I've watched all the videos in this series so far and its incredible what you can learn from youtube. Thank you MIT! I want to see more stuff like this that is finance/economics related.
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Long-Term Capital Management (LTCM) lost U.S. dollars 4.6 billion in fixed income arbitrage in September 1998. LTCM had attempted to make money on the price difference between different bonds. For example, it would buy U.S. Treasury securities and sell Italian bond futures. The concept was that because Italian bond futures had a less liquid market, in the short term Italian bond futures would have a higher return than U.S. bonds, but in the long term, the prices would converge. Because the difference was small, a large amount of money had to be borrowed to make the buying and selling profitable
23:45 "buffett just invested 5 billion on goldman sachs" (btw buffett made a 3 billion profit on that deal). It is extremely interesting to compare with 2020 crisis where buffett is selling all his banks' shares
yes I'm finding this extremely interesting, getting to understand the basics of Finance while learning about the crisis in 2008 in real time v. the unfoldings and parellels of 2020 in real time.
@@RaylinRecords Yes indeed ! I find very interesting as well, and these classes are amazing. In 2008 was mainly a financial crisis, driven mostly by the crashes in the financial institutions and government'-debt. So at that crisis, there were a more evident way to "fix" the economy: - inject money on failing institutions, - perform austerity, and -add new strong regulation. Whereas the crisis of 2020 is a humanitarian crisis, driven by the changes of human behavior (due to the pandemic), so that is a much more complex crisis in my opinion. It's a much more painful crisis, as we have no idea when all of this will finish (and in 2008 we had at least some estimates for the end of the crisis). I recommend you: Aswath Damodaran classes in youtube, they are also great!
@@luizfiorentini9522 I was looking at classes from that professor. I will start watching his classes after this course. I agree and think it's especially important to note what the large cap industries are doing now, expanding and investing more than several past years. The wealthy companies are using this as an opportunity to purchase stocks. From the Warren Buffet example, we can see this is a similar parallel, and I think it's important to note that when the market is crashing/down, large companies buy in.
@@RaylinRecords oh yeah definitely, u are definitely right. In time of crisis there are large investments made, especially because alot "very good" stocks are sold in discount (cause the markets crashes pushed them down) plus some large cap get even bigger (new demand and/or competitors going bankrupt). Bill Ackman for example invested and profited heavily during this crisis (his interviews about investing are great btw), Buffett abandoned airlines and banks, and invested heavily in gold (among multiple others investments for sure). Anyways enjoy ur lectures, I really like Damodaran, as much as these MIT classes, cause he is like a "bridge" between the "Academic Finance vs The real world finance" (as real world investors dont use most of academic stuff taught on universities/business schools). Cheers
Explaining slope and curvature of a non-linear function without drawing a graph and calculating it, is not optimal teaching. Other than this, it is cool to watch
On min 1:11:10 it says in red "Note: If the yield moves up by 0.1% the bond price decreases by 0.6860%". But according to the modified Duration, shouldn't the Price decrease by 0.6924% instead? Also, I plotted everything on excel and after simulating the exact Price at 3.1% yield, the result is of a real decrease in 0.6896%. Does anybody knows how did the professor get the 0.6860% presented? (edited) Solution: The problem is I was using all the decimals on excel, whereas the professor only used 2 decimals to compare the decrease in real simulated price at 3.1% to the one at 3.0% yield, which if you do it on excel, it will round it up to 0.6860% : (102.79 - 103.50)/103.50 = 0.68599... ~ 0.6860%
@@rohitjain4124 102.79 is just the price of the bond if you discount all the cash flows at a yield of 3.1% (3.0% + 0.1%). And the 103.50 is the bond price calculated at yield of 3.0%. Therefore, (102.79 - 103.50)/103.50 ~ -0.6860% represents the "real" calculated decrease in bond price when the yield to maturity increases by 0.1%. In other words, this demonstrates that D*= 6.92% is a good estimate in price decrease after a yield increase of 1% (linear approximation), which would be the same as saying it would decrease in 0.692% as a consequence of a yield increase of 0.1%. Finally, we can conclude that 0.686% (real calculated change in price) is very close to 0.692% (estimated change in price) after using a linear approximation of the Macaulay duration D*. Moreover, if you would like to use even a better approximation than this linear one of D*, that's what he explains about on min 1:12:10 when he mentions about creating a higher order approximation by including the convexity component into the equation. In simple words, it constructs a curve rather than a straight line, which provides a better estimate for a change in Price value% after a change in yield%. I hope this helps to clarify all your questions. Blessings.
the public market is smart and dumb at the same time it sometimes acts contrary to logic because of a misbelief so two identical cash flows could in theory command different market prices. When dealing with institutional investors, maybe they make the same cost assumptions (especially theoretically when dealing OTC).... just guessing here
At 40:38, is it true that without short-selling one cannot do arbitrage trades? I could borrow over-night a sum to buy the cheaper bond; and then sell the same bond at a higher price and pocketing the difference. Because I borrowed money over-night I will have to pay a small interest, the same interest I am paying my broker for short-selling.
That's exactly what he means by short-selling a bond with higher price and equal cash flows in this example (borrow money with same terms of payment but you get more money than what you have to lend, so you get a margin). However the situation he illustrates is when regulators do not allow you to borrow money or assets (short-selling) anymore and take advantage of any of these arbitrage situation. He later explains this happens when there is an economic turmoil and you do not want people to start betting against the fall of enterprises which can increase the possibility of companies to go bankrupt and contribute to disrupt the economy during a crisis, or even in later lectures, he explains that sometimes short-selling of assets can be restricted due to the pure nature of the business (e.g. pension funds), since short-selling strategies do not have a loss limit and can be very risky. However, in our business mindset this still doesn't make sense, but regulators do that anyway because they see it as a "normative" action that is right to do in order to keep markets (or certain participants) under control on different circumstances, and that's exactly the point the professor argues. Later between mins 42 and 50 of this lecture he explains that he would suggest to better increase the transaction costs rather than prohibiting them, so that only those who really really need to sell certain assets, can still do it.
two identical cash flows can have different market values.... suppose one financial instrument is based in sharia law and another in common law but the cash flow is the same.....the market value might be different bc of a cultural difference if you're dealing in a cash flow based on entertainment for example???? but maybe I'm wrong, I'm just guessing here.
@@LifeHacks-pl9wv well, if the size of the market and the average amount spent in those markets are different then you have a different potentials for the cash flow. Take for instance an international Disney movie, it's already produced and marketed and sent to theater's globally. However the different regions have different cultures and markets and responses to the same product. The cash flow is from the ticket in both markets but it has different market value For one thing in one instance the movie might technically be illegal but still available so it generates different a revenue..
@@LifeHacks-pl9wv in another instance the movie might just be less desirable because it's not a cultural fit, so then it would generally be less well received but the product is the same and the algorithm used to describe how you will be paid is the same... But it will pay you less or maybe even more ...
Another reason is because the cash flow isn't guaranteed it's just assumed to be a viable investment ..... the cash flow is subject to certain constraints so the cash flow model or expected return is stated as a constant but in the real world the income on for the security could vary. Im not sure what type of security/product he's talking about. If he's talking about a bond with a fixed coupon or something like that (you might end up using a covenant if you miss a revenue projection and cannot make the payment).
@@LifeHacks-pl9wvi think what im saying is the book value and the market value of that asset will be different and also the two market values for those assets will not match up if they are in different regions of the world.
I saw that post on Superstonk several days ago and I watched all the videos up to this one so far. I am grateful to have been led here, this guy is so easy to listen to
See the course on MIT OpenCourseWare for the complete materials: ocw.mit.edu/15-401F08 The problem set might not be there unless it is in the other material. There are lecture and recitation slides, and exams (with solutions) available.
You'd choose based in the risk you are willing to take on and how long you are willing to wait, if you mean $spy you will more then likely make money but how long will that take?
There are many videos on youtube where you can find in greater detail excellent explanations about each one of these concepts. However, if you'd like having a high-level explanation here (and you already understand a bit of calculus) please think of them as follows: the average time to maturity weighted on cash flows. The larger the cash flows in later periods, the longer then will be the avg time to maturity. the 1st derivative of the Price with respect to the yield, which incorporates the Macaulay duration as the basis for the calculation. This constructs a "linear" approximation of price vs yield. 2nd derivative of Price with respect to the yield which will help to construct a better "curved" approximation of price vs yield. : a more accurate bond price vs yield estimate through a curve plot, where only the first 2 terms of the expression are generally being used for simplicity (1st term is-Modified duration- and 2nd term is-Convexity-). Blessings.
Well, if you pay a premium on a fixed income security and another person doesn't on that SAME fixed income security. That means the other guy is better off then you are. And with these 200 equations you are looking for the 'premiums' so you can shortsell them and buy the ones without a 'premium' (this means you have the premium as a PROFIT, with all the other cash flows being equal). But BTW, I'm not sure if you talk about 'premiums' in fixed income securities, since you won't ever get rewarded for it (you just pay more to get the same).
I've watched all the videos in this series so far and its incredible what you can learn from youtube. Thank you MIT! I want to see more stuff like this that is finance/economics related.
Jets tswsthu uu jjjuluhl”$& u jkjijtv ewkktfjd7$$7$7$$$7 juju uh huh. Hi uh ight v. Skin I jqjkjjjwimkkii b uu. HbbuotKjijjjjjjjjjjjsinnjj juju klmkkjj mjiiii wan h
@@AsielDimas ffiiigggiiiiiiiiiigiiiiiiiiiifiiiiiiiiiiiifw
4:13 there is loud high pitched screeching audio feedback. Skip over it to save your ears.
This dude woke up today and decided to be an mvp. Thx man
important
Yearly rewatch, best series I’ve found
We need a new version that covers 2020 pandemic crash!!
Long-Term Capital Management (LTCM) lost U.S. dollars 4.6 billion in fixed income arbitrage in September 1998. LTCM had attempted to make money on the price difference between different bonds. For example, it would buy U.S. Treasury securities and sell Italian bond futures. The concept was that because Italian bond futures had a less liquid market, in the short term Italian bond futures would have a higher return than U.S. bonds, but in the long term, the prices would converge. Because the difference was small, a large amount of money had to be borrowed to make the buying and selling profitable
Indeed
23:45 "buffett just invested 5 billion on goldman sachs" (btw buffett made a 3 billion profit on that deal). It is extremely interesting to compare with 2020 crisis where buffett is selling all his banks' shares
yes I'm finding this extremely interesting, getting to understand the basics of Finance while learning about the crisis in 2008 in real time v. the unfoldings and parellels of 2020 in real time.
@@RaylinRecords Yes indeed ! I find very interesting as well, and these classes are amazing. In 2008 was mainly a financial crisis, driven mostly by the crashes in the financial institutions and government'-debt. So at that crisis, there were a more evident way to "fix" the economy: - inject money on failing institutions, - perform austerity, and -add new strong regulation.
Whereas the crisis of 2020 is a humanitarian crisis, driven by the changes of human behavior (due to the pandemic), so that is a much more complex crisis in my opinion. It's a much more painful crisis, as we have no idea when all of this will finish (and in 2008 we had at least some estimates for the end of the crisis). I recommend you: Aswath Damodaran classes in youtube, they are also great!
@@luizfiorentini9522 I was looking at classes from that professor. I will start watching his classes after this course. I agree and think it's especially important to note what the large cap industries are doing now, expanding and investing more than several past years. The wealthy companies are using this as an opportunity to purchase stocks. From the Warren Buffet example, we can see this is a similar parallel, and I think it's important to note that when the market is crashing/down, large companies buy in.
@@RaylinRecords oh yeah definitely, u are definitely right. In time of crisis there are large investments made, especially because alot "very good" stocks are sold in discount (cause the markets crashes pushed them down) plus some large cap get even bigger (new demand and/or competitors going bankrupt). Bill Ackman for example invested and profited heavily during this crisis (his interviews about investing are great btw), Buffett abandoned airlines and banks, and invested heavily in gold (among multiple others investments for sure). Anyways enjoy ur lectures, I really like Damodaran, as much as these MIT classes, cause he is like a "bridge" between the "Academic Finance vs The real world finance" (as real world investors dont use most of academic stuff taught on universities/business schools). Cheers
The guy is perfect. No risk here.
very interesting lecture and i have really enjoyed, i am a graduate of financial engineering.
starts at 28:00
"default in 30 years" joke hits a bit close to home in hindsight 😆
Explaining slope and curvature of a non-linear function without drawing a graph and calculating it, is not optimal teaching. Other than this, it is cool to watch
Thank you for explaining duration so well
You are incredible. Thank you .Very understandable.
AP The history of the US: institutions, amendment, amendments, the FED, FCC
starts at 28:00
QA for this lecture can be skipped
On min 1:11:10 it says in red "Note: If the yield moves up by 0.1% the bond price decreases by 0.6860%".
But according to the modified Duration, shouldn't the Price decrease by 0.6924% instead?
Also, I plotted everything on excel and after simulating the exact Price at 3.1% yield, the result is of a real decrease in 0.6896%.
Does anybody knows how did the professor get the 0.6860% presented?
(edited) Solution: The problem is I was using all the decimals on excel, whereas the professor only used 2 decimals to compare the decrease in real simulated price at 3.1% to the one at 3.0% yield, which if you do it on excel, it will round it up to 0.6860% :
(102.79 - 103.50)/103.50 = 0.68599... ~ 0.6860%
How do we get 102.79?
@@rohitjain4124
102.79 is just the price of the bond if you discount all the cash flows at a yield of 3.1% (3.0% + 0.1%).
And the 103.50 is the bond price calculated at yield of 3.0%.
Therefore, (102.79 - 103.50)/103.50 ~ -0.6860% represents the "real" calculated decrease in bond price when the yield to maturity increases by 0.1%.
In other words, this demonstrates that D*= 6.92% is a good estimate in price decrease after a yield increase of 1% (linear approximation), which would be the same as saying it would decrease in 0.692% as a consequence of a yield increase of 0.1%.
Finally, we can conclude that 0.686% (real calculated change in price) is very close to 0.692% (estimated change in price) after using a linear approximation of the Macaulay duration D*.
Moreover, if you would like to use even a better approximation than this linear one of D*, that's what he explains about on min 1:12:10 when he mentions about creating a higher order approximation by including the convexity component into the equation. In simple words, it constructs a curve rather than a straight line, which provides a better estimate for a change in Price value% after a change in yield%.
I hope this helps to clarify all your questions. Blessings.
the public market is smart and dumb at the same time it sometimes acts contrary to logic because of a misbelief so two identical cash flows could in theory command different market prices. When dealing with institutional investors, maybe they make the same cost assumptions (especially theoretically when dealing OTC).... just guessing here
At 40:38, is it true that without short-selling one cannot do arbitrage trades? I could borrow over-night a sum to buy the cheaper bond; and then sell the same bond at a higher price and pocketing the difference. Because I borrowed money over-night I will have to pay a small interest, the same interest I am paying my broker for short-selling.
That's exactly what he means by short-selling a bond with higher price and equal cash flows in this example (borrow money with same terms of payment but you get more money than what you have to lend, so you get a margin). However the situation he illustrates is when regulators do not allow you to borrow money or assets (short-selling) anymore and take advantage of any of these arbitrage situation.
He later explains this happens when there is an economic turmoil and you do not want people to start betting against the fall of enterprises which can increase the possibility of companies to go bankrupt and contribute to disrupt the economy during a crisis, or even in later lectures, he explains that sometimes short-selling of assets can be restricted due to the pure nature of the business (e.g. pension funds), since short-selling strategies do not have a loss limit and can be very risky.
However, in our business mindset this still doesn't make sense, but regulators do that anyway because they see it as a "normative" action that is right to do in order to keep markets (or certain participants) under control on different circumstances, and that's exactly the point the professor argues. Later between mins 42 and 50 of this lecture he explains that he would suggest to better increase the transaction costs rather than prohibiting them, so that only those who really really need to sell certain assets, can still do it.
two identical cash flows can have different market values.... suppose one financial instrument is based in sharia law and another in common law but the cash flow is the same.....the market value might be different bc of a cultural difference if you're dealing in a cash flow based on entertainment for example???? but maybe I'm wrong, I'm just guessing here.
Wouldn't being based on two different laws mean they would have different attributes and hence different cash flows?
@@LifeHacks-pl9wv well, if the size of the market and the average amount spent in those markets are different then you have a different potentials for the cash flow. Take for instance an international Disney movie, it's already produced and marketed and sent to theater's globally. However the different regions have different cultures and markets and responses to the same product. The cash flow is from the ticket in both markets but it has different market value
For one thing in one instance the movie might technically be illegal but still available so it generates different a revenue..
@@LifeHacks-pl9wv in another instance the movie might just be less desirable because it's not a cultural fit, so then it would generally be less well received but the product is the same and the algorithm used to describe how you will be paid is the same... But it will pay you less or maybe even more ...
Another reason is because the cash flow isn't guaranteed it's just assumed to be a viable investment ..... the cash flow is subject to certain constraints so the cash flow model or expected return is stated as a constant but in the real world the income on for the security could vary. Im not sure what type of security/product he's talking about. If he's talking about a bond with a fixed coupon or something like that (you might end up using a covenant if you miss a revenue projection and cannot make the payment).
@@LifeHacks-pl9wvi think what im saying is the book value and the market value of that asset will be different and also the two market values for those assets will not match up if they are in different regions of the world.
Got it. DRS more Gamestop.
I saw that post on Superstonk several days ago and I watched all the videos up to this one so far. I am grateful to have been led here, this guy is so easy to listen to
Is there any way to get the problem-set that Prof. Lo talked about?
See the course on MIT OpenCourseWare for the complete materials: ocw.mit.edu/15-401F08 The problem set might not be there unless it is in the other material. There are lecture and recitation slides, and exams (with solutions) available.
It's on Andrew Lo's website, just Google it. There are 2 parts.
very interesting !
Do I buy dip now?
You'd choose based in the risk you are willing to take on and how long you are willing to wait, if you mean $spy you will more then likely make money but how long will that take?
1:11:42 how to go about those formulas ?
There are many videos on youtube where you can find in greater detail excellent explanations about each one of these concepts.
However, if you'd like having a high-level explanation here (and you already understand a bit of calculus) please think of them as follows:
the average time to maturity weighted on cash flows. The larger the cash flows in later periods, the longer then will be the avg time to maturity.
the 1st derivative of the Price with respect to the yield, which incorporates the Macaulay duration as the basis for the calculation. This constructs a "linear" approximation of price vs yield.
2nd derivative of Price with respect to the yield which will help to construct a better "curved" approximation of price vs yield.
: a more accurate bond price vs yield estimate through a curve plot, where only the first 2 terms of the expression are generally being used for simplicity (1st term is-Modified duration- and 2nd term is-Convexity-).
Blessings.
🙏🙏👍👍🇮🇳🇮🇳
wouldn't the term premium fuck all this 200 equations 30 unknown stuff up?
Well, if you pay a premium on a fixed income security and another person doesn't on that SAME fixed income security. That means the other guy is better off then you are. And with these 200 equations you are looking for the 'premiums' so you can shortsell them and buy the ones without a 'premium' (this means you have the premium as a PROFIT, with all the other cash flows being equal).
But BTW, I'm not sure if you talk about 'premiums' in fixed income securities, since you won't ever get rewarded for it (you just pay more to get the same).
If only professor solved all questions on board...sorry if i sound dumb
no you definitely don't sounds dumb....
.
.
.
.
..
you are dumb
Which questions?