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.
Apple is very impressed with itself. So much so that the company has announced an increase in its share repurchase program and that it will split its stock in a 7-for-1 split in June.
From MarketWatch (Wakabayashi, 23 Apr 2014):
Chief Executive Tim Cook said the company chose to expand its stock-buyback program by $30 billion because it views its shares as undervalued.
“That should show you how much confidence we have in the future of the company,” Cook said in an interview with The Wall Street Journal.
The company said it would boost the overall size of its capital return program to more than $130 billion by the end of 2015, up from its previous $100 billion plan.
In your opinion, is Apple undervalued? Why or why not?
What factors will you consider to determine whether Apple is fairly valued?
photo of London Apple store by N. Richie
Healthy firms have a choice of funding sources that they can tap into when they want to grow. Chobani, the Greek yogurt maker, faced this choice recently and decided to borrow $750 million from private equity firm TPG Capital.
According to the NY Times (Alden, 23 April 2014):
The financing round was not based on a particular valuation, but the company believes it is worth around $5 billion, according to the people with knowledge of the deal. Mr. Ulukaya owns 100 percent of the equity. A major reason the company pushed for a loan, rather than a straight equity investment, was to prevent dilution, the people said.
Though the private equity firm invested in Chobani by way of a loan, it also received warrants that may convert to equity if Chobani meets certain conditions. Among those conditions: the launching of an IPO. Mr. Ulukaya may not remain the sole owner for much longer as the yogurt maker may issue an IPO next year.
What are the factors that a firm like Chobani must consider when choosing to finance the next phase of growth using debt versus equity?
The FDIC identifies underbanked households as, “Those that used non-bank check cashing, non-bank money orders, non-bank remittances, payday lending, pawnshops, rent-to-own agreements, or refund anticipation loans (RALs) at least once in the previous 12 months.” In other words, households that use these “Alternative Financial Services” are considered underserved by traditional banks.
(read the 2011 FDIC Survey of Banks Efforts to Serve the Unbanked and Underbanked here, as well as the 2013 Addendum here.)
A trend identified in this CNBC article (Wee, 23 April 2014) is the rise of mobile phones and the impact that may have on the unbanked.
From the article:
Access to the mainstream financial marketplace can help encourage savings, public safety, disaster preparedness and asset building for underserved groups, according to a 2012 bulletin from the Federal Reserve System's Board of Governors on the underbanked.
Now several mobile technology trends quickly are colliding and maturing. The end result could be more affordable financial services for more people around the world—including those in the U.S.
Based on the research, why do some Americans choose to remain on the “outskirts” of mainstream banking? Why might banks be reluctant to seek out the underbanked or the unbanked?
If you trade on material nonpublic information, but you don’t know who passed the information or how far the information has traveled before it got to you, are you still guilty of insider trading? The answer is, “Maybe.”
The issue is not whether you traded on inside information; rather the issue is whether you knew you were trading on inside information.
According to the NY Times (Henning, 22 Apr 2014):
A recipient can still be held responsible for insider trading as long as the government shows that person knew the tipper breached a duty of trust and confidence to the source of the information by passing it along to someone who would profit by trading on it. To prove that breach, the Supreme Court stated in Dirks v. S.E.C., “The test is whether the insider personally will benefit, directly or indirectly, from his disclosure. Absent some personal gain, there has been no breach of duty to stockholders.”
Referred to as the quid pro quo requirement, the benefit received by the tipper can be monetary or just the warm feeling generated by making a gift to family or friends. It can even be a more ephemeral benefit like enhancing one’s reputation in the eyes of the recipient.
The NY Times article cited above describes the case of Dirks v. SEC. What were the facts of that case and what was the SEC trying to show?
Stock brokers have choices when it comes to exchanges. Exchanges compete for order flow, and often offer incentives to brokers in the hopes that orders will be routed to their exchange.
According to Bloomberg (Michaels, 20 Apr 2014):
The U.S. Securities and Exchange Commission is weighing a requirement that brokers tell investors exactly where their stock trades go to be executed, a proposal that may address complaints that the decisions are sometimes made against the client’s best interests.
The proposal could give investors more insight into whether they are getting the best price when they buy and sell large numbers of shares, according to three people familiar with the matter. Brokers entrusted with orders in the U.S. stock market can choose from dozens of exchanges and private venues. Some money managers such as T. Rowe Price Group Inc. (TROW) have told regulators that incentives offered by exchanges for attracting orders can put a broker’s financial interest at odds with the customer’s.
Why is the SEC considering this requirement to increase disclosure of order routing practices?
Is more disclosure the answer to the potential conflict of interest? Why or why not?
In an interview with CNBC this week, BB&T CEO Kelly King describes a mortgage market that is not quite fully recovered. The current yield curve has been flattening and has caused people to worry about the economy. He explains that though the economy is improving, it is not yet robust. People are not yet confident about jobs and economic stability.
What is the yield curve? What do the different shapes of the yield curve imply about economic expectations?
Americans believe in home ownership. When asked what is the “best” investment, responders to a Gallup survey this week answered real estate. But the evidence suggests otherwise.
From CNNmoney.com (Matthews, 18 April 2014):
When adjusted for inflation, the average house has appreciated little since 1987. The picture looks a lot different for the other investments Gallup asked about it in its polls. The S&P 500, for instance, has produced an inflation-adjusted annual return of 6.32% since 1929, while investing in government debt would have returned roughly half that figure. Gold, interestingly enough, has performed pretty well on an inflation-adjusted basis, averaging a 4.12% return per year since the end of the Bretton-Woods monetary order in 1971.
One of the interesting outcomes of the survey is that, as investors, we are more likely to say that the best investment choices are best because we chose them. And many of us own homes. Ergo…real estate is best. Not great logic, but it does demonstrate the behavioral bias called the endowment effect.
In a nutshell, the endowment effect says that we deem items to be more valuable just because we own them, and not necessarily because they carry any particular intrinsic value in themselves. This effect is captured in a 2008 Economist article that quotes Ayn Rand.
“I AM the most offensively possessive man on earth. I do something to things. Let me pick up an ashtray from a dime-store counter, pay for it and put it in my pocket—and it becomes a special kind of ashtray, unlike any on earth, because it's mine.” What was true of Wynand, one of the main characters in Ayn Rand's novel “The Fountainhead”, may be true of everyone. From basketball tickets to waterfowl-hunting rights to classic albums, once someone owns something, he places a higher value on it than he did when he acquired it—an observation first called “the endowment effect” about 28 years ago by Richard Thaler, who these days works at the University of Chicago.
Where do you see evidence of a behavioral bias in how you or others value investments?
This week, Senators Sherrod Brown (D-OH) and Elizabeth Warren (D-MA) sent a letter to the Federal Reserve asking them to prohibit financial holding companies from holding physical commodities.
From the press release (16 Apr 2014):
With the public comment period for the rule closing today, the senators outlined significant concerns associated with FHCs’ expansion into activities that are commercial in nature, particularly their ownership of assets involved in the extraction, transportation, storage, and distribution of commodities and energy. They argued that commercial commodities and energy activities expose financial institutions, regulated by the Board, to unprecedented and unmanageable financial, legal, environmental, and reputational risks.
…In October 2013, Brown and Warren sent a letter to the London Metals Exchange (LME) regarding its proposed changes to rules governing industrial metals trading. According to a July 20th report in The New York Times, "the maneuvering in markets for oil, wheat, cotton, coffee and more have brought billions in profits to investment banks like Goldman, JPMorgan Chase and Morgan Stanley, while forcing consumers to pay more every time they fill up a gas tank, flick on a light switch, open a beer or buy a cellphone." While the United States once separated banking from traditional commerce, today’s banks are now allowed to engage in a variety of non-financial activities, such as owning oil pipelines and tankers, electricity power plants and metals warehouses. Today, the six largest U.S. BHCs have 14,420 subsidiaries, only 19 of which are traditional banks.
In your opinion, what are the risks associated with banks trading in physical commodities?
Financial advisors must know their clients and suggest investments that are suitable given the client’s risk tolerance and return objectives. But a number of consumer advocates say that “suitability” is not enough.
From a joint letter written to the SEC by AARP, Consumer Federation of America, CFP Board, FPA, Fund Democracy, Inc, and NAPFA:
Designed with a sales relationship in mind, however, the suitability standard does not impose the same clear obligation that exists under a fiduciary standard, which requires the adviser to put the customer’s interest first. Moreover, the suitability standard does not impose an obligation on brokers to appropriately manage conflicts of interest in order to ensure that they do not influence recommendations. These are among the standards that distinguish a suitability relationship from a fiduciary relationship.
According to this article from Thinkadvisor (15 April 2014), why do advocates claim that the fiduciary standard is needed to protect clients?
The common currency caused European nations a giant headache during the financial crisis. But now that the dog days are over, the euro seems to be a winner once again.
From Bloomberg (Wishart, 10 April 2014):
The euro had its biggest annual gain since 2007 last year as the currency bloc emerged from its longest-ever recession and investors flooded back in. Ireland, Italy and Spain have sold government bonds at record low yields. Even Greece, which briefly flirted with the idea of bringing back the drachma at the height of the crisis, ended a four-year exile from international markets with a bond sale April 10. Even so, it’s not all positive. The economy of the 18-nation bloc is forecast to grow just 1.2 percent this year, less than half the 2.9 percent pace in the U.S. Banks are still reticent to lend. Unemployment remains close to its record at about 12 percent and about a quarter of young workers can’t find a job. What’s emerging is a multi-speed recovery, with Germany and the newer members like Estonia powering ahead while peripheral nations like Italy and Portugal are barely creeping forward.
The Bloomberg article argues that perhaps monetary union is not sufficient. What are some of the arguments for increasing the degree of economic union among European nations?
This interview with one of the leading farmland investors in the US presents several cases for adding farmland to an investment portfolio.
One of the primary reasons for investing in farmland is the low correlation with stock markets. Another is the asymmetry in risk and returns.
Why is correlation an important factor in choosing an investment to add to your portfolio?
Do you agree that farmland is a sound investment? Why or why not?
How can an investor enter the farmland investment market?
Reuters reports that the SEC is considering a proposal to limit trading outside of exchanges and drive trades back to exchanges. “Dark pools” are one example of an alternative trading venue that is under SEC attack.
From the Reuters article (Lynch and McCrank, 11 Apr 2014):
They say that the amount of trading being done in the "dark" means that publicly quoted prices for stocks on exchanges may no longer properly reflect where the market is, meaning that investors may not be getting the best prices for their trades.
The measure under consideration, known as a "trade-at" rule, has long been sought after by exchanges like Nasdaq OMX and the New York Stock Exchange as a way to win back market share against off-exchange competitors such as Credit Suisse's Crossfinder, one of the largest dark pools in the United States.
(read the full article here)
What are dark pools?
What is the current SEC rule regarding trade execution?
How does the “trade-at” rule compare with the existing rule?
Photo of Chicago Board of Trade corn pit, 1993 courtesy of Jeremy Kemp, available by Creative Commons from Wikipedia
One trader described it as a “blast from the past.” In Chicago this week, a computer outage caused trading on the electronic Globex platform to stop temporarily. And that drove traders to the open outcry “pits” to keep business going.
From the Chicago Tribune (8 Apr 2014):
The world's largest futures markets operator had to shut electronic trade for leading agricultural contracts on Tuesday, just a day before key U.S. crop data, as rare technical problems hit and sent traders scrambling to get back on the floor.
CME Group, which has just won a court case giving it the right to use electronic trades as well as open outcry business in calculating end-of-day prices, had to rely solely on the centuries-old floor trading for these on Tuesday.
The outage was serious because it came just 15 minutes before the close of trading. According to the article, “Traders flocked back to the old octagonal ‘pit,’ packing shoulder to shoulder and shouting orders across its graduated floor. Traditional hand signals came to the rescue to communicate in the chaos.”
What are the benefits and limitations of electronic trading compared with open outcry trading?
The consequences of failing to pay your debts are severe. First, the next time you try to borrow money, you will pay a higher rate. But a worse consequence may be that the next time you borrow money, you can’t find any money to borrow.
Losing access to capital markets is serious for companies and for countries whose credit qualities decline. But Greece’s re-entry into the bond markets shows that bankruptcy isn’t the end of the world. On Thursday, Greece plans to begin selling long-term bonds again.
From the NY Times (Alderman, 9 April 2014):
The deal represents a major milestone for the country, which was effectively shut out of the markets in 2010 when the debt crisis left it dependent on international bailouts to stay afloat. Chancellor Angela Merkel of Germany, who more than any other leader is associated with European austerity, is scheduled to arrive in Athens on Friday to affirm that the government is on the right path.
The bond sale reflects increased optimism that Greece and other wobbly euro zone countries have turned a corner. In recent months, borrowing costs dropped significantly for Ireland, Portugal, Spain and Italy, as the investors deemed them less risky.
What factors must investors consider before they buy bonds from a recently bankrupt borrower?
A few short years ago, time was measured in seconds. Today on Wall Street, time is measured in milliseconds. A recent article in the NY Times (Lewis, 31 March 2014) gives us a glimpse into the new book by Michael Lewis, Flash Boys: A Wall Street Revolt, and also gives us a glimpse into the world of high-frequency trading.
“Latency” was simply the time between the moment a signal was sent and when it was received. Several factors determined the latency of a trading system: the boxes, the logic and the lines. The boxes were the machinery the signals passed through on their way from Point A to Point B: the computer servers and signal amplifiers and switches. The logic was the software, the code instructions that operated the boxes. Ryan didn’t know much about software, except that more and more it seemed to be written by guys with thick Russian accents. The lines were the glass fiber-optic cables that carried the information from one box to another. The single-biggest determinant of speed was the length of the fiber, or the distance the signal needed to travel. Ryan didn’t know what a millisecond was, but he understood the problem with this Kansas City hedge fund: It was in Kansas City. Light in a vacuum travels at 186,000 miles per second or, put another way, 186 miles a millisecond. Light inside fiber bounces off the walls and travels at only about two-thirds of its theoretical speed. “Physics is physics — this is what the traders didn’t understand,” Ryan says.
After reading the NY Times article adapted from Michael Lewis' new book, what is your opinion of high-frequency trading? Is regulation necessary?
This Bloomberg interview lists a number of factors that drive stock prices: momentum trading, valuation, multiples, economic reports. But sometimes, we just have a hard time deciphering precisely what is going on.
One possible explanation for the recent market selloff in the Nasdaq is the “Biotech Bubble.” Investor optimism can drive up stock prices, but it can't drive prices up forever. At some point, reality must set in and bring prices back to properly valuations.
Click here to view this Bloomberg video
· What is a “momentum stock?” How would you define a “bubble?”
· What factors drive stock valuations?
Corporate bonds are hard to find, according to online trading platform MarketAxess Holdings. This electronic exchange that was established in 2000 provides an electronic venue for buyers and sellers to meet and post bids and offers for corporate bonds. According to BloombergBusinessweek (Abramowicz, Apr 4 2014), about 46% of the attempts to purchase bonds on MarketAxess fail when no seller is found.
While economists expect Treasuries to lose value this year as the Fed slows its securities buying, investors are still stampeding back to U.S. assets in the face of uncertainty in China and an escalating conflict between Ukraine and Russia.
Buyers have gobbled up about $415 billion of new corporate bonds in the first three months of the year, the third-biggest quarter ever, according to data compiled by Bloomberg. Petroleo Brasileiro SA and Cisco Systems Inc. have led this year’s sales, which follow a record $1.5 trillion in issuance last year, Bloomberg data show.
Though MarketAxess has grown to approximately 15% market share, in what ways is the corporate bond market still an “over-the-counter” market rather than an exchange-traded market?
The idea that U.S. post offices should offer basic financial services is new to us, but not necessarily to others around the world. In many other countries, individuals can get basic banking services such as check cashing and bill paying at the local post office.
From the LA Times (2 April 2014), there are some good reasons to for the post office to offer banking services:
The Postal Service has an unmatched network of more than 30,000 post offices in virtually every community in America, nearly 60% of which are in ZIP Codes where there is only one bank branch or none at all. Many residents of these "bank deserts" are among the 68 million financially underserved adults who don't have bank accounts or who have to rely on costly services such as check cashers and payday lenders for some of their financial needs. The underserved collectively spent $89 billion in interest and fees on alternative financial services in 2012.
· What makes a bank a bank? In other words, what characteristics define a bank?
· What does it mean to be “underbanked” or “unbanked?”
· What are the benefits of allowing post offices to offer financial services? What are the risks?
In this CNBC video, we get a sense of how high-frequency traders try to take advantage of order imbalances in the market. These traders can determine that a large institutional investor is trying to buy or sell because the order size is so much larger than the average order size on an exchange.
· How would you define “price impact” and its effect on transaction costs?
· In your opinion, is the market “rigged?”