Workshop in Financial Engineering The Stock Game

1
Workshop in Financial EngineeringThe Stock
Game

• Dr. J. René Villalobos, Joel Polanco and Marco A.
  Gutierrez
• Industrial Engineering Dept.
• Arizona State University

2
Introduction

• This game was prepared for the IIE regional
  student chapter conference
• We will use it to start the discussion on stock
  selection

3
Objective

• Through hands-on exercises show the use of
  classical Industrial Engineering tools in
  devising Investment Strategies (Financial
  Engineering)

4
Financial Engineering

• Financial Engineering is becoming a very hot
  topic in Industrial Engineering Programs
• It has been established as a specialization area
  in programs such as Georgia Tech, Columbia and
  Michigan

5
What is Financial Engineering?

• Combining or carving up existing instruments to
  create new financial products. (http//www.duke.ed
  u/charvey/Classes/wpg/glossary.htm)
• Financial engineering is the application of
  mathematical tools commonly used in physics and
  engineering to financial problems, especially the
  pricing and hedging of derivative instruments.
  (from Neil D. Pearson, Assoc. Prof. UIUC)
• Financial engineering is the use of financial
  instruments such as forwards, futures, swaps,
  options, and related products to restructure or
  rearrange cash flows in order to achieve
  particular financial goals, particularly the
  management of financial risk. (www.stanford.edu/j
  aprimbs/00-Intro.ppt)

6
Investment Game

• You will be given 100,000 of virtual money to
  invest in 7 stocks and a risk-free alternative
  which yields an interest of 2 per year
• You can divide up the money any way you want
  among the 7 stocks and the risk-free investment
• You will have the opportunity to change your
  original investment up to 3 times before the end
  of the game
• Assume that you borrowed the original 100,000
  and that you have to repay it by making two
  payments of 55,000 at the end of rounds 2 and 3.
• Your job is to apply the IE tools that you know
  and your intuition to maximize the value of your
  investment when the game is over.
• If you cant meet the scheduled payments your
  company goes bankrupt and the game is over for
  your team

7
Example

• First Round You are given in Excel the daily
  closing quote for two stocks for around two
  years.The information looks like

8
Example

• From the previous information, the closing price
  for stocks A (the stock in blue) and B (the stock
  in pink) at May 31, 2001 are 8.55 and 25.64
  respectively.
• Based on the information provided we make our
  investment allocation decision as 50,000 in
  stock A and 50,000 in Stock B, which corresponds
  to 5848 shares of Stock A and 1950 shares of
  stock B.
• Then you will be given information for the second
  period

9
Example

10
Example

• Your previous investment is now worth
  (153,441.00, 76374 for Stock A and 77067 for
  stock B).
• Since stock B performed better than Stock A you
  decide to sell 4211 of your shares of stock A and
  use the proceedings to pay the 55,000 loan
  payment
• Now you are left with 1636 shares of stock A and
  1950 of stock B and an investment value of
  98,441.00
• The information for the next period looks as
  follows

11
Example

12
Example

• The value of your stock of 1636 shares of stock A
  and 1950 of stock B is now 66223
• Since you almost lost your shirt in the last
  period because of Stock B you now sell ALL your
  shares of this stock and 974 shares of stock A to
  pay your final loan payment.
• You are left only with 662 shares of stock A and
  none of stock B with a total market value of
  11223
• The information for the last period looks as
  follows

13
Example
14
Example

• Final Value
• Shares of Stock A 662, Price 19.14 Total
  12673
• Shares of Stock B 0, Price 24.4 Total 0
• We made 12,673 but almost when bankrupt in the
  process

15
Your Turn to play