The Practical Guide to Wall Street

The Practical Guide to Wall Street is an indispensable resource for anyone who aspires to a front-office sales or trading position on Wall Street and an essential desk reference for market practitioners and those who interact with this exciting but widely misunderstood industry. Written by an experienced trader in a clear, conversational style and assuming no previous background in finance, The Practical Guide to Wall Street provides a thorough schooling in the core curriculum of the equity and equity derivatives sales and trading business - exactly what you would learn from sitting beside the traders at a tier-one Wall Street investment bank (except that in practice, traders rarely have time to provide such detailed explanations!) Topics covered include: Clear, detailed and intuitive explanations of all major products, their function, pricing and risks (several of which are unavailable anywhere else despite producing billions of dollars in annual revenue for Wall St.) The layout of the trading floor, the roles and responsibilities of the different sales and trading groups and how they interact to service the client business An overview of the structure of the macro-economy and the trader’s perspective on the significance of economic data releases and their impact on the financial markets A review of those concepts from fundamental valuation and financial statement analysis of greatest relevance on the trading floor (as opposed to abstract valuation models) Practical details of the structure and functioning of the equity and derivative markets including translations of trader jargon, Bloomberg tips, market conventions, liquidity and risk considerations and much more… This book provides the first comprehensive explanation of all aspects of the functioning of the equities division, with information, details and insights previously only available to those who already worked on a trading floor. The availability of this material in a format accessible to non-professionals fundamentally changes the level of industry knowledge employers in the financial services industry can expect of new hires.

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