Don’t trade on a daily basis “Noises” cancel out earning daily Invest in the long run

42. COMPUTATION = Size 4 Company A Price today x # of shares bought Company A Price today x # of shares bought Company A Price today x # of shares bought TOTAL EARNINGS = _____

43. HOMEWORK Tom: 2 pcs, 5x8 or ½ index cards (with or without notes yet) USB (clean) with video CD (with names) with video Whoever’s bringing the USB for your group should come to class by 7:20am.