Junk Bonds to fund Noah's Ark?

Unbelievable, but true.

The bonds will have no secondary market, are callable at any point, have no guarantee by the issuer and pay about 5% interest.  Oh, and they are going to pay for a museum called "Ark Encounter".  

What could go wrong?

An interesting take on floating rate notes

There's been some discussion of whether the Treasury should issue floating rate notes.   Some people argue that doing so would expose the government to interest rate risk, but as this blog posting points out, this risk is already present in the current way that the government issues short term debt.  

An interesting piece and worth the read.

Paddy Hirsch explains prop trading

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.

The importance of the VIX

Nice article about the VIX.  (The S&P 500 volatility index).

HT: Mike (one of my MBA students).

Semi variance

Fama & French discuss the use of semi variance as a measure of risk.

How risky are stocks?

The widely held view that stocks are not risky in the long run is attacked by a nice article in today's WSJ.

It states:

Look at the long-term average annual rate of return on stocks since 1926, when good data begin. From the market peak in 2007 to its trough this March, that long-term annual return fell only a smidgen, from 10.4% to 9.3%. But if you had $1 million in U.S. stocks on Sept. 30, 2007, you had only $498,300 left by March 1, 2009. If losing more than 50% of your money in a year-and-a-half isn't risk, what is?

Finance Fallacy #2

In light of my recent post on "stocks for the long run" Zvi Bodie argues why the idea of "stocks for the long run" is flawed. Transcript and audio is here

His basic idea, which is not new, he's been harping on it for a long time, is that stocks will on average beat bonds, but only on average. This means that the average investor will do OK investing in stocks for their retirement. But some investors will do a lot better than average and some will be do terribly (and end up eating dog food in their old age, as Zvi elegantly states). As an individual investor has only one shot at getting it right, being right on average is not too helpful.

Definitely worth listening to.

Incidentally, this is finance fallacy number 2, I'll have to look up what #1 is.

R-squared and return predictability.

The R-squared of a regression of mutual fund returns on various measures in the so-called 4 factor model is a measure of how much of the fund's returns can be explained by the model. The 4 factor model is pretty close to the "state of the art" for return measurement. A lower R-squared implies that the fund's returns are less well explained by the 4 factor model.

A recent working paper argues that this R-squared has useful forecasting ability. Specifically that lagged R-squared is negatively correlated with future fund alphas. Even more surprising is that the negative relation also extends to information ratios which is commonly defined as alpha divided by the funds idiosyncratic risk. This is important because you could boost alpha by just sacrificing diversification. The information ratio result suggests that this is not the case.

The authors interpret their findings as evidence of "selectivity or active management".

Interesting stuff. Especially after I just finished teaching my MBAs that idiosyncratic risk is not priced. Hmmm the tangled web we weave...

The paper in question is...

"Mutual Fund's R2 as Predictor of Performance"

YAKOV AMIHUD, New York University - Stern School of Business

RUSLAN GOYENKO, McGill University - Faculty of Management


and appears on SSRN here