(Monday Lecture 1) Introduction to Trading and Investments

Supply and Demand: The Fundamental Driver of Prices

• The Universal Rule: In a capitalistic system, the primary driver of all prices—whether for McDonald's food, gasoline, oil, stocks, or bonds—is the relationship between supply and demand.

• Market Directions:

  • Price Increase: Occurs when there is a steady supply and an increased demand.

  • Price Decrease (Demand Side): Occurs when there is a steady supply and demand for the product decreases.

  • Price Decrease (Supply Side): Occurs when demand stays the same but supply increases.

  • Price Increase (Supply Side): Occurs when supply decreases while demand holds steady.

• Case Study: Oil and Geopolitics:

  • The Strait of Hormuz (waterway next to Iran) is a critical transit point where historically $20\,\%$ of crude oil passes through.

  • Threats to shut down this waterway create a fear of less supply, which drives prices up.

  • Historical Data: Prices were traded at roughly the low $60.00\,\text{per barrel}$ (estimates of $62.00\,\text{per barrel}$ to $65.00\,\text{per barrel}$). When the war started, prices jumped to as high as $115.00\,\text{per barrel}$ within a couple of weeks. As of the lecture date, prices have receded to approximately $72.00\,\text{per barrel}$ to $73.00\,\text{per barrel}$ as oil has been released and the Strait has opened.

Market Psychology and Trading Perspectives

• Emotion vs. Facts: Prices are not always directly tied to the exact level of supply and demand. They are heavily influenced by Emotion, specifically Fear and Hope.

  • Fear Factor: The fear of running out of oil can drive prices up even if current supply levels (e.g., in China or the US) are actually sufficient to run the economy.

• Behavioral Economics: Ultimately, what matters is what people are actually doing: are they buying, selling, or holding?

• Short Term vs. Long Term:

  • Short-Term/Day Trading: Often difficult because prices may deviate from fundamental facts due to erratic human behavior.

  • Long-Term (The Warren Buffett Way): Markets generally align with underlying facts over the long term.

Core Financial Concepts: Time and Interest

• Time Value of Money (TVM): A central concept in finance stating that the value of any security or asset is tied to time and interest rates.

• Required Rate of Return: This is the interest rate used to value a security today.

  • Risk Premium: If an investment is perceived as more risky, the investor requires a higher interest rate (higher return).

  • Inverse Value Relationship: If you require a higher return for a risky asset, you are willing to pay less for it today. Therefore, as the required interest rate increases, the value of the investment decreases.

• Compound Interest: The process where the interest earned on an investment earns interest itself. This effect is most significant when dealing with large sums of money ($\text{thousands}$ or $\text{millions}$).

• Discounted Cash Flow (DCF): The most popular valuation method. It involves estimating future cash flows and finding their Present Value today. Examples include:

  • Stocks: Cash flow received in the form of Dividends.

  • Real Estate: Cash flow received in the form of Rent.

Financial Markets and Institutions

• Financial Market Definition: A place where borrowers and lenders are brought together to exchange securities and financial assets (similar to how a supermarket facilitates the exchange of food).

• Commercial Banks: Institutions like Bank of America and Chase that make profit by taking deposits (paying out a low interest rate) and loaning that money to others at a higher interest rate.

• Primary Market: The market where new securities are traded for the first time. The company (the issuer) receives the money directly.

  • Example: SpaceX went public (IPO) to raise capital for projects like building ships to go to the Moon or Mars. SpaceX reportedly raised approximately $85,000,000,000.00$ by selling shares (estimated at $566,666,666\,\text{shares}$ at a price of $150.00\,\text{per share}$, though the speaker initially used an example of $85.00\,\text{per share}$).

• Secondary Market: The market where investors trade with other investors. This is where most day-to-day stock market activity occurs.

The Bond Market

• Definition: A bond is a loan made to a borrower (a company or government). Unlike stocks (which represent ownership), a bond must be repaid with interest.

• Scale: The bond market is significantly larger than the stock market, though less discussed because it is less volatile.

• Bankruptcy Priority: If a company like Blockbuster (which went bankrupt in $2009$) fails, bondholders have a higher claim on remaining assets than stockholders. Bondholders might receive partial repayment (e.g., $50\,\%$), while stockholders often lose everything.

• Interest Rate Relationship: Bond prices have an Inverse Relationship with interest rates. When interest rates in the economy rise, the prices of existing bonds fall.

• The Federal Reserve: The entity that influences the general level of interest rates by becoming a buyer/seller in the markets.

• Interest Rate as the "Price of Money": Driven by money supply and money demand.

National Debt and Treasury Securities

• Treasury Bonds: Debt issued by the US Government to fund its bills.

  • Risk: Often called "risk-free," though they carry interest rate risk. The US has historically never defaulted because it can borrow more to pay back old investors (re-financing).

• Debt-to-GDP Ratio: A measure of a country's debt relative to its economic output.

  • United States: Approximately $120\,\%$.

  • Japan: Over $230\,\%$ or $240\,\%$. This has led to the devaluation of the Japanese Yen.

• The Default Loop: If investors stop buying a country's bonds, the government must either increase taxes, cut spending (budget cuts), or print money (which leads to inflation).

Diverse Investment Vehicles

• Diversification: Spreading investments to reduce risk. Instead of owning one stock, investors use Mutual Funds to own hundreds of stocks.

• Mutual Funds: Pooled money managed by a company (like Charles Schwab). Investors buy shares directly from the management company.

• ETFs (Exchange Traded Funds): Similar to mutual funds in that they hold a basket of assets, but they trade on the secondary market like individual stocks. They often have no minimum purchase requirements and are generally lower risk due to diversity.

• Municipal Bonds: Bonds issued by state or local governments (e.g., Montclair State). A major benefit is that interest income is often exempt from federal income taxes.

• Real Estate:

  • Speculators: Buy and sell quickly for profit ("flipping").

  • Investors: Hold long-term for rental income.

  • Leverage: Using debt (other people's money) to increase potential returns.

  • REITs (Real Estate Investment Trusts): Securities that allow investors to buy into commercial real estate without owning physical property.

• Commodities:

  • Oil: Critical energy resource; heavily impacted by geopolitical negotiations.

  • Gold: Often traded via Futures Contracts (betting on a future price like $4,023.00$ in $August\,2026$). Used extensively in electronics (approx. $300\,\text{tons}$ annually).

• Cryptocurrency: Digital assets living on a Blockchain.

  • Security: Access is controlled by private keys in digital wallets. The keys are a function of $2^{256}$, making them virtually unguessable.

  • Volatility: Known for extreme price swings and high risk.

The History and Evolution of Wall Street

• Physical Origins: Named after a wooden wall built by Dutch colonists in Lower Manhattan in $1653$ to protect against the British and Native Americans.

• Buttonwood Agreement (1792): Signed by $24$ brokers under a buttonwood tree, establishing the New York Stock Exchange (NYSE).

• Main Street vs. Wall Street: Main Street represents individual investors and small "mom and pop" businesses, while Wall Street represents large financial institutions.

• Digitalization: Wall Street is now more of a metaphor. Many firms have moved to Dallas, Texas or Miami, Florida (Ken Griffin's hedge fund, for instance) due to tax benefits and technology. The trade floor is now largely electronic and quiet compared to the historical shouting and paper tickets.

Questions & Discussion

• Q: What happens if a company goes bankrupt?

  • A: If there's money left, bondholders are paid first. Stockholders are usually the last to receive anything and often lose their entire investment.

• Q: Are Treasury bonds compounded?

  • A: They compound if the investor reinvests the interest payments to buy more bonds. Treasury bonds typically pay interest semi-annually.

• Q: Why do investors require higher returns for riskier assets?

  • A: To compensate for the uncertainty and potential loss of the principal investment.

• Q: Does Japan have a debt problem?

  • A: Yes, with a debt-to-GDP ratio well over $200\,\%$, which has put significant pressure on the Japanese Yen.

• Q: What is the average return of the stock market?

  • A: Historically, it is cited between $8\,\%$ and $12\,\%$, but for the purpose of this class, the average is considered $10\,\%$.

Academic and Career Guidance

• The Skill-Based Future: Students should shift focus from just getting a "degree" (e.g., Marketing or Finance) to acquiring specific job skills (e.g., Banking). The speaker suggests a vocational approach to university education where students are trained for specific roles like a "banker."

• Recommended Literature:

  • Intelligent Investor by Benjamin Graham (The "Bible" of value investing).

  • Security Analysis by Benjamin Graham.

  • One Up On Wall Street by Peter Lynch.

• Calculators: The BA II Plus is a popular financial calculator used to solve for Future Value (FV), Present Value (PV), and interest rates ($I$).