October 19, 2017

 Church was opposed to the certain activities but it wasn’t opposed to risk bearing investments
 Democratization of investment
 You had more and more wide-spread business being undertaken where things were being traded among
the whole of western Europe.
o There were trade fairs like Champagne for the same reasons as Athens – they knew other traders
were going to be there
o If you were a Dutch trader and you wanted to trade with Italy, you went to the fairs at
champagne and did the trade but you didn’t necessarily have to buy stuff from Italy – you could
buy stuff from elsewhere. It let them trade throughout the whole of Europe without having to
travel to the whole of Europe by attending the fair.
 Instead of each trader carrying large sums of money, a lot of stuff was done on credit and the bankers
would get together and clear their books so all that had to be cleared was a small net amount of money
and even that money did not have to be shipped as they could have kept it as a credit. It limited the
amount of physical cash which meant that more and more trade was done with paper credit.
 If a credit instrument was stolen, it was no good to the person that stole the credit but you were still out
the money
o Finance helped limit the amount of gold and silver that would be moving around providing
security
o Evolution of finance was driven by how do we minimize the physical amount of gold and silver
we have to carry from one part of Europe to another.
o Paper credit evolved to protect and reduce the likelihood of losing the gold or silver
o You see a lot of modern business practices emerging in later medieval Europe
 Everything comes together at the modern of the business era, around 1600. What you get is basically the
Dutch East India Company (DEIC) and the English East India Company (EEIC). These were chartered
companies which means they were operating under specific government rules.
o They were monopolies and the two companies spent a lot of time fighting wars against each
other – they set up military posts.
o In this period, chartered companies were a popular way to reap money because the government
would sell the charter.
o The oldest surviving charted company is the Hudson’s Bay company. They had a monopoly in
North America because of the rivers that drained into the Hudson’s Bay.
o Popular way of bringing in revenue because when a monarch was short of cash they would sell
the charter to a group of businessmen. To have the monopoly over that large of an area it had to
buy the monopoly right from the crown.
o French were very in debt and sold monopolies over everything – large and small.
 English tried to do it but they weren’t as good as it but they still managed to set up a
couple companies which were able to produce revenues for the crown
o If you’re selling a monopoly over the fur trade in NA for the long term, the license is going to be
valuable to HBC.
 Chartered companies came into play in the 1500’s and 1600’s.
 DEIC was set up as a merger of Dutch companies. Dutch traded a lot to Indonesia whereas EEIC traded
to India.
 Silks and spices: ratio of value to weight. Value of silk to the weight of silk was incredibly high so there
were a large number of adventurers. In about 1600, they decided that competition among themselves
was wasteful. Around 11 companies merged together to create the DEIC in 1602. We had been talking
about isolated examples of business prior to the merger but when they merged, although it took a while
to become a corporation. Organized the same was as a venture basis business like the Medieval times.
You could separate each and every voyage by not owning any capital so they knew exactly what every
 single voyage cost them. There were no joint costs where you had to divvy up costs – you rented a
warehouse for the voyage.
o Some voyages took around 6 months which was nothing compared to the time that a trading
voyage to India could take which depended on the winds. You are in the era of wind being the
source of repulsion. Certain times of the year the wind blows from EU to India, and other times
India to EU so you had to send it off at the beginning of the period where the wind blew to India.
Most of the time they were taking silver to India. It was much more valuable to Indians that it
was to the Europeans. A lot of the time, they were taking silver on their voyages and buying silks
and spices in India and the silks and spices were more valuable in EU so you could profit from
the trade. You had to wait for the trade winds to turn around to turn back once you had made
your trade. If you were out late in the season, when the winds are blowing from EU to India, you
are going to be getting there late in the trading season. Suppose it takes you longer to get a full
cargo than you expected and the winds are blowing from EU to India again, you were stuck there
for another 6 months so you had a very precise window to do your voyages because it could take
a couple years depending on the winds. This meant you never knew when your trading ships
were going to come back.
o Super companies generally had a good idea of when their ships were going to come back to the
Netherlands.
o If the timing was wrong on your trip to India, you have no idea when your ships will come back.
o Super companies rented the ships and they knew how long they were renting it for so you could
enter into a definite contract with ship owners but with trading to India, timing was uncertain so
the ship owners would not want to rent but you were not in the financial position to buy.
o Renting a warehouse – if it took years to come back, you don’t know when you are going to need
the warehouse. If a couple unexpected voyages came back at the same time, you have a lot of
product coming in at the same time. They tried to pay their partners off with pepper so the
partner would be responsible for housing the pepper and selling it on the market. Partners were
not thrilled. Because of all this uncertainty, you had to own your own warehouses and have your
own ships.
 If you had a lot of pepper coming in at one time, you had an influx which pushed the
price of pepper down which means that when you pay them in pepper it is worth a lot less
than you valued it at.
o When you have a long term business and it has to own a lot of capital, the partnership structure
was not suitable. Initially had a charter for 20 years which means it was a partnership with a life
span but 20 years came a long and a lot of their capital was locked up in physical form in
warehouses which included ships and a lot of the ships were still in India with no clue of when
the ships would be back. The managers of the EIC got the charter changed which means that the
investors had no idea when they would get their money back because their money is no longer
locked in for 20 years – no more target date. In compensation for that, shares for the EIC went
on sale to the public in Amsterdam. They tried to organize their business in a way that was not
best suited and when they brought all the bits and pieces together you have a structure that looks
similar to the modern corporation. This worked better with the type of business they were doing
because it was long term with ownership of a lot of capital equipment.
 When the EIC shares were made public on the Amsterdam stock exchange this means there was a stock
exchange. What they were trading was government debt/stock. We treat the interest rate on government
stocks and bonds we consider it to be the risk-free instrument. Before, they used to be riskier because
you were likely to default in your load. Government financial debt.
 EIC has a lot of shares out there which were owned by individual owned, some with small amounts and
some with large amounts. If you wanted to sell your share in the EIC, you had to go to one of your local
offices. You had to actually sell the meat one of EIC’s cooperate office
o Allowing the shares to be traded, they didn’t have to do anything to get their money out of the
EIC and eventually they came to dominate the stock exchange.
 o Stock exchange got formalized and it developed its own administration. When the EIC put the
Amsterdam stock exchange on the map, it started out as small scale trading in government debt
to EIC shares being traded to a bunch of companies gathering to sell their shares. They then had
people who wanted to invest. It became the first modern stock exchange.
o The stock exchange also did great things for government debt. Because it was riskier, there was a
higher interest rate on government debt.
o With the Amsterdam stock exchange, you did not have to wait to see if they were going to make
a debt payment when they said they were going to, you could trade your shares rather than
waiting like before – you could sell your debt to someone else who was looking for a higher
interest and riskier stock.
o As anyone who owned government debt could sell it whenever they wanted to, it became a little
bit safer so it reduced the interest rate the Dutch authorities had to pay to raise money. As the
stock exchange was always going to be there, the debt became more liquid. The stock exchange
was big enough that you knew you would be able to make the trades which reduced the risk from
your point of view. Therefore, the Dutch government was able to raise money at much lower
interest rates than anywhere else in EU.
 In early to mid 1600’s, you have Charles II coming to the throne in 1660 and he was Roman Catholic.
James II was definitely Roman Catholic. English did not want to change their laws. Charles was
scandalous and the public liked him but they did not like James. James was replaced by William and
Mary and the English invited them to come across from the Netherlands and take the throne. William
was Dutch so a lot of Dutch businessmen and financiers came over London meaning that the financial
instruments were brought over and copied from the Dutch. Within a few years of them adopting their
financial methods, England had low interest rates. Charles and James weren’t reliable at repaying debt
but when you have a stock market, it became more reliable lowering interest rates. London took over
from Amsterdam as the best organized and most sophisticated financial market which helped spread
financial markets. When you get financial markets, you get financial bubbles.
 The earliest financial bubble was in 1637, referred to as Tulip Mania. It is greatly overblown; it was
fairly small though. It was a financial bubble which involved the price of tulip bulbs. Bubbles are
something we cannot define. Loosely defined: the price of some sort of a financial instrument takes off
and does not compare to what we think it should be.
 Think about buying a share in a company – it is a share in the future stream of profit that the company is
expected to make. The price you should be willing to pay should be no more than the expected present
value of your bit of expected future profits.
 Shares that are traded freely on the open market – prices should be the price that people who want to
buy it and prices that people who already own a share would accept which would reflect the stream of
profits that you are going to get in the future. The value of a reasonable expected profit that you can
expect in the future which depends on both the demand and supply of the shares. Not a matter of what
the company thinks the shares are worth but rather the individuals participating in the market. If the
market is competitive and reasonably well informed, then it should be well reflected. A bubble happens
when the price of shares in a company takes off and becomes way too high when it does not reflect the
expected future profit. You only know a bubble after it has collapsed.
 Amazon, at one point reached a point where they were so high above the expected value but the shares
never collapsed but if you look at the 1990’s dot com bubble, you see their shares soar and then collapse.
 If you look at tulip mania, it was a bubble regarding the price of tulip futures. Futures trading was a way
of trading in derivative type trading which was present in Amsterdam. It was a minor local bubble where
a few people lost money but that was about it. Touchstone of bubbles because of the name.