Thursday, May 28, 2009

Loss contingent capital structure?

An interesting idea here on how bank's capital structure (the amount of debt and equity that they have) should be determined. When the credit default swaps on the banks debt are above a certain level, the bank should be forced to de-lever (i.e. sell equity and buy debt).

Wednesday, May 27, 2009

Raleigh is top 10 again

Not really finance related, but my home town is in a top 10 list again - best cities to live and work.

GM and Ch 11. What a surprise.

Is anyone really surprised that GM is about to file Ch.11. I'm not, back in December I thought it was inevitable. The time has come to pull the life support.

Gloom and Doom...

Marc Faber, publisher of the Gloom, Doom and Boom report (nope, I never heard of it either) says that he is 100% sure that the US is heading towards the hyperinflation levels seen in Zimbabwe (231 million %). He must be right because he also predicted the October 87, at least according to his website.

Saturday, May 23, 2009

Cap and Trade

Greg Mankiw points out that the cap and trade plan now in the works has been greatly watered down. It appears we are repeating the mistakes of the EU. Shame.

Unfortunately there is slim hope for a pigou tax.

Wednesday, May 20, 2009

Violating APR part 2

As I said a couple of days back, the Government was wrong to violate the priority rules of bankruptcy and favor Chrysler's union over its creditors. In doing so, the administration created the credible threat that they would do this again, and thus also created a disincentive for lenders to lend to unionized firms that are in financial difficulty.

My prediction has come true. George Schultze, manager of Schultze Asset Management LLC says:

Don’t lend to a company with big legacy liabilities or demand a much higher rate of interest because you may be leapfrogged in a bankruptcy.

Tuesday, May 19, 2009

NASDAQ Marketsite

In my class last night I mentioned the NASDAQ MarketSite, which is just basically a store on Times Square with a bunch of flat panel screens displaying stock quotes. There are some pictures on wikipedia. This one is a little amusing (or depressing depending on your perspective).




Put options as portfolio insurance

A recent article on the WSJ site advocates the use of put options as portfolio insurance. The article is correct in that put options are a way of insuring your portfolio, but the basic premise that this insurance is getting cheaper is flawed. The author points to the fact that December puts on the S&P 500 with a strike of 600 have been falling in price as the market has risen. What a surprise! Options 101 will tell you that the value of a put moves in the opposite direction to value of the underlying asset. To suggest that these are "cheaper" is just silly. They are cheaper because, in effect, the amount of insurance that you are getting is declining as the index rises.

wolfram alpha

There is a ton of buzz about the latest search engine - Wolfram Alpha. Apart from being able to do loads of wacky things, this engine is an amazing financial analysis tool.

Check out some examples. The option valuation and time value of money tools are just fantastic alone.

Thursday, May 14, 2009

Violating APR

The Government is stepping in to rig the Chrysler bankruptcy in a manner that, in effect, violates the absolute priority rule (APR). Article here. This rule dictates who gets paid, and in what order, when a company files Ch11.

Deviations from APR are in fact common when a lower ranked claimant is able to extract a concession from a higher claimant, but usually these are matters that occur between two private groups. By dictating the deviation in favor of the auto workers union, the Government is, in effective authorizing a wealth transfer from the bond holders to the union. Had the bond holders known that this was likely, they would have probably not lent money on the terms they did.

Going forward, this is bad policy, because any rational bond holder will be reluctant to lend to a large unionized company because of the risk that their claim will get trashed by the Government in the event of bankruptcy. For example, who is going to lend to GM in the future?

HT: My friend Jeff.

Friday, May 8, 2009

Three Lessons from Buffet

The "Get Rich Slowly" blog has a nice article on some prognostications from Warren Buffet. It's standard Buffet fare but worth a glance over. Of course Buffet and Munger do go off a little bit on "geeks bearing formulas"

Buffett: False precision leads to Long Term Capital Management. It only happens to people with high IQs. Those of you with an IQ of 120 are safe.

Munger: Some of the worst business decisions I’ve ever seen are the consequence of complex calculations and projections. They do that in business schools because, well, they have to do something.

Academia in France

A quarter of French Universities are at a standstill because of strikes and protests against proposed reforms. These reforms include requiring faculty to do research, paying people for performance, and allowing schools to act more autonomously. Article here

Some of the quotes in the article are priceless and demonstrate just how utterly clueless some of those in French academia are ...
"Competition is just a right-wing ideology - in the case of humanities, competitiveness doesn't even make any sense," says Sorbonne English Professor Barbara le Lan
and

"We have a republican conception of universities," explains Sandra Nossik, a student who has now spent eight years in the French university system and who was demonstrating last week in a Paris train station.

"They have to be open to everyone," she added. "We don't like this neo-liberal view of knowledge... and we don't want to have to answer to the government or businesses."

Thankfully here in the US, we have a highly competitive academic system which competes not only for the best students, but also for the best faculty and the best practices.

Thursday, May 7, 2009

What do Finance Professors think the equity premium is?

A recent survey shows that in the US, Finance professors think that the equity premium is on average about 6.3%.

I actually participated in the survey and I think I said 6%. Of course more recently, the premium has certainly been higher, although before the credit market problems, I think it was headed lower than 6%.

If it is 6%, then what does this mean? Well, if the long term bond rate is about 3%, then the expected return on large cap stocks should be about 9%.

I have no idea whether or not 6% is the right number, but I am pretty sure about is that at current bond rates, a long term expected return on stocks of 12% (the historic nominal mean) is delusional.

The difference between 12% and 9% is massive.

$1000 per month for 30 years at 9% will grow to $1,830,743. While the same investment at 12% will grow to $3,494,964. Of course this assumes that the investment doesn't grow. The point is that if your financial plans are based on 12%, then you better hope that your kids are smart, because you're going to have to rely on them to pay for your retirement!

Monday, May 4, 2009

News Flash: Technical Analysis doesn't work

I don't believe in technical analysis in the same way I don't believe in reading the tea leaves. Market's are pretty efficient. Chartists who beat the market in a given period do so because of luck, not skill. Of course, they still call it skill.

This article summarizes nicely the recent performance of various technical trading strategies...

A nice quote - technical analysis is.. "the fastest way to lose money".

Deafult spreads approaching more normal levels

Bloomberg reports that default spreads are returning to normal.