● Senior CS Major out of South Bend● Probably a little under-qualified as I have no investing experience beyond
dicking around on Robinhood○ Sarah wanted me talk to you though
● Needed to leave South Bend so I applied to a billion NYC jobs, happened to get a job at BlackRock
● Got sucked up into the world of finance● Going to show you a couple of cool things re: finance and CS
CS in investing / FinTech
I’d say there are probably three big CS career paths in investing today.
● Quant investing / HFT○ Generally physics, mathematics PhD’s, but extremely heavy in computer science.○ Develop trading algorithms and extreme optimization of systems
● In house software or client-facing apps○ Split up into backend (servers) & front-end (what you see if you’re the user, trader, etc.)○ I worked on backend at BLK
● Fintech startups○ Apps such as Betterment, Robinhood, Acorns○ Also apparently blockchain
FIX / Swift
● FIX is the way financial institutions communicate with each other○ Analogous to HTTP, FIX is basically a set of agreed-upon rules on how to build messages.
● A simple protocol that’s been around since forever (the 90’s)● Anytime you send out and order, quote or fill electronically, you’re sending FIX
messages to the other financial institutions.○ All buy side & sell side institutions have FIX connections with each other○ I messed around with this this summer, making sure our dark pool orders worked
● Swift is a proprietary messaging system for settling trades after they’ve been booked○ Theoretically there’s nothing stopping you from any amount of money at your firm to your own
account but then you’d be fucked
HFT
● Accounts for 50%-60% of U.S. trading○ The way the algorithms are written, the risk / reward ratio is up to 1/10th of what it normally is○ Less capital is needed
● While the algorithms started out relatively simple, they quickly evolved○ Now use the forefront of machine learning/deep learning & processing techniques
● However, the market is oversaturated with HFT and volatility, even giants like Citadel reported a sharp decline in profits in recent years○ Anytime there’s a innovation and an algorithm is profitable, other firms catch on and the
profitability dries up
● Just read the books Flash Boys & Dark Pools
● Big issues today regarding ○ Cash Transfer - making sure both sides of a txn agree is expensive○ Centralization - banks keep track of everything, it's not transparent to us○ Privacy - we always need to involve third parties in our txns
● Bitcoin, a possible solution, started to gain traction after the financial crisis.○ De-centralized, the ledger is stored on every computer / node in the network○ Each transaction leaves the single ledger in a new state, no disagreement○ Anonymity - there is nothing explicitly linking you to your account
■ It’s super easy to figure out who matches with which account however....○ A finite supply, mined by essentially trying different combinations of numbers until one works
Cryptocurrency
● Incredibly valuable now, as well as some of its counterparts such as Ethereum○ I know a couple ETH millionaires (once ETH goes about $300 / ether)
● Bitcoin isn’t without its cons○ It’s really only used for drugs, ransoms, and other illegal purposes
■ Right now the only investors are people trying to get rich on hype, and traders taking advantage of its volatility
○ Governments don’t like it because they’re not in control■ Bitcoin exchanges can be shut down, and assets might even be seized (you couldn’t get
your money back○ It’s getting really expensive and slow to make new transactions
■ BTC: $6.50■ ETH: $0.26
○ Also it’s super easy to get hacked and lose all your coin
Crypto cont.
● Despite finance being stubborn to take up new technologies, computers have already replaced innumerable jobs in the industry○ Even more will be as technology gets better○ Banks are kind of in denial about this
● Algo trading is really crowded so there will be room for discretionary trading for a long time○ Sales & Trading, not so much
● Learning how to code makes you way more employable, you should probably get the basics down now while you’re at school
Future Outlook
Questions?
PORTFOLIO & MARKET UPDATE
1
Market Update▸ President Trump in Asia trip discussing trade deals
and North Korea– China has massive $26B trade surplus with the US
▸ SNAP down almost 20% after major Q3 revenue miss; Tencent has acquired a 10% stake
▸ Twitter doubling 140-character limit to increase user engagement… good luck
▸ Disney in talks to acquire 21st Century Fox▸ Major corruption probe in Saudi Arabia leading to
optimism among oil investors– Pres. Trump tweets that he would very much
appreciate if Saudi Aramco IPO was done in the NYSE
▸ Sprint / T-Mobile merger talks officially over (I think)
▸ UBER has struck a deal with NASA to develop software for managing “flying taxi” routes in the air– “Uber Elevate” will begin testing 4-passenger,
200mph flying taxi service in 2020 in LA, Dallas and Dubai
Portfolio Breakdown
IND4%
TMT22%
C&R15%
NR7%HC
9%
FIG6%
S&P20%
TIPS Bonds11%
Cash6%
Name Position % of PortfolioApple $38,458 5%Cabot Oil & Gas $29,232 4%Gap $34,709 5%Gilead Sciences $32,212 5%Global Payments Inc. $39,482 6%Infinera $21,816 3%Landstar System $27,143 4%Nike $34,193 5%Quest Diagnostics $35,396 5%Tegna $16,548 2%TransWorld Entertainment $8,050 1%Valero Energy $21,685 3%Verizon $20,507 3%Williams Sonoma $28,710 4%Yandex $57,080 8%S&P 500 Index $143,562 20%TIPS Bonds ETF $75,095 11%Cash $44,691 6%Total $708,568
Portfolio Update
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
16.0%
YTD Performance
NDIC Portfolio
S&P 500
Weekly ReturnNDIC -‐0.7%S&P 500 0.6%
YTD ReturnNDIC 9.4%S&P 500 15.2%
Top PerformersValero 3.73%Apple 3.41%Cabot Oil & Gas 0.51%
▸ Shares are bound to appreciate if a U.S. equity market correction or dramatic political event occurs. In volatile times, traders will manage risk with CME’s core products: futures and option contracts.
▸ Even without an equity market correction, the continued change in monetary policy from central bankers will demand risk management from professional traders, financial institutions, and major corporations. Interest rate futures and options make up a larger portion of volume for CME than any other products
▸ There are currently record levels of open interest—the number of contracts or commitments outstanding in futures and options that are trading on an official exchange at any one time—that signal continued trading volume in the future.
2
Sources: IBISWorld, Company 10-K
Introduction
3
CME Group
CBOT NYMEX COMEX
ChicagoMercantile
Exchange (CME)
• CME facilitates trading through both physical and electronic trade networks. Most revenue is derived from clearing and transaction fees on its electronic Globex platform
• Company generates revenue through market data sources, such as live/delayed quotes, market reports, and historical data services.
• Competitors include Nasdaq Inc., Intercontinental Exchange, and CBOE Global Markets.
Company Background Diverse Exchanges
Competitive Landscape
• Nasdaq, ICE, CBOE, and CME hold 95% share of stock and commodity trading
• Primary Sources of Revenue• CBOE and BATS: Equity and Indices
Derivatives• ICE: Data Services, Listings, and Equity
futures contracts• High barriers to entry industry, but very scalable
model; labor costs tend to dominate most expenses
Operators that arrange trades in commodities and derivatives contracts
generally have higher profit margins than firms that arrange trades in stocks. ARPC is
thus larger for CME
CME - Industry Leading Margins
4Sources: Morningstar Data, IBISWorld
• CME benefits from its high volume of non-equity derivatives in its product mix. Competitors mostly trade individual or equity linked options and futures, which deliver less revenue per contract than that of other products.
• Unlike other players, margins have been consistent over the past decade. Liquidity payments, a form of rebates to attract new customers, have not been abused by the company. Section 31 fees have been minimized
• Furthermore, management has been cautious of M&A deals, acquiring competitors that will exclusively be accretive to margins and the bottom line
CME Group Deutsche Börse Aktiengesellschaft Intercontinental Exchange, Inc.
Cboe Global Markets, Inc. Nasdaq, Inc.
CME Product Line – Interest Rate Contracts Dominate
5Sources: Company 10-K, Statista, Futures Industry Association
Interest Rate48%
Equity20%
Foreign Exchange
5%
Agricutural Commodity
8%
Energy 16%
Metal3%
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
2012 2013 2014 2015 2016
Interest Rate Equity Foreign Exchange Agricutural Commodity Energy Metal
Five Year Average Daily Volume by Product2016 Product Distribution
• CME’s niche is in the fixed income world, where it offers 5 out of the top 10 most heavily traded interest rate derivative contracts in the world, such as Eurodollar and 10 Year Note futures
• Despite nearly a decade of low interest rates, CME interest rate product volume has continued to increase annually. This signals traders are becoming increasingly vigilant about current and future movements
• While interest rate contract revenue is the lowest among all product categories, it has been the most resilient to price decreases versus metals and agricultural products
• A significant part of CME’s organic growth strategy is offering new products on the rate related products, such as weekly and mid point options & futures
Key Catalyst for CME: Interest Rate Volatility
6Sources: Federal Reserve, FRED Data
US Monetary Policy Overview
• Federal Reserve is on a tightening cycle, but it’s still unclear where the federal funds rate will end up in 2-3 years
• Factors that influence rate decisions include changes in PCE inflation, unemployment, real GDP growth, and pure discretion
• Following the latest FOMC meeting, the assessment on the appropriate target fed fund rate for 2019 ranged from 1.1 – 4.1%.
Non-Controllable Risk to Interest Rates
• While Fed meeting watches and sentiment may be slightly predictable, there exist other risk factors that move interest rates
• Equity market movements and geopolitical events are the most forceful factors on 10 Year Treasuries
• Other less impactful forces include domestic fiscal policy changes, regarding spending and taxation
10 Year Treasury Volatility has been Trending Downward (VXTYN) Similar Circumstance in Equities (VIX)
Global Options and Futures Contract Volume Forecast
0
5
10
15
20
25
30
35
40
2016 2017E 2018E 2019E 2020E 2021E
Billi
ons
High Volatility Forecast Base Volatility Forecast
High Vol. Assumptions
• 2021E ~33.5 billion contracts traded globally
• CME global derivatives share rises from 15.6% à18%
• Average Revenue per Contract declines from peak of $0.769 to $0.749
Clearing and Transaction Fees Increase from ~$3 billion to $4.5 billion by 2021
Potential Downside Catalysts
8Source: Yahoo Finance
• While volatility is good, a systemic issue with the economy that dramatically moves markets would be an overall net negative for CME
• Examples include the Savings and Loan Crisis and the Great Financial Crisis
• Short term trading would be dwarfed by overall decrease in future trading if people are hesitant to put money back on the line
• A correction due to valuation would not be a great risk however
Systemic Economic Issue
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Fifteen Year Stock Chart
S&P 500 CME
Decrease in Transaction and Clearing Fees
• The strong competition in the industry can lead to a race to the bottom in transaction and clearing fees
• So far CME and its competitors have maintained stable fees, but the industry has been consolidating
• Firms are now introducing variable pricing models to appeal to different segments in option markets
• Lower average revenue per contract by both ICE and CME could lead to a potential merger; talks were entered into last year
Regulatory Risk
• U.S. Commodity Futures Trading Commission (CFTC) and the Federal Reserve for cleared swaps and privately negotiated products may lead to the development of platforms that compete directly with CME’s exchange traded and privately negotiated products
• Potential further regulation may arise from the stigma against “high frequency trading.”
Conclusion – Buy CME
9
Diversification of Investment Club Portfolio
•Currently underweight financials•Low beta industry with higher than average return potential•Financials offer high yields, and CME is no exception (4%E w/special dividend)
Exchanges Offer UniqueExposure Within Financials
• High margin business with neutral/inverse correlation to other financial firms’ revenues
• Straddle the worlds of technology and finance with innovative financial products and trading systems
Hedge Against Uncertainty
• Best exchange for changes in US interest rate movements, from either Fed or market participants (10Yr.)
• Primed for equity market correction or swings in energy prices
• 9.2%EBITDA CAGR from ‘17-22 • EBITDA Margin expansion from 67.5% to ~71%• Terminal Year Multiple of 16.9x• 9% Discount Rate
• 10.3% CAGR in Clearing and Transaction Fee Revenue from ‘17-22
• Market Data, Access, Other Revenue held at 2% CAGR• No growth in cleared only interest rate and CDS swaps
Valuation Inputs
Implied Share Price of $153.50~11% Upside
Appendix - DCF
10
CME GroupDiscounted Cash Flow Analysis($ in millions, fiscal year ending December 31)Mid-Year Convention Y
Present Value of Free Cash Flow $1,512 $1,689 $1,886 $1,941 $1,920 $1,844
Enterprise Value Implied Equity Value and Share PriceCumulative Present Value of FCF $10,793 Enterprise Value $53,062
Less: Total Debt 2,233 Terminal Value Less: Preferred StockTerminal Year EBITDA (2022E) $3,885 Less: Noncontrolling InterestExit Multiple 16.9x Plus: Cash and ST Investments 1,362
Terminal Value $65,650 Discount Factor 0.64 Implied Equity Value $52,191
Present Value of Terminal Value $42,269 % of Enterprise Value 79.7% Fully Diluted Shares Outstanding 340
Enterprise Value $53,062 Implied Share Price $153.50
