September 2011 - Finance

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Nivine Richie, Ph.D., CFA is an Associate Professor of Finance at the University of North Carolina Wilmington. She teaches courses in corporate financial management, derivatives, fixed income, and commercial bank management. Her research interests include cost of capital, banking, and derivatives. She has published studies in the Journal of Economics and Finance, Journal of Futures Markets, Review of Futures Markets, and Journal of Trading, among others.

European Short Sale Ban Continues

09-30-2011 4:20 PM with no comments

 

 

Watch the WSJ Video Here

 

In an effort to reduce market volatility, Greece banned short selling.  France, Italy, and Spain soon followed suit.  Belgium too.  Now the bans that were due to expire have been extended. 

 

And yet, stock market volatility continues. 

 

“Short-sellers sell borrowed shares with plans to buy them back later at a lower price, a practice politicians and some investors blame for roiling markets” reported Bloomberg 9/29/2011. 

 

However, rather than reduce market volatility, some believe that short-sale bans are having an opposite effect:

 

“The ban has only succeeded in drying up liquidity, increasing volatility and those stocks subject to it will be worse performers,” said Simon Maughan, head of sales and distribution at MF Global Ltd. in London. “That is what this ban has achieved.”

 

Discussion Questions:

 

1.     How and why would an investor sell a stock short?

 

2.     Why do some investors believe that short sale restrictions do more harm than good?

 

 

Posted by Nivine Richie

The Problem of the Chinese Yuan

09-30-2011 3:23 PM with no comments

Chinese goods are cheaper than American goods because Chinese currency is too cheap.  That’s the story told by legislators, and they’re sticking to it. 

According to Bloomberg, new legislation with bi-partisan support has been proposed to penalize China for keeping the Yuan artificially low:

The legislation would let U.S. companies seek duties on imports from China to compensate for the effect of a weak yuan, which lawmakers said gives Chinese companies an unfair advantage against U.S. manufacturers.

Not everyone agrees, however.  The Club for Growth believes that the proposal is “disastrous” and starting an “ugly trade war…would benefit no one.”

Supporters of this bill believe that cheap imports from China are harming our nation's manufacturers, but they fail to realize that China ships intermediary goods and raw materials to the United States, not just final consumer products. These cheap goods are used by our nation's businesses to produce final products that can be sold at competitive prices. And even if supporters of this bill had a valid argument, the better course of action to spur our nation's economy is not to punish another country through higher taxes on ourselves, but by lowering taxes on corporate income, capital gains, and dividends. This would ignite economic growth, expand our access into foreign markets, and make American companies more competitive and innovative. Likewise, cheap imports are not a drag on the economy. They give consumers more choice and the extra resources to save and invest.

(Great Wall of China, photo N. Richie)

Discussion Questions:

1.     Go to www.oanda.com.  What is the current exchange rate between China and the U.S.? 

2.     How does a strong currency affect an economy?  How does a weak currency affect an economy?

Posted by Nivine Richie

Mutual Fund Loyalty

09-29-2011 5:20 PM with no comments

What keeps financial advisers coming back to the same mutual fund provider?  Survey says…mutual fund performance and some softer qualities.   A survey by Cogent Research LLC of 1,643 advisers revealed that mutual fund performance over 2 to 5 years was the primary reason for adviser loyalty.  However, some softer qualities such as the provider’s investment philosophy and the quality and depth of the research emerged as winning characteristics. 

 

According to this Investment News article (available by free subscription):

 

The two biggest gainers in overall adviser commitment were T. Rowe Price Group Inc. and Legg Mason Inc. In contrast, The Hartford Financial Services Group Inc., Dodge & Cox and Eaton Vance Investment Managers all lost ground. The top scorer, Dimensional Fund Advisors LP, also scored highest in last year's survey.

 

Discussion Questions:

1.     According to this related article, why did money flow out of mutual funds last month?

 

2.     What are exchange-traded funds, and how do they differ from traditional mutual funds?

 

Posted by Nivine Richie

Cash Flow to Shareholders

09-26-2011 7:06 PM with no comments

Cash flow to and from the firm can take many forms.  Firms generate cash flow from their assets through their day-to-day operations (called operating cash flows), by selling their fixed assets, or by reducing their net working capital.  On the other side of their balance sheets, firms can spend the cash they generate by (a) repaying debt or by (b) repurchasing shares of their own stock.

 

Warren Buffett has chosen to do just that--repurchase shares of Berkshire Hathaway stock.  Closing at $108,449 per share today, Berkshire stock is cheap, according to Buffett.  And he's "putting his money where his mouth is," according to Bloomberg.

 

Berkshire Hathaway's press release on 26 September:

In the opinion of our Board and management, the underlying businesses of Berkshire are worth considerably more than this amount [book value], though any such estimate is necessarily imprecise. If we are correct in our opinion, repurchases will enhance the per-share intrinsic value of Berkshire shares, benefiting shareholders who retain their interest.

Discussion Questions: 

1.     What is the current book value per share of Berkshire Hathaway stock?  What happened to the stock price for Berkshire Hathaway after the press release announcing the repurchase?

 

2.     What methods will the firm use to complete the repurchase transactions? 

 

3.     What alternative ways does Berkshire have for spending the excess cash?  Why are these options less attractive than a share repurchase?

Posted by Nivine Richie

Banks Take On More Derivatives

09-25-2011 9:24 PM with no comments

“Even as federal regulators ratchet up scrutiny of the derivatives market, Wall Street is diving deeper into the $600 trillion industry,” reported the N.Y. Times.

Despite all the bad press about derivatives, banks have increased their credit exposure to derivatives by $11 billion to $364 billion according to a recent report by the Office of the Controller of the Currency (OCC).  The number of banks reporting derivatives activity was 1,071 which is 24 more than last quarter.  According to the report,

Derivatives activity in the U.S. banking system continues to be dominated by a small group of large financial institutions.  Five large commercial banks represent 96% of the total banking industry notional amounts and 86% of industry net current credit exposure.

Discussion Questions:

1.     What is a credit default swap?  What risks are associated with this market?

2.     What is the Dodd-Frank Act implementing to reduce the risks associated with derivatives?

Posted by Nivine Richie

Can More Lending Cure Our Economy?

09-23-2011 12:31 PM with no comments

 

Will the Fed’s attempts to reduce long-term rates encourage new loans?  According to this CNNMoney article, probably not. 

 

"Low rates can only do so much," said Greg McBride, senior financial analyst with Bankrate.com. "Operation Twist will not prompt banks to make loans they're not comfortable making. It won't prompt people to buy houses if they're worried about a job loss, and it won't help homeowners refinance mortgages if they're already unable to qualify."

 

Some believe that lower long term rates will reduce bankers’ incentives to lend.  Banks make money by lending money long term and borrowing short term.  If long-term rates fall and short term rates rise, then bank profits get squeezed.  Is that enough to cause bankers to sit on the sidelines and stop lending?  I don’t think so. Bankers are innovative.  They’ll find a way to survive this interest rate environment. 

 

The bigger issue is that borrowers can’t qualify for the loans or don’t want more debt.  This is not something that can be fixed by the Federal Reserve’s Operation Twist.

Posted by Nivine Richie

Searching the Old Ledgers

09-23-2011 10:53 AM with no comments

“The merchant when bankrupt searches his old ledgers.” 

~ Arabic proverb

 

 

 

The Dallas County District Attorney is suing Bank of America and Mortgage Electronic Registration Systems Inc (MERS) for failing to properly record the sale of mortgages with the county and avoiding the filing fees that should have been paid since the company was created in 1997.  The county is seeking $10,000 per violation and liability could exceed $1 billion, according to this Bloomberg article by Fisk and Sterngold on Sep 23, 2011. 

 

One particularly interesting tidbit:

 

MERS is owned by financial institutions including Citigroup Inc., JPMorgan Chase & Co., Wells Fargo & Co. and Stewart Title Guaranty Co., and industry trade groups including the Mortgage Bankers Association and the American Land Title Association. It’s also partly owned by Fannie Mae and Freddie Mac, the housing finance agencies now controlled by the U.S. government after being bailed out in the 2008 financial crisis.

 

This may be a boon for counties around the country—a new source of revenue in troubled times.  If Dallas wins, others may follow suit. 

 

Discussion Questions:

 

1.     What has happened to Bank of America’s stock recently?

 

2.     What is Bank of America’s credit rating?  How has that been affected by recent events?

 

 

Posted by Nivine Richie

Technically, Oil Prices Fell Too Far

09-23-2011 9:56 AM with no comments

 

Crude oil prices dropped 7.4 percent this week, but rebounded when investors felt that the prices had fallen too far.  According to Bloomberg’s Rachel Graham and Ben Sharples on Sep 23:

 

Crude dropped below its lower Bollinger Band for the first time in more than six weeks, according to data compiled by Bloomberg. This indicator is at $80.84 a barrel today. Bollinger Bands plot support and resistance levels based on volatility and are used by investors to determine entry points for buying or selling contracts.

 

On his website, John Bollinger describes Bollinger Bands:

 

Bollinger Bands consist of a set of three curves drawn in relation to securities prices. The middle band is a measure of the intermediate-term trend, usually a simple moving average, that serves as the base for the upper band and lower band. The interval between the upper and lower bands and the middle band is determined by volatility, typically the standard deviation of the same data that were used for the average.

 

Back to oil.  If oil prices are driven by factors such as Bollinger Bands, then investors can find ways to profit from the changes in the market.  If, however, oil prices are driven by fundamental factors such as supply and demand for oil, then price charts won’t provide enough information. 

 

I think OPEC is choosing the latter (i.e. supply and demand).  Graham and Sharples reported, “The Organization of Petroleum Exporting Countries will decide whether to cut supply after monitoring the global economy over the next two months and the pace of Libya’s production recovery, an OPEC official with knowledge of the matter said yesterday.”

 

Discussion Questions:

 

1.     What is technical analysis? If investors can earn abnormal returns using Bollinger Bands, then what does this say about the Efficient Market Hypothesis? 

 

2.     What is fundamental analysis? If investors can earn abnormal returns by forecasting supply and demand, what would that say about the Efficient Market Hypothesis?

 

Posted by Nivine Richie

Twist and Shout

09-21-2011 3:36 PM with no comments

Watch the Bloomberg Video here

 

The Fed announced today that it plans to sell $400 billion in short-term Treasury securities and reinvest the proceeds in Treasury securities with maturities of 6-30 years.  Additionally, the Fed plans to reinvest in agency mortgage-backed securities (MBS).  The Fed plans to hold the Fed Funds rate at “exceptionally low” levels of 0-0.25 percent because of the downside risks that still plague our economy.

According to the Bloomberg interview pictured above, this “operation twist” is the Fed’s attempt to drive long-term rates down and help the mortgage market.  Unfortunately, this comes with higher interest rate risk for the Fed as they hold longer-term bonds.   

Discussion Questions:

1.     Why is this strategy called “operation twist?”

2.     According to the Fed, what is the likely effect of this plan on short-term interest rates?

3.     What are the likely effects on interest rates for other types of bonds such as corporate bonds?

Posted by Nivine Richie

Return of the Greek Drachma

09-21-2011 10:50 AM with no comments

European flag courtesy of www.europa.eu

In a recent Financial Times commentary, Nouriel Roubini of the Stern School at NYU said that Greece should default and exit the Euro.  Greece is currently stuck.  The country cannot repay its debts, and the future is looking bleak. 

 

According to Roubini,

"A return to a national currency and a sharp depreciation would quickly restore growth and competitiveness, as it did in Argentina and many other emerging markets that abandoned their currency pegs,”

 

The problem Greece is facing is an inability to compete and that is preventing the Greek economy from growing enough to repay its debts.  Roubini is suggesting that having the ability to devalue its currency will fix the problem.

 

Discussion Questions:

1.     In the Financial Times commentary, what are the other possible solutions suggested by Roubini?

 

2.     What is the problem with each of the solutions identified by Professor Roubini?

 

3.     According to the CNBC article, what are the costs if Greece or Germany choose to exit the euro?

 

Posted by Nivine Richie

Merger Fever

09-16-2011 11:44 PM with no comments

B.F. Goodrich was a former Civil War surgeon who started a rubber company in Akron, Ohio in the late 1800s.  The company grew to be one of the biggest tire manufacturers in the world, and later sold the tire brand to Michelin.  Along the way, Goodrich diversified into manufacturing of airplane components.  According to their website, Goodrich is a “leading global supplier of systems and services to the Aerospace and Defense industry. If there's an aircraft in the sky - we're on it.”

United Technologies is the conglomerate that owns Pratt & Whitney and Otis Elevators.  In a NY Times article, United Technologies said it is considering buying Goodrich. 

Though the shareholders of acquirers usually see their shares declining at the time of a merger announcement, this hasn’t been the case lately.  United Tech has made a practice of growing by way of merger or acquisition. 

United Technologies’ top executives have made no secret that they consider acquisitions a key growth strategy. “You’re going to see us put our balance sheet to work, you’re going to see us put more cash to work on the M.&A. side,“ Gregory J. Hayes, the company’s chief financial officer, said in July, according to Reuters.  (Read the NY Times article here).

United Tech has successfully acquired some companies, but not all.  In 2009, it bought GE’s fire alarm and security systems unit.  In 2008 it attempted to buy Diebold, the auto battery manufacturer, but withdrew because of the financial crisis.  Though Goodrich no longer has a relationship with B.F. Goodrich Tires, Goodrich itself is a worthy target for this acquisition by United Technologies.  With $587 million in net income, it is enough to attract an acquirer.

 

Discussion Questions:

  1. Why might United Technologies be interested in buying Goodrich?
  2. What is the typical pattern of stock price behavior for the target firm and for the acquirer firm in the days (or weeks) surrounding the new stock purchase?

Posted by Nivine Richie

Diamond in the Rough

09-16-2011 10:44 PM with no comments

“Diamonds” photo by Mario Sarto licensed under Gnu Free Documentation License (GFDL)

 

What’s the problem with investing in Diamonds? For one thing, they are hard to value (without the help of a diamond appraiser).  And they are illiquid (that is, they cannot be converted to cash quickly without a pawn shop). 

If you expect diamond prices to rise but aren’t sure how to invest in the glassy substance, you can now invest in the diamond fund established by Harry Winston Diamond Corporation (NYSE: HWD), the diamond mining and retail firm.  The fund is being set up as a limited partnership with Diamond Asset Advisors with up to $250 million in assets and “offering institutional investors direct exposure to the wholesale market price of polished diamonds.” (thestreet.com May 19) 

According to CNBC,

"I think that over the long term there will be a strong appreciation of diamond prices based on increasing luxury demand from India, China and the Pacific Rim," said industry expert Rapaport, adding that a weak dollar would also increase diamonds' appeal as a safe haven for investors.

Broader demand and a consequent improvement in liquidity should support diamond prices over the longer term, making such funds attractive, although the horizon is cloudy in the near term, some market watchers said.

Investing in diamonds is not without its pitfalls. Others have tried and failed over the years.  Still, if you want to invest in diamonds and aren’t knowledgeable enough to invest directly in the precious gem, perhaps a diamond fund is something to consider.

 

Discussion Questions:

1.    According to the CNBC article, the fund is being launched as a “private placement.”  What is a private placement and who can invest in it?

2.    How have previous diamond funds fared in the past?

3.    Why might investors choose to invest in this diamond fund? Why might they choose not to?

 

Posted by Nivine Richie

Bad News for French Banks

09-15-2011 11:24 PM with no comments

 

photo by N. Richie

 

Moody’s cut the credit rating of Societe Generale (SocGen) and Credit Agricole and is still reviewing BNP Paribas.  In its press release on 14 Sep 2011, Moody’s expressed concern about the banks’ “exposures to the Greek economy.”  The long-term debt rating for Societe Generale was reduced from Aa3 to Aa2 and for Credit Agricole from Aa2 to Aa1, a one notch downgrade for both banks.  Moody’s also indicated that the banks faced potential problems in the banks’ “funding and liquidity profile.”

According to Market Watch, 15 September 2011,

The ability of European banks to access funding, especially in dollars, has come under increasing scrutiny in the last few weeks as U.S. money-market funds have reduced their exposure to European banks and shortened the time period over which they will lend money.

All three of the French lenders are among the European banks that are most dependent on money-market funds for funding of that type. 

Watch this Bloomberg interview with Frederic Oudea, CEO of Societe Generale

Discussion Questions:

1.     According to the Market Watch article, what other evidence exists that European banks are facing a potential funding crisis?

2.     What impact will these downgrades have on French banks?

 

Posted by Nivine Richie

Europe's Financial Crisis

09-15-2011 10:29 PM with no comments

Photo of euro banknotes copyright by European Central Bank and used by permission of ECB

Jean-Claude Trichet, the President of the European Central Bank (ECB), the European counterpart to our Federal Reserve, is pushing European governments for “decisive action to halt the debt crisis.”  According to this Bloomberg article,

Eighteen months of crisis-fighting and 256 billion euros ($355 billion) in aid for Greece, Ireland and Portugal have failed to stabilize markets. The turmoil has spread to Italy and Spain, sending tremors through Europe’s banking system and leading to speculation that a currency meant to be permanent might break up.

The ECB has been busy lending money to European banks facing a liquidity crunch.  Additionally, German Chancellor Angela Merkel and French President Nicolas Sarkozy  have promised to help Greece remain in the euro.  These two actions have helped give financial markets some hope.

Posted by Nivine Richie

The Rogue Trader Strikes Again

09-15-2011 8:41 PM with no comments

photo of UBS sign by twicepix licensed under Creative Commons

 

Every few years, the same story grabs headlines.  In 1994, Nick Leeson held the infamous title of “Rogue Trader” when he lost the equivalent of $1.4 billion and single-handedly brought down Barings Bank.  In 2008, the title was passed to Jerome Kerviel, the 31-year old who lost $7.2 billion for Societe Generale.  Today the title goes to Kweku Adoboli, the trader for UBS who lost $2 billion for the troubled bank.  In an internal memo republished by the NY Times, UBS seeks to reassure employees:

Dear colleagues,

We regret to inform you that yesterday we uncovered a case of unauthorized trading by a trader in the Investment Bank. We have reported it to the markets in line with regulatory disclosure obligations. The matter is still being investigated, but we currently estimate the loss on the trades to be around 2 billion US dollars. It is possible that this could lead UBS to report a loss for the third quarter of 2011. No client positions were affected.

We understand that you have already had to contend with unfavorable, volatile markets for some time now. While the news is distressing, it will not change the fundamental strength of our firm.

We urge you to stay focused on your clients, who are counting on you to guide them through these uncertain times.

We want to reassure you that we, together with the rest of the management, are working closely with the Investment Bank’s management and risk and controlling to get to the bottom of the matter as quickly as possible, and will spare no effort to establish exactly what has happened. We will keep you updated on the progress of our investigation.

Yours,

The Group Executive Board

Discussion Questions:

1.     How did some of these actions go undetected and generate such large losses at these banks?

2.     What risk management practices would prevent such behavior in the future?

Posted by Nivine Richie

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