Wednesday, February 29, 2012

How much does JP Morgan make on a trade?

An interesting table showing how much JP Morgan makes per trade on average, broken out by different trades.

A few interesting points:
1. There isn't much money in equity trading.  It's a high volume low margin business.  
2. Swaps and loan deals are much more profitable but probably require more effort to put the trade together.
3. Most of JPM's revenue comes from fixed income.   Students who are interested in investment jobs take note - the action is in the fixed income business not long equities.

Tuesday, February 28, 2012

Weird stuff in high frequency markets

John Cochrane (of U. Chicago) has a really interesting post on some strange behavior that has been documented in high frequency trading environments.   It seems as though some of these phenomena are driven by the interaction of multiple execution algorithms.

A great quote:
High frequency trading presents a lot of interesting puzzles. The Booth faculty lunchroom has hosted some interesting discussions: "what possible social use is it to have price discovery in a microsecond instead of a millisecond?" "I don't know, but there's a theorem that says if it's profitable it's socially beneficial." "Not if there are externalities" "Ok, where's the externality?" At which point we all agree we don't know what the heck is going on.

Oil arbitrage

Brent crude (priced in Europe) and West Texas Intermediate (WTI) (priced in OK) have deviated in price quite a bit recently - raising the question - Are higher oil prices a result of a lack of pipelines between OK and the East Coast?

It's an interesting question.  Certainly more pipelines would allow oil to flow more rapidly to wherever markets need it.

In the case cited above, the higher prices are in Europe and presumably would be lower if we could export more WTI to that market to substitute for Brent crude.  But this isn't likely to impact domestic prices, as domestic prices are driven by the price of WTI.

I'd have thought that a pipeline would result in WTI prices rising and Brent prices falling as the mispricing declines.

It's also worth remembering that the keystone pipeline proposal runs north-south and not east-west.

Monday, February 27, 2012

IQ and Investing

Robert Shiller discusses a recent Journal of Finance article that finds a link between IQ and the amount of exposure to stocks an individual has in his/her retirement portfolio.

Shiller concludes that what is needed is more financial education.  I couldn't agree more.

Wednesday, February 22, 2012

The strange world of high speed trading.

An interesting Wired Magazine article. 

Thanks Mark (one of my students).

High oil prices are not caused by Obama or speculators

Spring is in the air, and as usual at this time of year, the talk turns to oil prices, and specifically why they are high. While the various GOP Presidential candidates are furiously blaming the President for the level of oil prices (and in doing so demonstrating their complete lack of understanding of how oil markets work), the media is blaming nasty speculators.  Today's Mcclatchy piece in my local paper has the bold headline "Markets to blame for oil prices".  Well duuhh, of course markets are to blame - they are to blame when prices are high and when prices are low, because markets set prices.  It's like saying the weather is to blame for the rain.   But dig into the article a bit further and we find that apparently it is actually evil speculators that are to blame - something that I seriously doubt.

But I won't go into the arguments as to why it is unlikely that speculators are to blame, because about a year ago, Srini Krishnamurthy (my colleague) and I wrote an op-ed piece explaining just that.  I discuss this piece in more detail in a blog posting back then.

In the meantime, I suggest blaming supply and demand.

Monday, February 20, 2012

What economists do

Greg Mankiw with a graphic of the current internet viral meme...

The first one reminds me of when my son and his friend came to my office one day. They'd visited his friend's dad's office (who is an architect) and presumably seen lots of drawings and models.  When they came to my office, the first question was "So where's all the money then?"

What good are hedge funds...

Marginal Revolution has a collection of links on the topic.  

One argument is that hedge funds are valuable because of their volatility reducing properties and not their ability to create a raw alpha.   It's an interesting view point, but in that case, should the fees be based upon the ability to post positive return with low covariance to the market?

In another post, MR links to an article that claims that Hedge Funds have lower return volatility.  I'm not entirely convinced about this because hedge funds don't have to post prices continually.  If I recall, they often can self report fund values periodically which would serve to smooth their volatility (but I might be wrong on this).

Thursday, February 16, 2012

What does it mean to "subscribe" to a blog and how do I do it?

Not really finance related, but this may be useful to some people.

If you look over on the right hand side of this page there is a link that says "Subscribe to Finance Clippings".  If you click this link you'll see a bunch of options.   So what exactly is all this stuff?

There are a variety of ways you can view this (and any other blog).  The two most common ways are either to bookmark it and then go the actual page of the blog whenever you want to see what is new, or get the blog "syndicated" to a reader.  The first is pretty obvious, but let me talk about the second as it is the better option.

I use gmail, and part of gmail is something called google reader.  Google reader is an "RSS" feed reader which basically puts all your blog feeds in one place.  When a blog is updated, the blog posting automatically shows up in your reader.  It's sort of like email for blogs.   Google reader is great because you can subscribe to lots of blogs and quickly navigate through the posts - skipping over the boring stuff and then stopping to read the good stuff.  You can star your favorite posts to come back and read them later.

Here's a screenshot of my google reader...
You'll notice all the blogs I subscribe to are on the left hand side.  When a new posting is made by one of these bloggers, the post will show up in my reader.  I usually look at them while I am eating lunch.

I also subscribe to other non-finance blogs, but the screenshot only shows the finance stuff.

So how do you get a blog to show up in your reader?  

If you click on the subscribe link in my blog and select google and then google reader, then the feed will automatically be added.  

If the blog you are interested in doesn't have that feature then you just need to click on a button that says RSS and you should get a link.  Click the button on the reader page that says "SUBSCRIBE" - its the big red one, and paste this RSS link in there.  The blog should show up.

If you don't want to use google reader, there are lots of apps that can fetch blog feeds.  You can get these for your phone, or your computer.  Reeder is a popular one for Apple products.  There a hundreds for windows - just google RSS reader.  Personally though, I like Google reader best.

A Facebook valuation

Aswath Damodaran puts together an excellent valuation of Facebook.

If you're interested in equity valuation and in developing analyst skills, you could do a lot worse than to carefully study Prof Damodaran's work.

Why target date funds are like hotdogs.

Target date mutual funds are portfolios of funds that adjust the allocation to stocks and bonds based on how close the fund is to its specific target date.  These funds are, in theory, great for people saving for retirement, as they gradually reduce the risk exposure of the fund as the retirement date gets closer.  By buying a target date fund, the retiree doesn't have to worry about rebalancing his/her portfolio each year.

This article explains the idea pretty nicely and contains a graphic showing how the allocations might change over time.

So what's not to love about target date funds?  A lot actually.   Ron Elmer has done a nice investigation of exactly what goes into one of these funds.  You can read it here.  The analogy I'd like to make is one of making hotdogs.  The good cuts of meat (the good funds) are generally sold directly to the public, but the nasty stuff is mushed up and put into hotdogs (target date funds).   To understand why this is so, you need to know a little bit about how mutual funds come and go.  

Most mutual fund companies are constantly starting new funds.  But no one wants to put money in these new funds because they don't have a track record.  In addition, because they are small, their expense ratios are often pretty high.  But the mutual fund company can stick these start up funds in a target date fund.   Because people buy the target date fund without paying attention to the funds within the fund, they will put money into these start up funds.  The start ups that do well will most likely be sold directly to investors (these turn out the be the good cuts), but the ones that do badly will be closed or folded into other funds and replaced with a new startup.

As a result, at least for the target date fund that Ron looked at, the fund is heavily weighted towards new, high fee funds that have poor track records.  Case in point, the Fidelity Freedom 2035 fund has an expense ratio of 0.77% which is basically the average of the funds it contains.   This is much higher than the expense ratio of an equivalent portfolio of index funds.

As a side note,  the Fidelity Freedom 2035 fund is one of the options offered to employees at my institution.

Sunday, February 12, 2012

The equation that caused the crash...?

A reasonably good account of the impact of the Black Scholes equation.  Despite the rather dramatic title of the article, the equation did not cause the market crash.

For my MBA 523 students - you need to read this.  We're talking about the derivation of the Black Scholes model this week!

Thursday, February 9, 2012

College Endowment returns are not too good.

Ron Elmer over at Investor Cookbooks has an interesting post on how well College endowment funds and public pension funds have performed relative to a passive fund comprising fixed income and stocks.  The bottom line is that you could beat the return of the average endowment with a simple blend of Vanguard index funds.

Now while it is always possible to look back and say "you should have done x and not y", Ron's passive fund makes a lot of sense.  It's very diversified and it's super low cost and the reason why pension funds and endowments don't do so well is because of fees.

Most endowments and pension funds employ teams of people to pick investment managers who then pick fund managers who then pick securities.  Each layer charges a fee.   All these layers of management beg the question - wouldn't it just be easier to employ one manager who indexes the entire portfolio in stocks and bonds and be done with it?  

The Dow is a horribly constructed index

Another nice post from Kid Dynamite.  This time having a go at the Dow Jones Average.   If you don't know why the S&P 500 is fundamentally different from the Dow 30 (apart from the little matter of 470 stocks), then you need to read this.

Warren Buffet on gold and cash

I've been enjoying a new (to me) blog - Kid Dynamite's World.  KD has a really great analysis of Warren Buffet's most recent prognostications on gold and government bonds.

Suffice to say, Warren doesn't think much of gold as an investment class.  

The key point - highlighted by KD is:

He (Buffet) can’t fathom how an investor could chose the cube over the other portfolio of productive assets.  Then he points out this reality:
“Beyond the staggering valuation given the existing stock of gold, current prices make today’s annual production of gold command about $160 billion. Buyers — whether jewelry and industrial users, frightened individuals, or speculators — must continually absorb this additional supply to merely maintain an equilibrium at present prices.”

I'm inclined to agree with Buffet.  Gold is not an investment, it is merely a directional bet on a useless asset.   You could make the same bet on, say, nice wine.   At least if that bet goes bad you could still drink the stuff.

Wednesday, February 8, 2012

Friday, February 3, 2012

Felix talks about the good news on jobs

A nice analysis (with graphs).

Buffet's stock screens.

Apparently this how Warren screens his stocks.

Your mileage may vary...

A couple more on pension returns...

Are pension return forecasts too sunny?  Umm ..Yes.

California Teacher's Fund reduces its return assumption to 7.5%.  A step, albeit a small one, in the right direction.

Pension fund return assumptions are not a matter of opinion.

I came across this letter written by Curtis Hutchins, the President of the Retired Educators Association of Minnesota.  Mr Hutchins argues against a reduction in the pension return assumption for the state pension fund.  In the letter he states:
Some believe pension fund investment returns should be held to more of a “risk free” rate of return — such as the Treasury yield, which is about 4 percent. The debate over what is an appropriate investment return assumption is largely a philosophical one between optimists and pessimists.
I'm afraid that Mr Hutchins is completely wrong here.  Return assumptions are not a philosophical debate that depends on whether you are an optimist or pessimist.  In fact your opinion about future returns shouldn't influence your return assumptions at all - because it is just that - an opinion!

The risk free rate is more appropriate rate to use because the liabilities of the fund are risk free.  They are promises to the current and future retirees on Minnesota.

The use of a riskless rate to value a riskless liability is based on simple finance.

Thursday, February 2, 2012

The Facebook halo effect...

OK I didn't see this one coming ... LNKD spikes up on Facebook's IPO filing.

Wednesday, February 1, 2012

Facebook IPO filing details...

Some details on the big one.  The number that stuck out to me was that FB made $1 billion last year.  That seems a lot, but remember that the company is being pegged at a valuation of $100 billion.  That implies a trailing PE of 100.  Ouch - that's a sky high valuation for a huge company.


Analytics - the analysis of large amounts of data is the hottest thing since sliced bread these days.  At NCSU we've had an Advanced Analytics Masters for a few years.  In fact we were one of the first schools to offer one.  The degree is very popular - as this recent blog post on the NYT site indicates.

I've taught the "Financial Analytics" module in the NCSU program for several years, although due to other commitments, this will be my last year.

The trend in Analytics makes it pretty clear that to succeed in the business world today, students must be comfortable with data, data manipulation and data analysis using statistics.  Programming and excel skills are always good to have.  And of course you need all the other stuff as well (especially finance).

A Facebook IPO explainer.

Everything you wanted to know about Facebook's IPO in a nice easy to read format.

Nicely done.

(edited to put in correct link)

GRPN LNKD update on the eve of Facebook's filing.

As all finance pundits eagerly await the IPO filing of Facebook, I thought it might be worth just checking in on a couple of the high profile IPOs from 2011 - Groupon (GRPN) and LinkedIn (LNKD).

GRPN -18%.
LNKD -23%.

I'm sure Facebook will do a lot better.