• More CDOs Coming Soon?

    Investors are seeking returns, and according to this article by CNBC, they may soon be turning to structured products like collateralized debt obligations.


    From the article (31 Jan 2013):


    "The big story this year has not been the record issuance of corporate bonds – that is a big story in and of itself – but because demand is outstripping supply, we have begun to shift to structured finance," Reynolds told CNBC on Wednesday.


    "At the end of last year we started to see a surge in CLO [collateralized loan obligation] issuance, and now we are going to start to see a surge in CDO issuance. These are the same instruments that were used in the last credit boom, which turned out to be one of the greatest credit booms in history, from 2003 to 2007."


    CDOs, which are collateralized against an asset pool comprising of a variety of bonds and other fixed income securities, were blamed for the 2008 financial the crisis. Investors purchase a "tranche" of the CDO comprising different types of debt with varying degrees of credit risk. The riskier the tranche, the more it pays.


    (read the full article here)


    For discussion:


    What are structured bonds? Why are they blamed for playing a role in the recent financial crisis?


  • Looking Back: The Impact of Early Dividends

    In an effort to get ahead of the fiscal cliff tax hikes, companies paid investors and early dividend.  (Read an earlier blog post here.)

    This CNBC video looks at the impact of these special dividends on the economy.


    For discussion


    ·       What happened to personal income and savings after the early dividends?


    ·       Is this a pattern that is common throughout history?


    ·       What is the likely future economic impact?


  • Is It Ever OK to Lie or Cheat?

    It takes two to lie. One to lie and one to listen.

    ~ Homer Simpson, The Simpsons



    Question: Is it OK to tell a lie if the listener is supposed to know better?

    Answer: No.  


    It’s never OK to lie or cheat. That’s the message being delivered to former bond trader Jesse Litvak, with Jeffries & Company. According to the NY Times (30 Jan 2013):


    The accusations outline a rather simple act: Mr. Litvak is charged with telling clients that the cost of the residential mortgage investments was higher or lower than what Jefferies paid for them, depending on which side of the transaction the firm was on. In other trades, he took securities from the firm’s inventory and sold them at an undisclosed markup, although he indicated Jefferies was only matching firms for the transaction.


    One interesting detail about this case is that Mr. Litvak is accused of lying to sophisticated investors. These investors are assumed to be knowledgeable enough to determine the value of their investments without details from Mr. Litvak. In other words, these are not the investors to whom brokers normally owe a fiduciary duty.


    From the article:


    The defense can argue that the fact the market is opaque, with prices based on informal sources. And the decision whether to buy or sell a security is based on the total cost, so whether it included a higher commission or price spread than the customer was led to believe might not have been material to the transaction.


    But fraud does not require that the victim be gullible or lose money on the transaction. The indictment claims that outright falsehoods were made in connection with the transactions, not just the shady practices of the used-car dealer who proclaims that the vehicle was only driven to church on Sunday.


    For discussion:


    What is a fiduciary duty?


    What does it mean that the market for mortgage-backed securities is “opaque?”


    What are the arguments for and against Mr. Litvak failing to meet his fiduciary duty?



  • Activist Investor Seeks Changes at Hess

    Investor activism by Elliott Management has had an impact on shares of Hess. A letter from Elliott challenges Hess to make changes to the Board of Directors, amid other changes. This is an effort by investors to get Hess to stop being the underperforming stock that it is, and get it to be the profitable company they are convinced it can become.


    According to this NY Times article (29 January 2013)


    Elliott, in part, took aim at the oil company’s lack of focus. The hedge fund contends Hess is “distracted” by its ventures outside its core exploration and production business. Among the distractions Elliott identified were the company’s financing of fuel cell technology and its ownership of an electric generating station.


    The hedge fund also criticized Hess’s use of capital. Elliott noted that the company had not increased its dividend or repurchased shares in the last decade, even as oil prices have risen substantially. The company has instead “destroyed” capital through “its failed exploration program,” the hedge fund claimed.


                (read the full article here)


    For discussion


    What is investor activism? How can investors influence the direction of a company?


  • The 1794 Flowing Hair Silver Dollar and the Time Value of Money

    Rare coins, like art, are a wise investment according to experts. Legend Numismatics, the rare-coin dealer that paid $10 million for the 1794 silver dollar that was recently auctioned, certainly agrees. According to Martinez (Orange County Register, 25 Jan 2013), “Experts agree that the pristine ‘flowing hair' silver dollar coin is among the first few dollars produced by the United States and is likely to be the literal first U.S. dollar ever created. Paper money wasn't authorized by Congress until the Civil War. The 1794 coin is a national treasure, a milestone of a fledgling new country.”




    For discussion:


    1.  What is the annual return on the coin that was worth $1 in 1794 and is worth $10 million dollars in 2013?


    2.  According to the article, the coin traded for $2.5 million in 2003. What is the annual return on the coin based on its 2003 value?





  • The Bull Call Spread

    If you think the market is going higher, then buy the market. One way to do this is to buy the SPDR exchange traded fund (ticker SPY) that mirrors the S&P 500 index.

    Another bullish trade is to buy call options on the SPY.

    The example in this video is the SPY bull call spread. In the trade described in this video, you buy a call option on the SPY with a strike price of 150 at a premium of $3.00 and simultaneously sell a call option with a strike price of 155 at a premium of $0.90. The net entry fee for this trade is $2.10, and as long as the SPY rises above 150, you make money on the trade.

    A call option gives the buyer the right to buy the underlying asset at the strike price. In the example above, you would have the right to buy the SPY at $150, so if the SPY trades higher, you exercise your right to buy at $150 and make a profit. If you sell a call, i.e. “short" the call, then you give your counterparty the right to buy the underlying asset at the strike price. In our example, you give the counterparty the right to buy from you at $155. By doing both trades simultaneously, you effectively cap your profit at $5.


    For discussion:


    What is the difference between a call option and a put option?


    Why might an investor choose to use a bull call spread instead of investing in the ETF directly?


    What advantages and disadvantages does the investor face in a bull call spread compared with simply buying a call option?


  • Derivatives: Replacing Old Risks with New Risks

    Risk isn’t eliminated, it simply shifts from one party to another…sometimes as a new risk altogether.


    This is the warning from Mark Morris, CFO of Rolls-Royce, the British aircraft engine manufacturer. From CFO Magazine (Sawers, 22 Jan 2013):


    “In essence, you can’t destroy risk,” Morris said. “It morphs into something else. If you take market risk and go into a foreign exchange [hedging] transaction with a bank, you’re replacing it with counterparty risk. If you try to replace the counterparty risk by using central clearing or some form of posting of collateral, what you’re doing is you’re replacing counterparty risk with liquidity risk.”


    (Read the full story here)


    Mr. Morris is addressing the move by regulators to force derivatives to trade on exchanges rather than over the counter. In the OTC markets, counterparty risk is the risk that one party will default on the contract. To limit this risk, regulators are insisting that these contracts trade on organized exchanges where the counterparty risk is all but eliminated. The problem is, though, that contract size is limited on exchanges and the collateral requirements for such transactions may be prohibitive. Hedgers may not be able to hedge the full amount of their risk as they once could and thus may face a newfound liquidity risk.


    For discussion:

    ·       What are financial derivatives?

    ·       What are some differences between OTC and exchange-traded derivatives?

    ·       What is counterparty risk? What is liquidity risk?


  • Insurance Companies Weathered Hurricane Sandy

    Hurricane Sandy was costly, especially for insurance companies. But despite announcing losses of $669 million, Travelers Insurance stock was up.


    Now it’s possible that not all claims are in, and Travelers may see further losses associated with Sandy. For now, though, it looks like the insurance companies have weathered the storm.

    For discussion

    Why would Travelers' stock be up after such large losses?


  • Competition Among Credit-Rating Firms

    Rating bonds is big business, and the business has long been dominated by a few big players. For years, the only firms recognized by the SEC as Nationally Recognized Statistical Rating Organizations, or NRSROs, were Moody’s, Standard & Poors, and Fitch Ratings. Since the Credit Agency Reform Act of 2006 allowed for competition among credit-rating firms, the number of rating agencies has grown to 10.


    One of those firms, Egan-Jones, recently settled with the SEC over allegations of misrepresenting how long the firm has been rating certain types of debt. Through barred for 18 months from rating government debt and asset-backed securities, Egan-Jones can continue providing its customers with credit ratings on other types of debt.


    What makes Egan-Jones particularly interesting is that the firm follows a different business model than the well-known credit rating firms. According to Bloomberg (22 Jan 2013):


    Investors pay Egan-Jones for its opinions unlike S&P, Moody’s and Fitch, which charge issuers of debt securities for their grades. The company had 1,136 ratings outstanding and five employees at the end of last year, according to a November SEC report.


    Egan-Jones, which has moved markets with its rating decisions, preceded Moody’s by an hour on June 13 in cutting Spain’s credit grade by two steps to CCC+ from B. Yields on the country’s 10-year obligations rose to a euro-era record the following day. The company reduced its rating on the U.S. by one step to AA+ from AAA on July 18, 2011.   


    For discussion:


    How do the traditional credit rating firms generate their revenue? Why might Egan-Jones’ method of generating revenue be appealing to investors?


    Is completion among credit-rating firms healthy? Why or why not?


  • Currency: The Race to the Bottom

    Question: What helps a country’s economy win by losing value?       


    Answer: The domestic currency.


    According to this CNBC video, “An all out  global currency war” is underway as central banks try to boost their economies by devaluing their currencies.


    For discussion:


    ·        Why does a weak currency help an economy?


    ·        According to the video above, which country is currently winning this “race to the bottom?”


  • Are Structured Notes OK For You?

    There’s no such thing as bad bonds—only bad prices.

    ~ Comment from a bond trader, 1995


    Bond markets are creative, always coming up with new ways to vary the stream of cash flows to be earned by the investor. Notes are issued with coupon rates linked to reference interest rates. The coupon rate may change in the same direction or in the opposite direction. For years, investors bought these instruments, but may not have realized they were taking on a level of interest rate risk that they may not have been prepared to accept.


    Today, bond markets are even more creative. Structured notes are not as simple as they once were. Now, the return on the bond can be tied to anything.


    From an article on Bloomberg (Braham, 18 Jan 2013):


    Such hybrid securities, which have maturities like bonds but are linked to asset classes such as stocks, currencies and commodities, are increasingly popular. That’s especially true for notes linked to the stock market, which has risen 16.5 percent in the past year and 116 percent since the March 2009 bottom. Some $10.1 billion of structured notes tied to the S&P 500 were issued in 2012, the highest amount in three years, according to data compiled by Bloomberg.


    For discussion:

    Why have structured notes become so popular?


    For which investors are structured notes appropriate?


    Can investors replicate structured notes themselves? What securities would they use to create a “synthetic” structured note?


  • Why No IPO?

    Not all firms want to be publicly traded corporations. Take SurveyMonkey for example, the successful tech company that provides online surveys. They’ve decided that if they can raise money without going public—that is, without an IPO—then they provide value for their investors.


    For discussion:

    What are some of the differences between a publicly held firm and a privately held firm?


    According to the video, what are some good reasons to go public?


    What are some good uses of debt financing? What are some less-than-good uses for debt financing?


  • Dell: Public or Private?

    Dell Computers is facing declining demand for PCs. Increased competition from IBM, Oracle, and Cisco in the corporate data markets and from Samsung and Apple in the consumer markets has caused Dell’s stock price to decline 43% in the last five years. 

    Now Dell may be in talks to sell the company to a private equity firm in a leveraged buyout (LBO) and go private. According to Bloomberg (15 Jan 2013), “An LBO would free Dell from the fluctuations of a stock market that has lost patience with the company’s shrinking PC division and its inability to adapt to an industry-wide shift to mobile and cloud computing.”

    From the article:

    “They could generate a tremendous amount of cash for many years to come, or they could be more dramatic and invest heavily in a mobile strategy -- and not be scrutinized by public investors every quarter while they did it,” said Rich Kugele, an analyst at Needham & Co.







    For discussion:

    ·       What is a leveraged buyout? What are the benefits and risks associated with an LBO?

    ·       According to the Bloomberg video above, is the “public to private” strategy likely to work?


  • It's All About Expectations: Best Buy

    No bad news is good news for Best Buy. Though the holiday season wasn’t great, it wasn’t terrible either. Same store sales were flat and overall same store sales, including international sales, were down. But because the market expected the retailer to do poorly, investors were pleasantly surprised. 


    As with many things in life, it’s all about expectations. Expectations are priced into the market and when companies meet those expectations, we see no further changes to the stock price. When they fail to meet expectations, even though the firm may have reported positive earnings, we find stock prices falling. In Best Buy’s case, markets expected bad news, so flat sales was enough to send the stock price up. 


  • Employment with a College Degree

    Good news, college students. For years, the question has plagued many young minds: is college worth it?


    According to a recent report by the Pew Economic Mobility Project, a college degree offered protection during the recent recession.


    From the report:


    ·        Although all 21–24 year olds experienced declines in employment and wages during the recession, the decline was considerably more severe for those with only high school or associate degrees.

    ·        Before the recession, just over half of young adults with a high school degree (HS) were employed, compared to almost two-thirds of those with an associate degree (AA) and nearly three-fourths of those with a bachelor’s degree (BA).

    ·        Job losses during the recession made existing employment gaps even worse. The employment declines for those with HS and AA degrees were 16 and 11 percent, respectively, compared with 7 percent for those with a BA degree. 

    ·        The comparatively high employment rate of recent college graduates was not driven by a sharp increase in those settling for lesser jobs or lower wages.

    ·        The share of non-working graduates seeking further education did not markedly change during the recession. 

    ·        Out-of-work college graduates were able to find jobs during the downturn with more success than their less-educated counterparts.

    o   The proportion of BA degree-holders who transitioned from being excluded from the labor market (i.e., not working or in school) to employment barely changed during the recession.

    o   In contrast, the proportions of HS and AA graduates who found employment declined significantly with the recession—by approximately 10 percent for those with AA degrees and 8 percent for those with HS degrees.


  • Women and Hedge Funds

    The world of finance has long been thought of as an “Old boys club” of sorts. But lately, women have been more successful than men when it comes to managing hedge funds and alternative assets. 


    According to the NY Times (Alden, 10 Jan 2013):


    An index from the professional services firm Rothstein Kass showed that female hedge fund managers produced a return of 8.95 percent through the third quarter of 2012. By contrast, the HFRX Global Hedge Fund Index, released by Hedge Fund Research, logged a 2.69 percent net return through September.


    … Female financiers can have particular advantages over their male counterparts, including being more risk-averse and better able to avoid volatility, the report says. The Rothstein Kass hedge fund index, based on 67 hedge funds with female owners or managers, may be a case in point.


    For discussion:


    Why do you think there is a difference in the performance of male and female investment managers?



  • What Makes a Bank a Bank?

    Have you ever been charged an overdraft fee by your bank and thought it was unfair? Have you ever fought with your bank and came away frustrated?


    Josh Reich did, and he decided to do something about it. The software engineer from Australia and his colleague, Shamir Karkal, chose to offer an alternative to traditional banks by creating Simple, the online bank. This bank offers customers free checking account and lots of data analysis of transactions. However, it does not offer joint checking accounts, business checking, or paper checks.


    Still, the customer base seems to like the idea of a Simple bank. According to the NY Times (Wortham, 8 January 2013):


    Some of Simple’s early users are big fans, like Chris Lanphear, 30, a Web developer in Fort Collins, Colo., who signed up in July.


    Mr. Lanphear said he had been hesitant to try Simple at first because of the company’s lack of physical infrastructure, “but then I realized it doesn’t ensure better service if you see the face of the person you are talking to.”


    He said he had been impressed with Simple’s quick responses, via phone and e-mail, to questions about transactions and charges. The tracking features helped him realize he was spending too much on dining out, so he decided to cut back.


    Mr. Lanphear was impressed enough to move over to Simple and close his old bank account. “I figured it couldn’t be worse than the alternatives,” he said. “But it’s actually turning out to be much better.”  


    For discussion:

    1.    What defines a “bank?” In what ways does Simple meet the qualifications of a bank? In what ways does it not?


    2.    Would you use a financial services company like Simple? Why or why not?


  • Who's Smarter Than the Market?

    Who’s smarter than the market? According to this Bloomberg article, hardly anyone.


    From the article:


    Paulson, who manages $19 billion in hedge funds, said the euro would fall apart and bet against the region’s debt. Morgan Stanley predicted the Standard & Poor’s 500 Index would lose 7 percent and Credit Suisse Group AG (CSGN) foresaw wider swings in equity prices. All of them proved wrong last year and investors would have done better listening to Goldman Sachs Group Inc. (GS) Chief Executive Officer Lloyd C. Blankfein, who said the real risk was being too pessimistic.


    For years, we’ve heard about active versus passive investing. Active managers seek to “beat” the market using one method or another. Some rely on trends to choose when to buy and sell. Others rely on fundamental information about values to choose which stocks to buy and sell. 


    According to the article, “Money managers who aim to beat markets lagged behind instead.”


  • Buy Bonds? Goldman Says No.

    10-year Treasury note yield, http://finance.yahoo.com



    This just in. Warning to all bond investors. According to Goldman Sachs, don’t buy bonds. (CNBC, 4 Jan 2012)

     "A reversion of risk premiums to historical averages of 6% nominal rates (3% real rates and 3% inflation) would suggest estimated losses in portfolios with bond durations of 5 years of 25% or more," equity strategist Robert D. Boroujerdi said in a note.

     ... Instead of bonds, Goldman suggests investors look to equities for income. That's because companies have plenty of cash to pay out on their books, mutual fund flows are set to pick up for stocks and equity valuations relative to bonds are very attractive. They list a number of "income-through-equity" plays.

    For discussion:

    Define the following terms in this article:

    ·        Risk premium

    ·        Bond duration

    ·        Nominal rate

    ·        Real rate


  • Looking Back on Business 2012

    According to this video from CNN Money, the biggest business stories from 2012 include #10 Apple, the company that invents things we can’t live without, #8 Facebook’s IPO, trading glitches and all, and #6 nature, with drought in the Midwest and hurricane Sandy in the east. Also joining the list were Europe, China, and the Presidential election. 


    And the number one story of 2012? The fiscal cliff.


    Happy New Year!