Economics 434: The Theory of Financial Markets

1. Economics 434: The Theory of Financial Markets Professor Burton Fall 2014

2. Administrative • Office Hours: 11am-12pm Tues/Thurs at 1900 Arlington Blvd; Suite C • Monroe Office: Room 262, 434-924-4054 • VNB Office: 1900 Arlington Blvd., Suite C, 212-731-2340 • Email: etb6d@virginia.edu • Student lunches every weekday • Class Website: http://people.virginia.edu/~etb6d/classes.htm • Syllabus posted on site with required readings • Additional course material to be posted here (textbook chapters, etc.) • Students are responsible for: • All lectures including powerpoint slides and all lecture content • All readings; no exceptions

3. Course Overview – 3 main topics covered • Debt and Equity Markets • Modern Portfolio Theory • Leverage, Corporate Balance Sheets, Buyouts • See me for any questions/concerns (especially transfer students)

4. Grading Policy • First midterm (30%) – Tuesday, September 30th • Second midterm (30%) – Tuesday, November 4th • Final (40%) – Tuesday, December 9th, 2pm - 5pm • Grades on each exam adjusted against the mean • Grade distribution is roughly 1/3 A’s, 1/3 B’s, 1/3 C’s (can be D’s or F’s though) • Absolute grade does not matter e.g. could make a C with a 90 average • There is no “Dutch knockout” – you must take all exams • Honor System applies to all graded assignments/exams • Conscientious Retraction Option

5. 3 main readings used in this class • “A Random Walk Down Wall Street”, Malkiel • “Theory of Financial Markets”, Burton • $30 when and if available • Otherwise look for notes on the course website • “House of Debt,” by AtifMian & Amir Sufi

6. For today: A brief history of financial markets… Began on May 26th 1896 at: 40.94

7. The Early Years

8. The Early Years 381.17Sep. 3rd, 1929 40.94May 26th, 1896

9. The Great Crash of 1929

10. The Great Crash of 1929 381.17Sep. 3rd, 1929 41.22Jul. 8th, 1932

11. The Thirties in Review

12. The Thirties in Review 381.17Sep. 3rd, 1929 192.91Mar. 3rd, 1937 155.92 Sep. 12th, 1939 41.22Jul. 8th, 1932

13. 1939 to 1966

14. 1939 to 1966 – 954.73 Apr. 21th, 1966 725.76 Aug. 22th, 1961 536.98 Jun. 27th, 1962 155.92 Sep. 12th, 1939

15. 1966 to 1981 631.16 May 26th, 1970

16. 1966 to 1981 – Fifteen year period with no growth 1036.27 Dec. 11th, 1972 1007.42 Jun. 11th, 1981 954.73 Apr. 21st, 1966 774.88 Sep. 8th, 1966 631.16 May 26th, 1970 584.56 Oct. 4th, 1974

17. 1981 to 2000

18. 1981 to 2000 – Boom in the stock market Peak in April 2000 11,287 April 11th, 2000

19. 1987

20. 1987 – The “Rip van Winkle” year 2,722 Aug. 25th, 1987 2,246 Oct. 16th, 1987 1,938 Dec. 31st, 1987 1,927 Jan. 2nd, 1987 1,738 Oct. 19th, 1987

21. Since 2000 17,113 Jul. 22nd, 2014 13,950 Jul. 16th, 2007 6,547Mar. 9th, 2009

22. Since Jan 1st 17,113 Jul. 22nd, 2014 16,493 Aug. 1st, 2014 15,372 Feb. 3rd, 2014

23. Inflation and Interest Rates • Peaked in 1979-81 • Secular, long-term decline since then • Now • Inflation around 2 percent • Short term rates barely above zero • Ten year yields around 2.5 percent • Thirty year yields around 3.25 percent

24. Fixed income rates have been declining since 80’s 16.30% May 1st, 1981 5.03% Feb. 1st, 2007

25. On the tail end of the fixed income decline in rates 15.32% Sep. 1st, 1981

26. Inflation has been stable since 80’s 14.40% 1947 13.50% 1980 1.50% 2013