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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.

Overcoming Behavioral Investing Biases

06-08-2014 8:56 PM with no comments

Traditional finance says that investors are rational and that they make decisions based on optimizing the expected return and risk tradeoff. In other words, investors weight all available information correctly and arrive at optimal investment portfolios.

 

Behavioral finance, on the other hand, suggests that investors have psychological biases that cause them to overweight some information and underweight other information, which could lead to suboptimal investment decisions. In this Financial Times video interview, Michael Ervolini, the chief executive of Cabot Research, discusses how portfolio managers can be coached to improve their buying and selling decisions based on their particular behavioral biases.

 

 

For discussion:

 

One behavioral bias is called the “Endowment Effect.” What is this behavioral bias and how does it impact a portfolio manager’s selling decisions?

 

Posted by Nivine Richie

Capital Budgeting and Ethical Decision Making

06-07-2014 12:57 PM with no comments

In evaluating a project, finance students are taught to compare the present value of all expected cash flows with the initial investment. If the total present value of all expected cash flows is greater than the initial cost of investing in the project, the net present value (NPV) is positive and the project should be accepted. If the NPV is negative, then the project should be rejected.

 

What we may not discuss much is the fact that some projects or ideas should be rejected, even if the NPV is positive.

 

Take GM’s recall, for example. 

If the firm was to decide whether to recall a faulty product based strictly on the numbers, some executives may choose the profitable path, but not the ethical one. 

For discussion:

 

In what ways is the NPV decision rule a reliable way to make capital budgeting decision? In what ways is it not reliable? 

Posted by Nivine Richie

S.E.C Chief Takes On Market Structure

06-06-2014 11:56 AM with no comments

In a speech in New York yesterday, S.E.C. Chair Mary Jo White announced her intention to improve market structure. In her speech, she identified several measures of market quality that indicate markets are well-functioning, such as:

 

·       Trading costs for large orders have declined for institutional investors

·       Intraday volatility has returned to 2006 (pre-crisis) levels

·       Bid-ask spreads are narrower than ever

 

She went on to say that though the market is not “fundamentally broken,” issues associated with technology still exist.

 

From the speech:

 

First, as I have said from the day I took office, one of the most serious concerns about today’s equity markets is the risk of instability and disruption. Technology can and has greatly increased the efficiency of our markets, but it can also allow severe problems to develop very quickly — just consider some of the systems events of the last few years at exchanges and brokers.

 

Regarding high frequency trading, Ms. White stated:

 

These traders use a variety of low-latency tools, including co-located servers in trading data facilities and direct data feeds from trading venues rather than the slower consolidated data feeds of the SIPs. Much of the recent public focus has been on high frequency trading firms, but it is important to remember that many brokers use the same tools on behalf of their customers.

 

The SEC should not roll back the technology clock or prohibit algorithmic trading, but we are assessing the extent to which specific elements of the computer-driven trading environment may be working against investors rather than for them.

 

For discussion:

 

What is high-frequency trading and how does that differ from algorithmic trading? Should high-frequency trading be banned? Why?

 

Posted by Nivine Richie

Qualities Shared by the Super-Rich

06-01-2014 11:04 PM with no comments

A recent CNN Money article (Sahadi, 1 June 2014) investigates the characteristics that the wealthy seem to share.

The list includes such qualities as:

1.    An entrepreneurial spirit

2.    Willingness to work long days

3.    High energy and positive attitudes

4.    Can-do spirit

5.    Recognize talent in others

6.    Ability to live within their means

7.    Risk tolerant but not risk seeking

 

For discussion:

 

Which of those qualities would you rank as the top three qualities of super-wealthy individuals?

 

Posted by Nivine Richie

Is Active Investing Worth It?

06-01-2014 10:58 PM with no comments

Determining whether active or passive investing is the best choice is widely debated. Active managers claim that their superior stock picking or asset allocation skills are worth the management fees that they charge. Passive managers claim that the best investment is the market as a whole, so choosing to mimic the market is the wisest, and least expensive, choice.

 

Given the debate of whether active management is worth the fees, a recent Institutional Investor article asks the question, “Is Investing an Art of a Science?” Some, like value investor Seth Klarman believe that investing is more art than science. Others like Vanguard Group founder Jack Bogle disagree.

 

From the article (Pelz, 1 June 2014):

 

[Bogle] has long argued that investors are best served by putting their money in low-fee mutual funds that closely match the returns generated by the stock or bond market as a whole. The science for firms like Vanguard is in replicating the performance of an index at the lowest possible cost.

 

For discussion:

 

What evidence exists to suggest that active management is a wise choice? What evidence exists to suggest that passive management is a wise choice?

 

Posted by Nivine Richie

The Link Between Household Debt and Economic Growth

05-29-2014 2:52 PM with no comments

In this Financial Times interview, authors Atif Mian and Amir Sufi of the new book House of Debt explain the link between the rise of household debt and the decline in spending and employment. Using data at the city and zip code level, the authors list household debt as the single most important factor to explain economic decline.

 

For discussion:

 

Beyond the household debt argument, what are the other explanations for the economic crisis?

 

Posted by Nivine Richie

Can Efficient Markets Be Beat?

05-25-2014 4:04 PM with no comments

The Efficient Market Hypothesis is the central theory of finance. The notion that market prices reflect all available information immediately and fully is widely accepted among many academics and practitioners.

 

This Financial Times video discusses the current view that because of behavioral biases, markets are not perfectly efficient, and yet the market is still nearly impossible to beat.

 

For discussion:

 

What are the three forms of the Efficient Market Hypothesis? What are some of the behavioral biases that violate the EMH?

 

Posted by Nivine Richie

Jobs For Bond Traders

05-25-2014 3:28 PM with no comments

A recent Bloomberg article reports that Wall Street hiring of bond traders has increased recently as Nomura and Deutsche Bank add to their bond trading desks.

 

From the article:

 

Debt trading hasn’t been what it was before the 2008 crisis from a profit point of view for two main reasons: New rules have reduced the wagers banks can make with their own money, and near record-low yields are eroding returns. But with interest rates forecast to finally go up sometime soon, it’s poised to become more lucrative.

 

[read the full article here]

 

Bond trading is profitable in both the primary and the secondary markets. According to the author, in volatile markets, traders can generate profits as investors sell bonds in the secondary markets. At the same time, bond underwriting fees mean that investment banks earn profits from primary markets as well.

 

Posted by Nivine Richie

Banking and Community Development

05-23-2014 5:05 PM with no comments

Photo of abandoned Packard Automotive plant in Detroit, 2009 by Albert Duce. Used under creative commons license and available on Wikipedia.

 

 

 

JP Morgan is in the business of taking deposits and issuing loans. That business thrives during times of economic growth when businesses borrow to finance profitable ventures. So it makes sense for JP Morgan to invest in the economy, and that is exactly what JP Morgan’s CEO, Jamie Dimon, announced in his interview with Matt Lauer on NBC’s Today Show.

 

According to the article from Today Money (Stump, 21 May 2014), Dimon announced a $100 million investment by JPMorgan Chase into Detroit.

 

From the article:

 

Detroit, the largest U.S. city to seek bankruptcy protection, is $19 billion in debt and currently has an unemployment rate of about 14%, more than double the national average.

 

"We're doing this to grow investments, to grow the city, and create a healthy and vibrant city,'' Dimon said. "And if that happens, it's good for us, too. I also look at it as an American patriot. This is one of the few cities that hasn't had a renaissance. Most other cities have. If it's done right, they can have one here, too."

 

In a city where 40 percent of the buses are broken, 40 percent of the streetlights don't work and a third of the population has left over several decades, Dimon sees opportunity. The bank is hoping to make money from interest on the loan and by rejuvenating a market in which it has a million regional customers.

 

For discussion:

 

In your opinion, is this announcement by JPMorgan a publicity stunt, or is it good business sense? Why?

 

Posted by Nivine Richie

Repay Student Loan Debt or Build Savings?

05-18-2014 10:54 PM with no comments

According to this CNBC article, graduates should maintain a balance between paying off student loan debt and saving for retirement. With average student loan balance at $29,400 and credit card debt at $3,000, new graduates are tempted to focus strictly on getting out from under the control of debt.

 

From the article (Grant, 16 May 2014):

 

Though it can seem overwhelming, don't focus solely on student loan debt. "A lot of people ask, 'should I be paying off my debt and then start to invest?'" said Stanzak, whose son and daughter will be graduating from college this spring. "It's really important to keep a balance and do both." Time is on young adults' side to build those savings into a retirement nest egg.

 

Saving as you pay down the debt can also make your financial situation less precarious. Most planners recommend having at least three months' worth of living expenses in a savings account. "Establish an emergency fund so if something goes wrong, you aren't begging, borrowing or stealing," said Mark Prendergast, a certified financial planner based in Huntington Beach, Calif.

 

 

Posted by Nivine Richie

What Does The Future Hold for Fannie and Freddie?

05-18-2014 9:45 PM with no comments

Fannie Mae and Freddie Mac are two government-sponsored enterprises (GSEs) that were born for the purpose of breathing new life into the mortgage market after the Great Depression. These GSEs provided banks with a secondary market by buying mortgages and freeing up banks’ balance sheets so that banks could originate new mortgages and encourage more families to buy homes. In other words, when banks ran out of lending power, Fannie Mae and Freddie Mac stand ready to buy existing mortgages so that the banks can have fresh capital and begin lending once again. (Read more about the history of GSEs here.)

 

Today, some question whether Fannie Mae and Freddie Mac should live on.

 

According to Bloomberg BusinessWeek (Coy, 16 May 2014):

 

On Thursday a narrow bipartisan majority of the Senate Banking Committee voted to send along to the full Senate a bill that would wind down Fannie Mae and Freddie Mac over five years. But because of all the opposition from left and right, the bill is unlikely to get a floor vote this session.

 

(Read the full article here)

 

For discussion:

 

What are the arguments for and against bringing Fannie Mae and Freddie Mac to an end?

 

Posted by Nivine Richie

"Recession Babies" Avoid the Stock Market

05-17-2014 9:16 PM with no comments

Working as a summer bank teller, I remember seeing an older gentleman cash his pension check then carry the cash to his safe deposit box and lock it up. This man and others like him were called “Depression Babies,” and as a group, they distrusted banks after the crash of 1929.

 

Today, millennials are being renamed “Recession Babies” because of a similar distrust. This time, however, the distrust is directed at the stock market rather than at banks.

 

According to a recent Bloomberg article (Smialek, 14 May 2014):

 

Affluent millennials hold 52 percent of their money in cash and 28 percent in stocks, compared with 23 percent and 46 percent for older people, a UBS survey released in the first quarter found. The study focused on 21- to 29-year-olds with $75,000 in income or $50,000 in investable cash, and 30- to 36-year-olds with $100,000 in income or assets.

 

“They are risk averse, so they have the most conservative portfolio profile of any age bracket under 65,” said Neil Howe, founding partner of LifeCourse Associates, a consulting service for generational marketing and workforce issues. Howe is credited with coining the term “millennial.” “They look at the stock market and they see nothing but danger,” he said.    

 

For discussion:

 

What are the consequences of avoiding the stock market?

 

Posted by Nivine Richie

Failure to Supervise During IPO Sale

05-16-2014 3:36 PM with no comments

The Financial Industry Regulation Authority (FINRA) recently announced that one of the big brokerage firms is being fined for failing to supervise its brokers as they solicited orders from retail customers in 83 initial public offerings (IPOs).

 

In a typical IPO, the brokerage firm asks investors for “indications of interest” before the IPO is launched. These indications are not true orders, however, because the brokerage firm must reconfirm that the investor actually wants to buy the shares before a transaction can take place.

 

According to the FINRA press release (6 May 2014):

 

Firms may solicit non-binding indications of customer interest in an IPO prior to the effective date of the registration statement. An "indication of interest" will only result in the purchase of shares if it is reconfirmed by the investor after the registration statement is effective. Brokerage firms are also permitted to solicit "conditional offers to buy," which may result in a binding transaction after effectiveness of the registration statement if the investor does not act to revoke the conditional offer before the firm accepts it.

 

On February 16, 2012, Morgan Stanley Smith Barney adopted a policy that used the terms "indications of interest" and "conditional offers" interchangeably, without proper regard for whether retail interest reconfirmation was required prior to execution. The firm did not offer any training or other materials to its financial advisers to clarify the policy and, as a result, sales staff and customers may not have properly understood what type of commitment was being solicited. FINRA also found that Morgan Stanley Smith Barney failed to adequately monitor compliance with its policy and did not have procedures in place to ensure that conditional offers were being properly solicited consistent with the requirements of the federal securities laws and FINRA rules.

 

(read the full press release here)

 

For discussion:

 

What is the difference between an “indication of interest” and a “conditional offer,” and why is it important?

 

What can Morgan Stanley Smith Barney to remedy the supervisory failure?

 

 

Posted by Nivine Richie

The "New Neutral" For U.S. Treasury Yields

05-16-2014 3:09 PM with no comments

The rise in the price and drop in yield of the 10-year US Treasury note is telling us that the market expects central banks to keep rates at their current low levels.

 

In a recent MarketWatch article (Eisen, 16 May 2014), Bill Gross of PIMCO is quoted as saying that the new 10-year yield of 2.50% is the “new neutral.”

 

From the article:

 

With economies expanding more slowly than they did prior to the financial crisis, central banks are likely to keep their key interest rates low, cushioning lending rates from a sharp rise. In the U.S., the fed funds rate is currently anchored near zero, with many traders expecting it to begin rising in the middle of next year . But Gross suggested yields will be dictated by how high the Fed eventually hikes rates. It may stop at a lower point than it did in past rate cycles.

 

“If the new neutral policy rate is 0% and the Fed achieves its 2% inflation target, then the 10-year Treasury should trade at close to 2%. However, because of the large uncertainty as to what the New Neutral rate should be, I would not expect it to trade there,” the Pimco founder said.

 

Under his outlook, the Fed’s nominal funds rate would top out somewhere near 2% in the coming years. That’s a relatively small climb from the current rate of near zero.

 

For discussion:

 

According to this blog post, what is meant by the shift from the “new normal” to the “new neutral?”

 

Posted by Nivine Richie

Financial Literacy in America

05-11-2014 9:51 PM with no comments

Financial literacy continues to elude many. According to the 2012 report on the Financial Capability in the United States released in May by FINRA, the Consumer Financial Protection Bureau, and the U.S. Department of Treasury:

 

,,,While the percentage of Americans with “rainy day” funds for unanticipated financial emergencies has increased relative to 2009, the majority still have not set aside emergency funds, and do not plan for predictable life events, such as their children’s college education or their own retirement.

 

… Americans continue to borrow in potentially expensive ways. More than two in five credit card holders engage in costly behaviors such as paying the minimum, paying late fees, paying over-the-limit fees or using cash advances from their credit cards. Nearly a third of Americans report using non-bank borrowing methods (such as payday loans, advances on tax refunds or pawnshops). Forty-two percent of Americans feel they have too much debt.

 

For discussion:

 

How do you rate yourself in terms of financial literacy?

 

Posted by Nivine Richie

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