The Practical Guide to Wall Street: Equities and Derivatives

Preface xiii

A Comment on the Events of 2008 xxiii

Acknowledgments xxv

Part One What Is a Stock? 1

Chapter 1 Equity Fundamentals (Part 1): Introduction to Financial Statements 3

Introduction 3

Equity and Corporation 4

Introduction to Financial Statements 5

The Balance Sheet 6

The Income Statement 15

Statement of Cash Flows 20

Summary 24

Chapter 2 Equity Fundamentals (Part 2): Financial Ratios, Valuation, and Corporate Actions 27

Introduction 27

Financial Ratios 28

Growth and Value 38

Bloomberg 39

Valuation 40

Technical Analysis 51

Corporate Actions 54

Summary 64

Part Two Products and Services 67

Chapter 3 Cash Market 69

Introduction 69

How a Stock Exchange Functions 69

Exchange Structure 76

Order Types 81

How the Cash Trading Business Works 102

Communication 112

Purchasing a Stock in a Foreign Currency 115

Summary 121

Chapter 4 Equity Indices 123

Introduction 123

Index Construction 125

What an Index Doesn’t Tell Us 129

Valuation and Calculation 131

Replicating Portfolio 134

Trading an Index Portfolio 136

Index Changes 139

Index Dividend Points 142

Total Return Index Calculation 144

Multicurrency Indices 145

Equity Indices in Practice 147

International Indices 156

Summary 165

Chapter 5 Program Trading 167

Introduction 167

Explanation of a Sample Trade 173

When Is Program Trading More Beneficial? 182

Portfolio Analytics 184

Transition Management 189

Principal Trades 191

Summary 201

Chapter 6 Exchange-Traded Funds (ETFs) 203

Introduction 203

Trading Mechanics 205

Net Asset Value (NAV) 207

Popularity 208

Trading versus Holding 212

ETFs in Practice 214

Summary 214

Chapter 7 Forwards and Futures 217

Introduction 217

Calculation of Fair Value 219

Futures 223

Index Arbitrage 233

The Futures Roll 240

Exchange for Physical (EFP) 245

Basis Trades 254

Futures Contracts in Practice 259

Technical Comment on the Accuracy of Approximations 263

Summary 264

Chapter 8 Swaps 267

Introduction 267

Motivation for a Swap 267

A Long Equity Swap Example 269

The Swap in Detail: Definitions and Terminology 272

Calculation of Payments 277

Short Swap 279

Back-to-Back Swaps 280

Swaps as a Trading Tool 281

A Comment on Hedging 286

Swap Valuation: Accrual versus NPV 287

Currency Exposure 289

ISDA 293

Risks and Other Considerations 294

Summary 296

Chapter 9 Options (Part 1) 299

Introduction 299

Definitions and Terminology 300

Payoff Structure 301

Option Values Prior to Maturity 311

Quantitative Considerations 323

The Black-Scholes Derivation 326

Types of Volatility 337

Summary 341

Chapter 10 Options (Part 2) 343

Volatility Trading 343

Option Sensitivities: The “Greeks” 354

Implied Volatility Revisited 374

OTC and Exotic Options 377

Summary 383

Chapter 11 The Trading Floor 385

Introduction 385

Organization of the Sales and Trading Businesses 386

Other Groups 390

Summary 404

Part Three Economics 405

Chapter 12 Macroeconomics for Trading and Sales 407

Introduction 407

Capital Asset Pricing Model (CAPM) 408

Overview of Macroeconomics 408

The Fed 417

Moving beyond the Big Three: Other Macroeconomic Concepts 424

Other Variables 426

A Final Observation 428

Summary 429

Chapter 13 Economic Data Releases 431

Introduction 431

Preliminary Definitions 433

Principal U.S. Economic Indicators 436

Rest of the World Economics 456

Europe 457

European Economic Statistics 462

Asia 466

The Market’s Reaction Function 471

What the Market Tells Us about the Economy 476

Summary 480

Appendix Mathematical Review 481

Introduction 481

Functions 482

Compound Interest and Exponential Growth 483

Calculus 487

Random Variables, Probability, and Statistics 494

Summary 505

Notes 507

About the Author 519

Index 521