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  • Google's New Debt

    Photographer: David Paul Morris/Bloomberg

    Seven years after its IPO, Google is back in the capital markets with a new bond issue.  According to Streetwise, Google borrowed money for the first time because it could. 

    “Google sold debt because bond investors are currently begging any and all companies to take their money, nearly free. Its new borrowing seems more like a teenager's first new (low-interest) credit card than a retiree's reverse mortgage.” 

    The yield on Google’s three-year notes was 1.258%, while the yields on the five-year and ten-year notes were 2.241% and 3.374%, respectively.  Though these yields don’t sound very appealing from an investor’s perspective, compared with the yields on U.S. Treasuries, the credit spreads make the Google bonds more attractive than the U.S. Treasury note alternative.

    Read more on Streetwise and on Bloomberg.com.

    Discussion Questions:

    1. What is capital structure, and how has Google's capital structure changed?
    2. Why is the bond market being described as a seller's market?
    3. What are some of the factors that are driving bond yields to their current levels?
  • Skunked by Debt


    Photo by Hannah Foslien/Getty Images

    What goes around comes around. Borrowed money must be repaid, and that is the lesson that Frank McCourt, owner of the Los Angeles Dodgers, is learning-the hard way. Bloomberg reported that the baseball team filed for Chapter 11 bankruptcy this week after years of "lavish" spending and debt by team owners. Read the full article here.                                              

    U.S. consumers (like baseball team owners) can fund their lifestyles with debt or equity. For generations, folks chose to pay for most everything using cash. Credit cards were rarely used; mortgages were hard to come by. Then things changed. Students were offered credit card applications on campus. Graduates bought their first cars on credit, and decided that they wouldn't notice an extra $5,000 in the price tag spread out over monthly payments. Mortgages were easy to get. Buy now pay later.

    Reducing debt is like losing weight-one must eat less and move more. Solving a debt problem requires reduced spending or increased income. And just as the extra pounds take time to disappear, reducing debt won't happen overnight.

    Consumers can take a lesson from the L.A. Dodgers. Lesson #5 in the Bloomberg article by Jack Hough is to go easy on debt.

    Debt has made plenty of real estate developers rich, but it provides little room for flexibility when the economy tanks. True, finance nerds will argue that debt makes mathematical sense when used strategically, but it also has a way of tempting buyers to overpay. For deeply indebted consumers, the terms can worsen at just the wrong time. Before you know it you're looking at Chase MasterCard advance offers with 4% service fees. Or in McCourt's case, you're having your lawyers ask a bankruptcy judge to approve $150 million in financing from a JP Morgan Chase hedge fund at 10% interest plus a $4.5 million fee.

    Discussion Questions:

    • 1. Consider a 5-year loan on a new car that costs $21,000. What are the monthly payments if the interest rate is 5% per year? What if the new car costs $26,000? Over the life of the loan, what is the total interest paid in both cases?


    • 2. What are some potential solutions to the debt problem currently facing consumers and governments?
  • Shares and Shareholders


    CNNMoney.com reported that Netflix shares jumped on news that Netflix plans to expand internationally. The announcement that Netflix will begin to expand beyond the U.S. and Canadian market caused the share price to rise from $267 to $289 on July 5th.

    The announcement of expansion plans caused the price to rise, but the expansion hasn’t happened yet. Clearly, the market believes that Netflix will benefit by gaining customers outside the U.S. and Canada. Revenues and profits will increase, leading to positive cash flows for the company owners, i.e. the shareholders. And since we’ve been taught that the goal of the firm is to maximize shareholder wealth, this future project for Netflix seems to be good news for the owners of the firm. 

    Discussion Question:

    1. What are some other potential goals for a firm? If a firm chose to follow some of these other goals, what kinds of actions might the firm managers choose in order to meet these goals?
    2. How might “maximizing shareholder wealth” lead to positive choices by firm managers? How might this goal lead to negative choices?



  • The Dream of a Small Business

    Many people dream of starting and running their own businesses. Despite tough economic times, the entrepreneurial spirit is alive and well.

    When a new business is started, the owners face a number of big decisions—one of which is the type of business organization to chose. For folks considering sole proprietorships or small partnerships, the Small Business Administration has helpful information to get started.


    Another big decision is the type of financing that will get the business off the ground. Venture capital is a type of equity investment where wealthy investors called “angel investors” or venture capital firms give the firm cash in exchange for shares. The alternative is to use bank loans or loans from other sources. Each of these funding sources comes with its own opportunities and threats, of course. In the end, though, they make the dream of owning a small business a reality for many Americans.  

    Discussion Questions:

    1. What are the benefits and limitations of sole proprieterships? What about partnerships? What about corporations?
    2. What are the different sources of funding available to a new small business? What are the benefits and limitations of each funding source?


  • Introducing the Finance Blog

    Greetings! Welcome to the finance blog for Cengage. I want to introduce myself and welcome you to this site. I've posted a few blogs this week to give you a taste of what to expect. You should find three posts per week through the rest of the summer and then five per week throughout the academic year. For most posts, I'll try to provide some discussion questions to encourage you to consider issues in finance. Professors might want to use them in class assignments, and students might find them food for thought. Whether or not you're a student of finance, I hope these blogs will be relevant to you. After all, finance touches all of us one way or another.

    I'm an Associate Professor of Finance at the University of North Carolina Wilmington where I teach courses in Corporate Finance, Derivatives, Banking, and Fixed Income. I look forward to a great year ahead.

    Nivine Richie, Ph.D., CFA

  • The Double Eagle Has Landed

    Imagine finding some old coins that belonged to your grandfather tucked away in your attic.  Now imagine discovering that each one is worth millions of dollars.

    The heirs of Israel Switt, a gold dealer who died 21 years ago, discovered 10 gold “double eagle” $20 coins in a safe deposit box in 2003. But when they asked the government to authenticate them, they discovered they’ll have to fight Uncle Sam for rightful ownership. In a case that began Thursday, the Assistant United States Attorney is arguing that the coins were stolen and therefore should be returned to the people of the United States. The Langbord family, heirs of Mr. Switt, claims that the gold coins belong to them legitimately and are suing the government for wrongfully seizing private property. In a NY Times article on July 8, 2011, John Schwartz describes both sides of a fascinating story:

    How did the coins get out? Gloriously designed by Augustus Saint-Gaudens, the 1933 double eagles were never officially distributed. President Franklin D. Roosevelt, trying to stop a bank panic and to stem hoarding, issued an executive order that made owning large amounts of gold bullion and coins illegal. So while nearly a half million were made, all but two, sent to the Smithsonian, were supposed to have been reduced to bullion.

    But in 2004, Joan Langbord, Mr. Switt’s daughter, and her sons contacted the United States Mint to say they had discovered the 10 coins tucked away in a safe deposit box, within a folded Wanamaker’s department store bag, and asked for help in authenticating them. Instead, the government seized the double eagles—an eagle was a $10 piece, a half eagle a $5—saying that since they had never been circulated, they must have been stolen. The Langbords sued to get them back.

    From a finance perspective, what an amazing investment. And what a windfall to discover such value in your family safety deposit box.  CNN reported in 2002 that a double eagle coin had sold for $6.6 million, a record price. From a historical perspective, what an interesting lesson on depression-era financial markets. And from a legal perspective, what an important story about the burden of proof and the reach of government.

    Discussion Questions:

    1. What rate of return did the Langbords earn if one coin was worth $20 in 1933 and $6.6 million in 2003?


  • Investing in a Home

    Homeownership has always been touted as the path to financial independence, but that is not what Robert Bridges is saying in his Wall Street Journal article entitled, "A Home is a Lousy Investment."

    For years, young couples saved money to buy a home. They paid 20 percent of the price as the down payment and financed the rest over 30 years. Thirty years later, they would be able to live in the house rent free, which would be necessary once they entered retirement and stopped earning an annual salary. Hence, financial freedom.

    But there is more to the story.

    First, living in any house is not exactly rent free, even without a mortgage payment. Roofs need repair, carpets need to be replaced, broken windows need to be fixed.  All of these expenses are absent when renting, since they are the responsibility of the landlord.

    Second, homes have not proven to be very good investments over the long term. This article reports that the median price of a single-family home in California was $99,550 in 1980 and $296,820 in 2010, a measly 3.6% growth per year. In contrast, had the young couple in 1980 invested their down payment plus homeownership expenses in an investment earning the same return as the Dow Jones Industrial Average, they would have had over $1.8 million by 2010.

    So from a purely financial perspective, perhaps homeownership is not the path the financial freedom that it was cracked up to be. However, there may be some intangible benefits that (in my opinion) make homeownership part of the American dream. After all, there’s something to be said for painting the walls your favorite color and growing your own vegetables.  Whether that is worth the financial tradeoff is for each homeowner to decide.

    Discussion Questions:

    1. What was the value of the Dow Jones Industrial Index in 1980? In 2010? What is the annual compound rate of return on $1 invested in the DJIA over that time period?

    2. Do you consider homeownership to be one of your financial goals? Why or why not?

  • RIM: Research in Motion...or Standstill?

    Blackberry’s Smartphone is facing serious competition and investors are blaming management. Apple’s iPhone (ticker:AAPL) and phones based on Google’s (ticker: GOOG) Android software have gained market share while Blackberry (ticker: RIMM) has lost significant ground.  The solution? New management.

    Investors are claiming that the board is not sufficiently independent. The two founders of the company, Jim Balsillie and Mike Lazaridis, serve as Co-Chairmen of the Board and Co-CEOs. They are facing pressure to split these functions, but have not yet taken action.

    Can shareholders influence a company to change its leadership structure? Maybe. This story is an interesting case of shareholder activism. The investors who are calling for splitting the top job at RIM are institutional investors such as Northwest & Ethical Investments LP (NEI). After calling for a vote on the issue, they have softened their demands for the time being while RIM studies the issue. Now that the vote will not take place, the shareholder’s meeting will not be as contentious as it might have been.  According to the Bloomberg article on 12 July 2011:

    RIM managed to avoid a public showdown by persuading NEI to drop its proposal with an agreement the company would form a committee to study its leadership. The move has frustrated investors who want RIM to shake up management and respond more quickly to its competitive threats.

    With the institutional investors placated, the smaller individual shareholders will probably not shake things up.

    “I expect a lot of grumpy senior citizens rather than fund managers,” who hold the larger stakes, said Jackson. “Even if it’s a placid event, no one should be fooled that shareholders are happy.”

    So for now, we wait to see what happens. I’m considering buying a smart phone myself. I thought I wanted a blackberry, but I’m considering the competition.

    Discussion Questions:

    1. Read this related article on Bloomberg. Why do investors want to split the roles of CEO and Chairman of the Board at RIM?
    2. How can investors influence managers to make changes at a firm?
  • What Will Become of Our Risk-Free Rate?


      (source: http://www.aoc.gov/cc/capitol/flags.cfm)

    Although we always knew that no rate is truly risk-free, financial models and investors have relied on the U.S. Treasury bill yield as their best estimate of the risk-free rate. Now what will we use if the U.S. government is no longer risk free?

    On July 14, 2011, S&P announced:

    Standard & Poor's has placed its 'AAA' long-term and 'A-1+' short-term sovereign credit ratings on the United States of America on CreditWatch with negative implications.

    We may lower the long-term rating on the U.S. by one or more notches into the 'AA' category in the next three months, if we conclude that Congress and the Administration have not achieved a credible solution to the rising U.S. government debt burden and are not likely to achieve one in the foreseeable future. (source: Standard & Poor's RatingsDirect on the Global Credit Portal, July 14, 2011)

    This action follows S&P's April 18 announcement where the ratings outlook was changed from 'stable' to 'negative.' In this video, S&P Managing Director explains that a negative ratings outlook indicates a six month to one year horizon for possible credit downgrade, whereas a negative CreditWatch is a three month or shorter time frame.  In other words, time is running out.

    On July 13, Moody's made a similar announcement:

    Moody's Investors Service has placed the Aaa bond rating of the government of the United States on review for possible downgrade given the rising possibility that the statutory debt limit will not be raised on a timely basis, leading to a default on US Treasury debt obligations. On June 2, Moody's had announced that a rating review would be likely in mid July unless there was meaningful progress in negotiations to raise the debt limit.

    In conjunction with this action, Moody's has placed on review for possible downgrade the Aaa ratings of financial institutions directly linked to the US government: Fannie Mae, Freddie Mac, the Federal Home Loan Banks, and the Federal Farm Credit Banks. We have also placed on review for possible downgrade securities either guaranteed by, backed by collateral securities issued by, or otherwise directly linked to the US government or the affected financial institutions. (source: Moody's Investor Services, Global Credit Research, 13 July 2011)

    With the August 2 deadline just around the corner, the government will have to come to a resolution very soon to avoid default.

    Discussion Questions:

    1. According to this Washington Post article, what are the implications of a lower credit rating on the U.S. government?
    2. According to the ratings listed by S&P, what proportion of governments are rated AAA?


  • Lessons From a Prior U.S. Default

    photo: Ace Clipart

    Apparently, the U.S. has defaulted before. So this current scare of an "unprecedented default" is not our first rodeo.

    Back in 1979, when the U.S. debt was $800 billion, the Treasury faced a back office glitch and failed to send out $120 million worth of payments on its Treasury bills. The default was blamed on a bookkeeping error, but it was a default nonetheless. And as unintended as it was, it cost taxpayers, according to an academic study that was published in 1989

    More than 20 years ago, Zivney and Marcus reported that the 1979 default was expensive. Their research revealed an increase of 60 basis points in the cost of the U.S. debt as a penalty for the default. This was a 60 basis point increase on the full $800 billion, not just on the $120 million the government failed to pay. (See Zivney, T. L. and Marcus, R. D. 1989. The Day the United States Defaulted on Treasury Bills. Financial Review, 24: 475-489.)

    This increased cost of debt had a lasting effect. According to the interview on NPR with Professor Zivney, the market remembered the default for several months following the event and penalized the U.S. for its mistake. (Listen the interview on NPR below or read the full transcript here.)

    Does it seem rational that the market would insist on higher interest rates over such a "small" and temporary default? After all, we're talking about the U.S. government. Surely, investors would understand.

    Consider your own debt for a moment. Would your bank let you off the hook if you failed to make your car payments? Would the bank be satisfied that you had a "back office glitch?" Probably not. Intended or not, default costs the borrower. Default was costly for taxpayers back in 1979 and it will be costly for taxpayers again today.

    Discussion Questions:

    1. What is the dollar cost to taxpayers of 60 basis points on $800 billion for 6 months?
    2. According to this Wall Street Journal article, what is "financial repression" and what are its effects?
  • Quality Matters

    Accrding to Pankaj Patel, Managing Director at Credit Suisse, now is the time for investors to “derisk” their portfolios. When asked in his CNBC interview with Maria Bartiromo what he means by derisking, he replied that high-quality, low risk companies have started outperforming low-quality, high risk companies. This seems to be true for large cap, mid cap, and even small cap firms. 

    In these current market conditions, when we don’t quite know what to expect, investing in companies that are highly rated sounds like good advice. He listed some rules of thumb to follow when investing: 

    • High-quality stocks outperform during market uncertainties
    • Add low-earnings risk stocks
    • Avoid high-earnings risk companies

    At the end of the day, quality matters.

    Discussion Question:

    1. How would an investor determine the riskiness or quality of a potential investment? 

  • Hulu's Allure

    Hulu is up for sale, and everyone seems interested. Hulu is the web service that provides streaming video content of TV shows and movies, and everyone-Yahoo, Google, Amazon, AT&T, Verizon, even Apple-wants a slice of the online video market.

    In the history of mergers and acquisitions, acquirers have not always fared well. Acquirers have overpaid in the past and ended up with negative abnormal returns. Targets, on the other hand, have won. Investors who owned shares of takeover targets have often benefitted when the stock price rose during the merger.

    Looks like history may be repeating itself. Whoever buys Hulu will gain access to the online video market, but will likely be inheriting some problems as well. One of the big problems that this acquirer may face will be the cost of programming content once Disney and News Corp's Fox networks are no longer the parent companies. As the current owners of Hulu, these networks provide cheap programming and have helped Hulu make a name for itself. Once that relationship is over, the new owner of Hulu runs the risk that it may not be able to access the same content at the same low cost.

    According to CNNMoney,

    "Hulu is highly dependent on a continuing stream of new content from the current owners," says eMarketer analyst David Hallerman. "Fox and Disney are not going to hand low-cost content contracts to whoever buys Hulu."

    Instead, Disney and Fox "could just start playing in another sandbox," Hallerman says, because they wield a lot of power as the content owners.

    A loss of content could dent Hulu's impressive number of users -- which is key to drawing in advertisers.

    Hulu attracted 26.7 million unique U.S. users last month, according to data that comScore released last week. Those viewers watched nearly 160 million TV programs or movies on Hulu in June, and they spent more than 3 hours each watching, on average. That time spent watching is second only to YouTube and other Google-owned sites.

    We'll have to wait and see whether the research on mergers and acquisitions will hold true in the case of Hulu.  If the buzz continues, the current owners of Hulu could walk away with a windfall profit. Time will tell whether the acquirer will win as well.

  • Good as Gold

    (Photo by BullionVault)

    If you thought diamonds are a girl's best friend, think again.   At over $1,600 per ounce, gold is the big winner. The precious metal hit a record high of $1,624 per ounce on Monday and has remained strong ever since.  Fears over the U.S. debt and global economic conditions have pushed gold into the stratosphere. If the U.S. gets downgraded, then U.S. bonds and the U.S. dollar won't be the safe havens they've always been.  That leaves gold.

    But can the price continue to rise? The word on the street is mixed. Some investors remain bearish on the world economies and are consequently bullish on gold. Others see upcoming weakness.  In her Bloomberg interview, Suki Cooper, precious metals analyst at Barclays indicated that the price of gold could face pressure for the following reasons: (Watch the Bloomberg interview here.)

    • Supply of gold. At these prices, suppliers of scrap metal may begin to release added supply of gold which would cause weakness in the price of gold.
    • Profit taking. Investors may see these prices as a good opportunity to sell holdings and realize their profits now.
    • Weak demand. Gold is not just used for investment purposes, it has industrial purposes as well. Apparently, weak physical demand in the coming weeks may prevent prices from increasing further.

    On the other hand, fear is a big motivator. Investor fears may be driving demand for gold, and that may not go away any time soon. Though an agreement on the U.S. debt may alleviate some investor fears and cause the price of gold to decline, others believe the price can still go higher.  

    So if you're in the market for an engagement ring or wedding band, perhaps prices will soften a bit, that is if investors become a little less jittery.

    Discussion Questions:

    1. What is the current price of gold according to www.cmegroup.com?
    2. What happens to the price of gold during times of economic distress? What is the explanation for this?
  • Coffee Anyone?

     (Watch the NY Times Dealbook video here)

    Dunkin Donuts is my favorite. Krispy Kreme has its followers for donuts and Starbucks for coffee. Me, I prefer Dunkin Donuts for both.

    Investors are betting that I'm not alone in my tastes. Dunkin Donuts went public yesterday at $19/share, a higher price than the estimated $16-18/share that was expected. Apparently, this is a brand with room for growth. Already popular in the Northeast, the company is looking to double the number of stores as it seeks to expand its market share in Philadelphia, Chicago, and South Florida.

    Though Dunkin Brands has fewer stores than its competition, growth opportunities are promising.  According to the Reuters report on CNBC:

    Where it lags Starbucks and McDonald's in store numbers, Dunkin' Donuts wins when it comes to customer loyalty.  Brand Keys Inc, a consumer and brand loyalty consulting firm, says Dunkin' Donuts has ranked No. 1 for customer loyalty and engagement in coffee over the past five years.

    I guess I'm the loyal customer they were describing. I don't mind Starbucks, especially when it comes to in-store atmosphere, but for a good cup of coffee, I'll choose Dunkin Donuts every day.

    Discussion Questions:

    1. Read the Dunkin Brands press release here. What is the market capitalization of the firm now that it has gone public?
    2. How does this market capitalization compare with Starbucks (ticker SBUX) and McDonalds (ticker MCD)?
    3. Do you think Dunkin Brands has opportunity for growth or do you think that the competition from its rivals will be a difficult hurdle to overcome?
  • Insider Selling: A Bearish Signal

    (Watch the Marketwatch.com video here)

    Corporate insiders are selling more shares than they are buying. Last week that ratio reached 6.43 sells to 1 buy, which is higher than 95% of all previous weeks in the last decade.

    Insiders are people too. They need cash to finance house purchases and college tuition just like anyone else. So typically, insiders sell more shares than they buy. When markets trend upwards, insiders tend to sell more shares, and when markets trend downwards, insiders postpone their sales and tend to sell less. So selling is not necessarily newsworthy, but selling in down or volatile markets may be a bearish signal.

    Who is an insider? For filing purposes, the SEC defines an insider as "a company's officers and directors, and any beneficial owners of more than ten percent of a class of the company's equity securities registered under Section 12 of the Securities Exchange Act of 1934." These individuals must file the Ownership Reports and Trading by Officers, Directors and Principal Security Holders.

    Of course, this doesn't mean that officers, directors and principal security holders are the only people who can be caught for insider trading. Anyone who trades on material non-public information is guilty of that crime. This report is just one tool in the SEC fight against insider trading. This report is also a tool for investors to figure out what these knowledgeable investors must be thinking.

    Trying to decipher information gleaned from this report is not all that easy. Though a higher than usual sell-to-buy ratio is noteworthy, not everyone will agree that it is clearly bearish. According to Mark Hulbert of MarketWatch.com:

    Perhaps the strongest counterargument the bulls can muster at this point is that the insiders are not infallible. That indeed is true. Still, researchers report that they have been more right than wrong.

    At a minimum, I think we can all agree it can't be good news that insiders recently have been selling at such a fast pace.

    Discussion Questions:

    1. According to the MarketWatch.com article, why is this sell-to-buy ratio important? How might bearish investors interpret this information? How might bullish investors interpret this information?
    2. Go to www.sec.gov and search for "insider trading." What is insider trading and who is considered an insider?
  • ...Where the Deer and the Antelope Play...

    photo by Clydehurst under Creative Commons

    If you’re looking for an alternative investment, you might want to consider investing in a ranch.  Investments in farmland and timber have long been popular among many asset managers. Offering slow and steady returns in a world of rising food prices, these investments have gained in popularity.

    According to Paul Sullivan of the NY Times: 

    Ranch life taps into the American desire for space, freedom and a connection with the land. Lately, owning a ranch, and selling the products raised on it, has emerged as an alternative investment class for those with deep pockets and a time horizon that stretches as far as the eye can see.

    But owning a ranch is not all campfire songs and cloudless skies. There are maintenance costs to keep it running and a lack of liquidity should you want to sell. Agricultural land is perhaps less “fun,” but may offer better returns. In any case, owning a piece of America (especially a piece of the wild, wild west) may bring a certain satisfaction that can’t be valued in dollars and cents.

    Discussion Questions:

    1. How would a potential investor determine the right value for a ranch?
    2. What are some of the problems an investor might face if he/she invested money in this alternative investment?
    3. What are some of the benefits of investing in agricultural land, timber land, or ranch land?


    (photo by Clydehurst under Creative Commons licence at www.flickr.com)

  • Three Years After Lehman

    Lehman Brothers Times Square Aug 2007, photo by David Shankbone

    Who’s in charge of the over-the-counter market? When no exchange acts as a middleman or serves as a counterparty, what happens when one party fails to make good on its end of the bargain?

    Investors are learning the answer to questions like these as the fallout continues in the case of the Lehman Brothers bankruptcy that hit Wall Street in 2008. Many financial institutions had purchased or sold financial assets from or to Lehman Brothers before Lehman announced its bankruptcy on September 15, 2008—a textbook example of counterparty risk.

    Now three years later, on Friday, August 5 2011, State Street Bank announced that it has reached an agreement with some of the Lehman Brothers bankruptcy estates over the value of some of the contracts that failed.

    According to Reuters on Friday:

    With some $23 trillion of assets under administration and thousands of investment clients around the globe, State Street was embroiled on both sides of the 2008 Lehman bankruptcy. The bank said it is both seeking the return of some funds and may be liable for some claims.

     "We are in discussions with other Lehman bankruptcy administrators and would expect over time to resolve or obtain greater clarity on the other outstanding claims," the filing stated. "We continue to believe that our realizable claims against Lehman exceed our potential return obligations, but the ultimate outcomes of these matters cannot be predicted with certainty."

     Discussion Questions:

    1. What is a “repurchase agreement” and why would State Street have been affected by the failure of Lehman in the case of these contracts?

    2. What is the over the counter market and how does it compare with an exchange-traded market?

  • Breaking News: S&P Downgrades the U.S.

     (see the full report here)

    One of the CEO’s responsibilities is convincing financial markets that all is well at the shop. In fact, the entire executive team of a firm sets the tone for how well the company’s stocks and bonds will be received by investors. If investors are not convinced, then P/E ratios languish and stock prices do not climb. 

    Standard and Poor’s announced on Friday that it is unconvinced. The “firm” in question is the United States of America, and the executive team is led by our nation’s chief executive. 

    According to the S&P announcement that was sent to the U.S. Treasury after markets closed on Friday, August 5:

    The political brinksmanship of recent months highlights what we see as America's governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed….

    Our opinion is that elected officials remain wary of tackling the structural issues required to effectively address the rising U.S. public debt burden in a manner consistent with a 'AAA' rating and with 'AAA' rated sovereign peers. In our view, the difficulty in framing a consensus on fiscal policy weakens the government's ability to manage public finances and diverts attention from the debate over how to achieve more balanced and dynamic economic growth in an era of fiscal stringency and private-sector deleveraging….

    As expected, the government was not thrilled with the news.

    The Obama administration reacted with indignation, noting that the company had made a significant mathematical mistake in a document that it provided to the Treasury Department on Friday afternoon, overstating the federal debt by about $2 trillion. (Read the full NY Times article here)

    The question now is just how much the downgrade will affect the cost of debt in the U.S., both the cost of government borrowing and the cost of household borrowing. According to the NY Times article, the effect might be “modest,” particularly since the other rating agencies have decided not to downgrade for the time being.

    Time will tell.

    Discussion Questions:

    1. According to the S&P announcement, what are the reasons for the downgrade?

    2. According to the government, why is S&P wrong?

    3. What are the likely effects of this decision by S&P?

  • Just Another Manic Monday

    Monday was a bad day for Bank of America. It was a bad day for all financial stocks in general, but for B of A, it was particularly unpleasant.

    According to this NY Times video, banks are the “plumbing of the economy” so when something is bad news for the economy, it is bad news for banks. And bad news was in abundance yesterday. With the decision by S&P to downgrade the U.S., global fears of recession led to selling in Asian markets followed by European markets declining. The S&P 500 index fell 6.6%, possibly due to overreaction by investors to the news.

    If all that wasn’t enough, Bank of America (along with Merrill Lynch and Countrywide, which were purchased by B of A during the credit crisis) was slapped with a lawsuit for $10 billion in damages by the American International Group on Monday.  A.I.G. asserted the Bank of America engaged in fraudulent practices when it sold mortgages and mortgage-backed securities to investors. Apparently A.I.G.’s forensic team uncovered what they consider to be deceptive information and poor underwriting practices.  According to the lawsuit filed by A.I.G. with the Supreme Court of N.Y.,

    Between 2005 and 2007, Defendants fraudulently induced AIG to invest in nearly350 residential mortgage-backed securities (RMBS) at a price of over $28 billion. Driven by a single-minded desire to increase their share of the lucrative RMBS market and the considerable fees generated by it, Defendants created and marketed RMBS backed by hundreds of thousands of defective mortgages.

    The Offering Materials used to sell the RMBS fraudulently misrepresented and concealed the actual credit quality of the mortgages by providing false quantitative data about the loans, thus masking the true credit risk of AIG’s investments. The Offering Materials also falsely claimed that the mortgages had been issued pursuant to objective underwriting guidelines. In fact, the loan originators, including Defendants, encouraged borrowers to falsify loan applications, pressured property appraisers to inflate home values, and ignored obvious red flags in the underwriting process.

     The CEO of Bank of America, Brian Moynihan, will be answering questions on a conference call on Wednesday. In the meantime, Bank of America’s response, according to the N.Y. Times is:

    In a statement, Bank of America rejected A.I.G.’s assertions. “A.I.G. is the very definition of an informed, seasoned investor, with losses solely attributable to its own excesses and errors,” Bank of America said.

     The NY Times called this a no good, very bad day for Bank of America.  They’re right.

    Discussion Questions:

    1. What is a mortgage-backed security?

    2. Who is responsible for the due diligence on the securities purchased by A.I.G--Bank of America or A.I.G. itself?

  • The Contrarian Play

    A discontinued 10 Deutsche mark banknote showing a graph of the normal distribution and a portrait of the mathematician, Carl Freidrich Gauss.

    (Photo: public domain)

    Some of the big names in hedge funds lost money this week. Lots of money. Meanwhile others are simply raking in the profits.   

    Calamity funds—hedge funds designed to profit during market downturns—are turning up as the big winners. A hedge fund is an investment company that invests in financial assets. Like a mutual fund, a hedge fund pools the investments of its owners, and uses the funds to invest in stocks and bonds. Unlike mutual funds, however, hedge funds are organized as private partnerships and are often secretive about their investment strategies. These strategies include “long-short” equities, which means that the fund managers can go long to profit from market upturns and go short to profit from market downturns. Those who have chosen to go long, hope to be successful in picking the winning stocks.

    However, according to the NY Times article by Azam Ahmed (Aug 10, 2011):

    Industry watchers say it has been a tough month for such traders because when markets collapse, it doesn’t matter how well you pick stocks. While many of these managers pride themselves on knowing which companies are undervalued and which are overpriced, everything tends to decline during a big market sell-off.

    Enter the double-secret calamity funds.

    These funds win by taking the very unlikely bet that the market will collapse. Sometimes the probability of such a collapse is less than half a percent, which is why the risk of calamity can be called “tail risk.” Calamity funds bet on tail risk, and right now, their bets are coming up heads.

    “Our philosophy is more like a trapper: we set volatility traps and the market falls into them,” said Jerry Haworth, the head of 36South, which returned more than 200 percent in 2008. “We seem to have a windfall every time there is a systemic crisis. All the traps seem to get sprung.”

    Discussion Questions:

    1. What are the characteristics of a hedge fund?

    2. According to this second NY Times article, what are “fat tails” and how do they affect investors?


  • The Downside to Low Interest Rates


    Are low interest rates a good thing or a bad thing? Depends on who you ask. 

    Borrowers like low interest rates because of the low interest expense. Savers, on the other hand, find themselves in a bind.  With rates near zero and the promise from the Fed that rates will stay there through 2013, retirees are having trouble living off their investments.

    $100,000 invested in a 1-year bank CD earning 1% delivers $1,000 per year.  For a 6-month CD, you’re looking at half of that amount. That’s not much to retire on, but many Americans are finding themselves in that boat. 

    According to this Times Magazine article, financial advisers are suggesting investing in a diversified portfolio of high-quality stocks as an alternative. Though investing in stocks is riskier than putting your money in a bank CD, at least stocks offer the possibility of higher returns. 

    So when Chairman Ben Bernanke announced that rates would remain low for the foreseeable future, not everyone was jumping for joy.  Some investors recognized that they’ll need to hunt for yield elsewhere because that future doesn’t look too bright for their “safe” investment options.

    Discussion Questions:

    1. What reasons did Chairman Bernanke give for the continued low interest rates?
    2. What risks do investors face if they choose to invest in stocks instead of CDs or bonds?
    3. To be able to retire with $1 million in 40 years, how much would an investor need to invest each year if interest rates are 6% per year? What if interest rates are 2% per year?
  • Fear of Volatility

    (photo by Stevage and licensed under Creative Commons)

    This recent roller coaster ride (a.k.a. the stock market) has investors heading for the hills. Though investors would like to pull their money out of the stock market altogether, there aren’t many alternatives.  Those heading into their retirement years have shifted their money into bonds and passive mutual funds. The young ones with many years to retirement don’t seem to be much braver.  According to Bloomberg,  

    Younger investors aren’t replacing their retiring counterparts. Cash holdings are at the highest levels since the record in March 2009, according to an Aug. 16 survey by Bank of America Merrill Lynch. Investors from 18 to 30 years old have the highest cash position of any age group at 30 percent of their portfolio, MFS Investment Management said in an Aug. 8 report. Almost three in five investors cite fear about volatility or needing money someday as a reason they hold high or increasing levels of cash.

    (read the full article here)

    The roller coaster ride isn’t quite over yet. The S&P 500 ended down 4.46% today. The Dow was down 3.68%. Though it may feel like time to head for the hills, perhaps there’s a silver lining. Perhaps it’s time to buy.

    Discussion Questions:

    1. How do investors measure volatility in financial markets?
    2. According to the related article, how did investors react to volatility in the past?
  • Jobs in Finance

    In an effort to right the ship, Bank of America has announced that it is laying off 3,500 workers and that more job cuts may be on the horizon, perhaps as many as 10,000. This isn’t sounding like good news for business students in general or for finance students in particular. So what’s a college student to do? Give up? Change majors?

    Not just yet.  According to Vault.com, jobs in finance can still be had.

    Even in these days of downturn, companies make money, and as long as getting the green is the bottom line, companies are going to need finance and accounting professionals to manage their money. This simple truth should make corporate finance an attractive option if you’re the type of person who has great math skills and enjoys being part of real solutions with bottom line impact. You’ll be asked not just to manage a business’ finances, but forecast where the money will come from and help decide how to spend it in ways that will ensure the greatest return. This means it’s your job to free up capital while raising profits and decreasing expenses. Oh, and you’d better be a fan of spreadsheets, because you’ll be looking over many of them as you detail all of this.

    Corporate finance might not be as high-profile as investment banking, but keep in mind, every company makes financial decisions, whether the company sells lumber or stocks and bonds.  Firms must choose which assets to place on their balance sheets, and they must find ways to finance those assets. Finance goes beyond the high-flying world of M&A, hedge funds, and IPOs. Finance includes the most fundamental business decisions: where can we get funds and how should we invest them. Understanding capital budgeting and capital structure—those topics covered in every Fundamentals of Corporate Finance course—will serve you well.   

    (photo N. Richie, all rights reserved)

    Discussion Questions:

    1.     According to www.vault.com, what are some other careers in finance? What is the outlook for these careers?

    2.     What kinds of skills will help a graduate succeed in these fields?

    3.     How can a college degree help you in these careers?

  • Big Brother Banking

     photo by lydiashiningbrightly licensed under Creative Commons


    If the government is having trouble collecting taxes, why not outsource that responsibility? Delegate the job to banks.


    In an effort to stem tax evasion, the Foreign Account Tax Compliance Act, or FATCA, forces global financial institutions to collect and report data about their wealthy U.S. clients or withhold 30 percent of investment earnings from those clients. If the financial institutions fail to comply, they face a stiff penalty of 40 percent of the amount and “heightened security by the IRS.”


    Being called “A U.S.-centric law for the world,” FATCA is facing opposition by bankers and other trade groups. In this CNBC article, criticisms center on FATCA’s reach and the cost of its implementation.


    In a barrage of letters to the Treasury, IRS and Congress, opponents from Australia to Switzerland to Hong Kong assail FATCA's application to a broad swath of institutions and entities. Those affected include commercial, private and investment banks and shells and trusts; broker-dealers; insurers; mutual, hedge and private-equity funds; domiciliary companies; limited liability companies, partnerships; and other intermediaries and withholding agents.


    Many questions remain unresolved. Among them is how the U.S. government will handle the flood of information that will be reported. Another question is how banks will react. Some have already indicated that they’ll take their business and go home.  According to CNBC, “the private banking arm of HSBC said it will stop offering services to U.S. residents outside the United States because of the cost of complying with the rule.” Yet another question is what this will do to international bank relationships. Swiss bankers are feeling especially picked on as the U.S. government tries to nab those pesky tax evaders who hide money in their numbered accounts.


    Discussion Questions:

    1. How much revenue is this new law expected to generate for the U.S. government?

    2. What are some unintended negative consequences of such a law?