Security Markets Structures

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The Iowa Electronic Markets
Security Markets Structures
Introduction to the IEM
The Iowa Electronic Market (IEM for short) is a computerized market on which financial
contracts can be traded (bought or sold). For this assignment, we will be using a series of
contracts based on three popular companies, Apple Computers (AAPL), IBM (IBM) and
Microsoft (MSFT), and an important index called the S&P500 index. Shares of the firms trade
over the counter (NASDAQ) and on the New York Stock Exchange (NYSE). Similarly, a daily
index value is determined for the S&P500 based upon the stock prices of the 500 companies
that comprise it.
These contracts are listed on the IEM under the market label “Computer Industry Returns
Market” or “Comp_Ret” for short. These contracts are described briefly later in this note and in
more depth in the IEM Trader’s Manual. Detailed descriptions of these markets are available at
the IEM website:
http://www.biz.uiowa.edu/iem/markets/computer.html
Objectives
The objectives of the IEM assignments are to help you apply class concepts in a "real world,"
unstructured way to learn how to:
1. Apply the CAPM to determine expected stock returns
2. Evaluate actual stock performance
3. Implement investment /trading strategies
Opening an IEM Account
All students need to open an account with the Iowa Electronic Market. This involves a
minimum deposit of ____ dollars. Funds remaining in your account are refundable at the end
of the semester.
You can open an IEM account over the internet. To do so, go to the sign-up webpage:
http://iemweb.biz.uiowa.edu/signup/
and follow the instructions given to you by your instructor. (DO NOT use forms other than
those given to you by your instructor. Using other forms may result in fees or decreased
deposits in your account.)
After filling out your signup forms, you may need to deposit cash with the IEM office. Your
instructor will give you details about any deposits you need to make.
Accessing the IEM
You can access the IEM through its website address:
http://www.biz.uiowa.edu/iem/
The IEM market has several contracts for trading. The contracts of interest for our course are
the Computer Industry Returns Market (Comp_Ret, for short).
You may access your trading account from the market pages or directly at:
http://iemweb.biz.uiowa.edu/
Computer Industry Returns Contracts
The Computer Industry Returns Contracts consist of a series of contracts. Every month,
existing contracts in the series are liquidated and payments are made as described below.
Then, new contracts are created as described below. These events occur on the Monday
after the exchange-traded options for the underlying stocks expire (the Monday after the third
Friday of each month).
The liquidation values for the contracts in this market are determined solely by the rates of
return of Apple Computers Common Stock (AAPL), IBM Common Stock (IBM), Microsoft
Common Stock (MSFT) and the S&P500 index (SP500). Whichever of these has the highest
rate of return as specified below will payoff $1.00 per share. The remaining contracts will
payoff zero. Thus, to do well in this market, you will need to understand what determines real
stock market returns.
Contracts will be designated by a ticker symbol and a letter denoting the month of contract
liquidation. Thus, the contracts traded in this market for liquidation in month “m” are:
Code
AAPLm
IBMm
MSFTm
SP500m
Underlying Asset
Apple Computers
IBM
Microsoft
S&P 500 Market Index
Liquidation Value
$1.00 if AAPL Return Highest
$1.00 if IBM Return Highest
$1.00 if MSFT Return Highest
$1.00 if SP500 Return Highest
In these contract codes, “m” refers to the month of expiration as given by the following table:
Month
January
February
March
April
Designation
a
b
c
d
Month
May
June
July
August
Designation
e
f
g
h
Month
September
October
November
December
Designation
i
j
k
l
For AAPLm, IBMm and MSFTm, the dividend-adjusted rate of return is computed based on
closing stock prices of the underlying listed firm between the third Friday in the liquidation
month and the third Friday in the previous month. For these purposes, closing prices as
reported in the Midwest edition of the Wall Street Journal are used. In particular, this return is
calculated as follows. First, the raw return on the underlying stock is computed (as the closing
price on the third Friday of the liquidation month, minus the closing price from the third Friday
of the previous month, plus any dividends on ex-dividend dates). Then, we divide the raw
return by the closing stock price from the previous month to arrive at the dividend-adjusted rate
of return.
For the SP500 contract, the return is computed as the capital gains rate of return. To do this,
subtract the closing index value on the third Friday of the previous month from the closing
index value on the third Friday of the liquidation month. Then, divide by the previous month’s
closing index value.
Trading on the IEM
You can trade on the IEM in several ways. First, you can buy or sell unit portfolios. A unit
portfolio is a set of contracts such as AAPLm, IBMm, MSFTm and SP500m. You can always
buy or sell such portfolios for $1.00 each. Thus, when you start to trade and do not own any
contracts, you can buy a unit portfolio and then start to trade. (To do this, select the
appropriate contract under “Buy Bundles” or “Sell Bundles” in the “Market Order” drop down
menu. Enter a quantity and press the “Market Order” button.)
Second, you can buy or sell using a "market order." On the market screen, you will see that
some individuals have posted an order to buy or to sell a contract (e.g., MSFTi, the contract for
September liquidation in the Computer Industry Returns Market) at a specific price. If you
believe that a posted order represents a good deal, you can buy or sell at the posted price.
(To do this, select the appropriate contract under “Buy at Best Ask” or “Sell at Best Bid” in the
“Market Order” drop down menu. Enter a quantity and press the “Market Order” button.)
Third, you can buy or sell using a "limit order." To do so, you state the price at which you are
willing to buy or sell a contract and post a limit order on the screen. In doing so, you are
waiting for someone who is willing to buy or sell at your stated price. In this manner, when your
order executes, it will execute at your stated price, not at somebody else’s. The negative is
that the order may never execute because nobody likes your price because it is too high or
low. (To place a limit order, select the appropriate contract under “Post a Bid” or “Post an Ask”
in the “Limit Order” drop down menu. Enter a price, quantity and expiration date and press the
“Limit Order” button.)
Completing Your Assignments and Submitting Them
As you can see below, the IEM assignments are extensive, multi-part assignments that draw
together many concepts from the class. It would be wise to work on the various parts of the
assignments as we go over the relevant topics in class. To prepare the assignments for
submission, please use the following guidelines:
1. Each assignment must be typed. Label clearly each assignment with a cover
page giving your name, student number, and section number.
2. Complete each part in a separate section clearly labeling them Part 1, Part 2, etc.
3. Within each section, give the requested information, including sources of
information gathered and equations used to calculate results.
4. Turn in your completed assignment to your instructor on the date it is due.
Security Markets Structures Assignment
Finding and Computing Returns and Evaluating Risk
DUE: ___________
GOAL
In this assignment, you will learn where to find current and historical prices and how to use
them to compute returns and risk and develop strategies for trading.
Current stock returns
The IEM Computer Industry Returns or MSFT (Microsoft) Price Level markets depend upon
the following three stocks: AAPL, IBM, MSFT and the S&P500 index. The prices of these
stocks and the value of the S&P500 index are reported in the Wall Street Journal and in
various places on-line (e.g., http://quote.yahoo.com).
Starting on the third Friday of ____________, record the closing prices each Friday for AAPL,
IBM, MSFT and the S&P500 index. (If you use a print source such as the Wall Street Journal,
notice that, typically, these prices will appear in the following Monday’s edition.) Continue
recording prices each Friday through the third Friday in ________. Report this information in a
table labeled Table 1. (Note: While you are free to use any source, the contracts are
liquidated based on Wall Street Journal reported prices.) In addition to gathering prices,
determine whether any dividends are paid on the three stocks AAPL, IBM and MSFT during
any week. (This information is also available on the IEM website,)
For each Friday from ________ to ________, report the dividend adjusted return from the first
recorded date to the current date for each stock calculated from the prices and dividends (if
any) in Table 1. Report these returns in Table 1 as well.
Historical stock returns
Download the third Friday to third Friday stock returns for AAPL, IBM, MSFT, the S&P500 and
one-month Treasury Bills from the IEM website at:
http://www.biz.uiowa.edu/iem/markets/compdata/compfund.html
You will use these returns in later parts of this exercise.
Now collect monthly historical data on securities in order to directly calculate returns and risk.
Download 1 year worth of monthly stock prices and dividends from Yahoo's website as follows.
1.
2.
3.
4.
Go to : http://quote.yahoo.com
Enter AAPL as the ticker symbol and press the "get quote" button.
Select the "Chart" link.
At the bottom of the chart, select the "monthly" tables link.
5. Select the appropriate dates in the resulting table and press the "get
historical data" button with the "Monthly" radio button selected.
6. At the bottom of the table, select the "download spreadsheet format"
link.
7. Save the resulting "csv" format file. You can load this into Excel for
analysis.
8. Select the "Dividend" radio button and press the "get historical data"
button again to download dividends.
Repeat this procedure for AAPL, IBM, MSFT and the S&P500 (ticker symbol ^spx). You can
also download 3 month T-Bill rates using the ticker symbol "^irx". The T-Bill data is in the form
of return each month.
For each stock, for the third Friday of each month, use Excel to compute the dividend adjusted
return from the third Friday of the previous month. Also, compute the returns to the S&P500 for
the same periods. (It may be easier to delete intervening days and keep only the data from the
third Friday of each month).
This data is also available from the IEM website at
http://www.biz.uiowa.edu/iem/markets/compdata/compfund.html
You can compare your calculations with these. In addition, download the returns for T-bills
over the same period from this site.
Risk Analysis
Analyze the calculated monthly returns by reporting the following information (all numbers can
be computed in Excel):
1. Report the historical average monthly return for each stock, the S&P500 index and TBills. (Use the Excel "average" function.)
2. Report the historical standard deviation in monthly returns for each stock, the S&P500
and T-Bills. (Use the Excel "stdev" function.)
Which security had the highest average returns over the period?
Which security was the most risky?
Returns to IEM Contracts
Although past performance is no guarantee of future performance, combined with current
information on the prospects for these securities you may form your own prediction of which
stock will have the highest return over the current period. How much are you willing to pay for a
security that would pay $1 if your prediction were correct? What determines your willingness to
pay?
An alternative way to profit from trading is to look for arbitrage opportunities rather than trade
based on your expectations of future payoffs. Describe a potential opportunity to make a profit
with zero risk using the IEM market.
Make at least one trade in the IEM Computer Industry Returns market between the ________
and ________. Choose one trade to use for the rest of this part.
Report the date of the trade, the contract traded and the price. Attach a print out showing your
trading activity. (You can either submit a “Processed Orders” report or an ‘Order History”
report. To get the first report, make sure that the “confirm” box is checked on the trading
screen. You will be asked to “execute” the order. Upon execution, the “Processed Orders”
report will appear. To get the second report, go to “My Account” information select “view order
history” and print the resulting report.)
Based on the date of your trade, what is the holding period (in days) to the contract buyer if
each contract is held to its liquidation date?
Calculate and report the return over this holding period to the contract buyer if the contract
liquidates for $1.
Also calculate and report the return over the holding period to the contract buyer if the contract
liquidates for $0.
Internet Resources
IEM Home Page:
http://www.biz.uiowa.edu/iem
Stock prices and dividends: http://quote.yahoo.com
Historical data for computer returns industry:
http://biz.uiowa.edu/iem/markets/compdata/compfund.html
Apple Home Page:
http://www.apple.com/
IBM Home Page:
http://www.ibm.com/
Microsoft Home Page:
http://www.microsoft.com/
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