Economics 434 Theory of Financial Markets

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Economics 434Theory of Financial Markets
Professor Edwin T Burton Economics
Department The University of Virginia
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Facts About The Course

• Examinations
• Two Mid-Terms
• Tuesday, Oct 21st
• TBA
• One Final Exam
• Wednesday, Dec 10th
• Only excused absences permitted
• Final Exam Date
• Wednesday, Dec 10th
• 2PM
• No Exceptions
• Grading
• Everyone hates this

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What Material is Covered?

• Fixed Income Markets
• Modern Portfolio Theory
• Leverage and High Yield
• Derivatives
• Recent Upheavals
• Crisis in the Credit Markets
• Globalization
• Alternative Assets

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What is the Reading?

• Malkiel Random Walk
• Burton Theory of Financial Markets
• 40 within 1st week available
• 50 after 1st week
• Pickup at VNB Office
• Money Ball by Michael Lewis

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For Today
A Brief History of Financial Markets
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The Dow Jones Averages Began
On May 26th, 1896
40.94
7
380
The Dow Jones -- The Early Years
160
120
110
101.71
75
40.94
1896
1906
1916
1919
1921
1929
1926
8
381
Feb
290
The Great Crash
260.64
230
June
170
198
Oct
80
Jan
41.22
Jan
July
1932
1929
1930
1931
9
The Thirties in Review
381
190
150
41.22
1929
1932
1939
1936
10
1020
1939 -1960
670
530
500
300
230
150
100
1939
1942
1946
1949
1953
1956
1959
1966
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1966 -1981
1050
1030
1020
1010
800
780
760
770
AUG
DEC
580
DEC
1976
1966
1969
1981
1973 - 1974
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Aug, 1981 -July, 1987
2700
July
1500
1000
780
1981
1987
1983
1986
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1987 - The Rip Van Winkle Year
2700
2300
2200
2200
2200
1700
July
Jan
October
Dec
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1988 - 2000
12,000
9328
11,500
6800
4,000
Peak in March, 2000
2200
1988
1994
1997
1998
1999
2000
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Since 2000
14,000
12,000
11,386
8,600
2000
2003
2006
Today
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The Current Economic Crisis

• Gross Domestic Product
• 1st and 2nd quarter up 1
• No negative quarters since 2002
• Unemployment 5.9

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So, what is the Fed doing

• Lowering the FF target rate
• Opening the FRS window to non-banks and accepting
  weak collateral
• Negotiating bail outs, e.g. Bear Stearns

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The Bursting of the Housing Bubble

• Dramatic overbuilding of residential housing
• Huge escalation of prices
• Easy financing
• Up to late 2006
• Oops

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Questions

• Why is the economy as a whole still okay?
• Why did Bear Stearns collapse
• What are Fannie and Freddie?
• Why are Lehman Brothers and Wachovia on the ropes?

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The End