Welcome back, and now for some exciting stuff. Just to show you why markets are important, and why what we do in finance is all there? It's every time I leave you with some thoughts that have nothing to do with the class, and I want to leave you one thought. Markets are more powerful the more people are able to participate. Markets are not very powerful, they do not create value if people are left out of them, it's just like democracy. And so please keep that at the back of your mind that a lot of us do not have the opportunity to participate. But I want to show you how markets work and how they are just the same thing that we have been talking about. I'm going to try to prevent myself from going too long simply because you know this stuff is, we could go on on this forever. But I'd encourage you if you notice what I have up there is the good old Yahoo Finance, it's finance.yahoo.com and I'm going to launch it from here. And if you notice, it jumps straight and I will just quickly browse the top part. If you look across, what is it showing? It's showing Dow Jones, which is the top 30 companies. S&P 500, we spoke about it I think, a little bit, it's a large portfolio. NASDAQ is another exchange, but notice what's here. Ten year bond, and if it says ten year bond unqualified, what do you think it's talking about? The government bond. And what is the chances that this bond will be paying a coupon? Pretty high, and the reason is very simple. Coupon paying bonds are much more common than zero coupon bonds. Just for some fun, there's an exchange rate here between the euro and US dollar and the price of gold. Gold fascinates people, it doesn't fascinate me very much because I don't know why its price behaves the way it does to be honest with you. Okay, what I'm going to do is I'm going to, if you are coming with me I'm going on the right panel of the site, right for me. And you'll notice there's some currencies. And this class doesn't talk about international finance, but I think that's a topic that is extremely important. And what's listed here are different exchange rates. And at some point after this fundamental class, if I do get involved in continuing to do online, I want to do international finance. I want to do valuation with a lot of real world examples, cases and so on. But I'll talk about that on the last day of class as to how do we go beyond. But let's scroll down a little bit. There are commodities which is not in the class, but they're bonds. Now notice, right away, you see a 5-year, 10-year, and 30. What do you notice? In the 5-year, 10 year and 30, the one thing has to be the case unless qualified otherwise, it has to be a government bond. So I'm going to now click on more bonds. And if you see there's a whole table here and what do you notice? You notice over three month bond, treasury and the word treasury means government. Six month bond, a two year bond, a three year bond, a five year bond, a ten year bond, and 30 year. These are not the only ones, but these are the listed ones. And what is happening to the yield to maturity? It's showing yield and maturity right now and it's showing you yesterday, last week, and so one. So let's stick with the yield right now. It's 0.05 for three month, 0.012 for six month, 0.026 for a two year, and by the way they are all analyzed so that it can compare them, right? Otherwise obviously a shorter interval will have a lower rate of return, right? But what do you notice, even analyze what's happening. It's almost remarkable the steady increase in them. Can you see that? Yeah, and what is that over here? Let's go to the right side. The right side has a little graph and this jumps out at you in whatever country you're in. This is the relationship between the interest rate or yield to maturity built into bond pricing with maturity. So let me just click on it and it'll jump out. So if you look at this graph, it is showing you how steadily the interest rates and yield to maturity on a bond is positively related to the horizon. And this tendency, if you dig deeper, this is a tendency, this is not a fact. This tendency, all the time pushing upwards, is because of two reasons. Long-term bonds are much more volatile than short-term bonds, compounding. [LAUGH] And we do not like that movement, are you with me? You do not like that movement. So if you don't like the movement, what are we willing to pay, more or less for that part? We are willing to pay less. And if we are willing to pay less, what does it say about the yield of maturity? It has to be higher. So remember, one thing, yield of maturity goes up, price goes down. The whole thing, so what I'm going to do, spend a little bit more time on this just because we are talking about bonds. And when we do stocks next week, I'll come back. But the bonds problems are very interesting. So this table we just saw, and look what are these US Treasury. Now look rated municipal, why are they rated? Because these are issued by municipal government, local government and bonds. And they are too are rated because the property of the fault is there built in. Now the question here is the maturity is increasing and the tendency of the interest rate to increase with maturity is there, right? But what you also notice is something which should be pretty obvious is that the municipal bonds in the US are tax exempt. Whereas treasuries are taxable. So what you'll notice is everything else the same, that tax thing should come through. But I'm not interested in municipal, I'm much more interested in showing you something which is peculiar to the US, largely. Corporate bonds and this has been a subject of a lot of pain and a lot of anxiety continuing to be the case and the reason is there has been a lot of turmoil in the financial markets. So if you notice what's going on is you have ratings, right? So which is the highest rating, AAA. So if you look at all these bonds, what you'll notice is there's a positive relationship. The higher the rating, the more you're willing to pay. And therefore, the return you're willing to get is lower, right? So look at these last three bonds, as the rating goes down the yield to maturity goes up. And the reason is very simple. The yield to maturity is fixed for all three, right? And why is the, sorry. The maturity is fixed, why is the yield to maturity going up? Because in order to entice you to buy a low rated bond, and given that you are risk averse, and I'm risk averse, we are willing to pay less. Which means automatically, we'll want a higher return. I told you we'll start talking about risk and return. So this is the relationship between the two, typically. One last point, and do it on your own, go to your Yahoo Finance page and do the following, answer the following question for me. Which bond will pay a higher rate of return, a corporate bond or the government bond? As long as I fix what? To be fair, I make them identical in every other aspect. So, at least make the majority the same and you should know the answer. And next time, what we will do is we will review very quickly what we did in bond pricing and we will start on stocks. And stocks are the most fascinating thing created by humanity. And I want you to also recognize, I will take the opportunity to show you rally creation and destruction using stocks. I cannot do that too much with bonds, because bonds are boring. You buy bonds only if you know what they're going to pay in the future. And I believe unless we all take risks we are not going to be able to do good stuff. So risk taking is inherent to value creation. You don't want to take too much risk, but you have to take some risk. So I'll come back to this, I want to remind you however, please go to the problem sets and assignments. I have built in assessments here and when I do a problem I ask you to do it and then do it with you. So I'm not too worried about the video assessments because I think everything that I do is with an example and you do it with me or on your own time. What I really want to test you on assessments is in your assignments. So please do the assignment. Please redo all the problems, make sure you got them. You can go back to the video, take the problem, do it. Go back to video and see if you got it right. See you next time. Have fun.
