New newsletter worth reading!

A friend of mine (Steve Horan) is working on this. Figured it was worth sending out to everyone.

Private Wealth - March 2008: "Welcome to the inaugural issue of the Private Wealth Management Newsletter, created to serve the needs of the growing number of our members who are serving private clients."

My favorite article in this first issue is :

"The Emerging New Model for Wealth Management
Zvi Bodie, PhD, and Paula Hogan, CFA

Consumers face very different challenges today in planning for lifetime financial security from what they did previous generations ago. The wealth management paradigm is transitioning from the Markowitz mean–variance perspective to the life-cycle theory of saving and investing worldview, with many implications for wealth management practice."

Aftershocks at Bear Stearns

Aftershocks at Bear Stearns:

"In a week it was all gone: Bear Stearns' (BSC) reputation, culture, identity; the savings of many of its 14,000 employees; and possibly their jobs, too. 'The speed of the collapse was traumatic,' says one banker who has worked at Bear for a decade. 'People aren't jumping out of windows,' he says. 'But we are all kind of anxious.'

A year ago Bear Stearns was worth about $20billion....On Mar.24, JPMorgan, under fire for unseemly opportunism, quintupled the offer to $10 a share, or $1.2 billion.....A comedown of such magnitude would be traumatic for any organization. But Bear Stearns was a Wall Street outlier. Although the country's fifth-largest investment bank, Bear still considered itself the scrappy underdog. A former chief executive, Ace Greenberg, liked to say Bear hired people who were poor, smart, and had a deep desire to become rich. It was a place of sharp elbows, but if you succeeded you were part of a family....Within the next couple of weeks, people expect the layoffs at Bear to begin. ""

I do know quite a few people at Bear and my heart goes out to you. Good luck. Stay positive. Things will work out for you. May not be what you had thought a few weeks ago, but who knows, maybe you will like things better.

SSRN-Technical Trading Revisited: Persistence Tests, Transaction Costs, and False Discoveries by Pierre Bajgrowicz, Olivier Scaillet

Does technical analysis work or not? Technical Trading Revisited: Persistence Tests, Transaction Costs, and False Discoveries by Pierre Bajgrowicz, Olivier Scaillet:

While the topic has been widely studied (indeed it has many times been tossed aside and scorned by academics), there are just enough papers that finds it works (see Lo, Mamaysky and Wang (2000)) that when coupled with the continual use of technical analysis, the effectiveness remains in debate.

Bajgrowicz and Scaillet examine this interesting question and find the answer is No and especially after transaction costs are included.

From their paper:

"...revisit the apparent historical success of technical trading rules on daily prices of the Dow Jones index. First, we use the False Discovery Rate as a new approach to data snooping. The advantage of the FDR over existing methods is that it is more powerful and not restricted only to the best rule in the sample. Second, we perform persistence tests and conclude that an investor would not have been able to select ex ante the future best-performing rules. Finally, we show that the performance fully disappears once transaction costs are taken into account."

Cite: Bajgrowicz, Pierre and Scaillet , O., "Technical Trading Revisited: Persistence Tests, Transaction Costs, and False Discoveries" (January 1, 2008). Swiss Finance Institute Research Paper No. 05-08 Available at SSRN: http://ssrn.com/abstract=1095202

Justice Dept. Approves XM Merger With Sirius - New York Times

Whatever happened to ____? You know those stories that just seem to drag on and on and on....this may take the cake. The XM Sirius Merger is once again back in the news for the third straight semester!

Justice Dept. Approves XM Merger With Sirius - New York Times: "

"The Justice Department gave approval...to the merger of two rival radio networks, XM and Sirius, a marriage that would create a de facto monopoly in satellite services now used by more than 17 million subscribers....The Justice Department’s antitrust division announced...it approved the merger after determining that prices were not likely to rise, in part because of competition from other program sources, like high-definition radio as well as iPods and other MP3 players that can be connected to home or car audio systems."

But lest you think you have heard the end of it, this still has to be approved by the Federal Communications and it seems like it is still far from a done deal:

"F.C.C. officials have offered conflicting signs on whether the commission would approve the merger.

The commission’s chairman, Kevin J. Martin, was quoted last week as saying that “I haven’t figured out what I think we should do on it yet.”"

This serves as a good reminder why horizontal deals can be difficult to get approved. This deal was first announced back in February of 2007.

The Incentive to 'Bet the Farm': CEO Compensation and Major Investments by Gavin Smith, Peter Swan

In prepping for my MBA 610 (Corporate Finance) class where we examine executive pay and how it impacts agency costs, I found this article by Gavin Smith and Peter Swan.

SSRN-The Incentive to 'Bet the Farm': CEO Compensation and Major Investments:

Swim and Swan look at firms that do major investments and those that do not. They find that the way the CEO is paid does influence the investment behavior of the firms.

From the abstract:

"CEO incentives with option-based asymmetric payoffs greatly increase the likelihood that a firm will increase risk by undertaking both major real investments and acquisitions. In contrast, equity-based incentives that induce upside and downside symmetric payoffs are associated with fewer major acquisitions and neither encourages nor discourages real investments. Fixed pay is associated with low likelihood of major investments and a poorer prognosis.

When option-incentivized CEOs use equity for funding real investment decisions they have the best combination of incentives and funding source"

Which is really cool. It may not be the most ground breaking paper I have ever seen, but it definitely is worth the read! (If nothing else, read the 8 page introduction! In fact, if you are in my class, you should definitely do so :) )

Cite: Smith, Gavin and Swan, Peter L., "The Incentive to 'Bet the Farm': CEO Compensation and Major Investments" (23 February, 2008). Available at SSRN: http://ssrn.com/abstract=1009323

Catching up-Newletter style

Catching up.

There is just not enough time in the day to do all I want to do. So given that it is break (we go back tomorrow) I will try to clear a few of the articles I wanted to mention as well as give you some book ideas and some random thoughts that I wanted to put out there as well.

* NCAA March Madness is a learning/teaching opportunity to discuss the relative effectiveness of stock picking vs. passive investing. Why pick upsets? Because it is fun. Boring but generally better strategy? Pick favorites. From Forbes two years ago.

* Recently JP Morgan officials asked their competitors to not hire Bear brokers away. Uh, ok. Of course he can say it, but why would anyone listen? If it works, I suggest that the professional sports teams try the same strategy when it comes to losing free agents.

* Implied Volatility (even with its acknowledged increase with the increased leverage that accompanies stock price declines) might resolve the issue of what happened to Andersen audited firms better than just using stock prices. This issue, which I hadn’t thought about in quite a while, was brought back into the spotlight (flashlight? Lol) by a new paper by Nelson, Price and Rountree that finds that Andersen audited firms were concentrated in industries that all went down and that Andersen's reputation may not have been to blame. Oh yeah, here is a bad paper that does use implied volatility to get around this problem somewhat.

* Insider trading does not pay. Even when it is a group of finance professors (at least former finance professors) doing it. From the SEC:

"The SEC's complaint alleges that Marshall received detailed and current information regarding the highly confidential ISE-Eurex merger talks, and tipped Tucker and Larson. According to the complaint, Tucker and Larson then purchased ISE securities resulting in illegal profits totaling approximately $1.1 million and $31,000, respectively."

* I have been reading several books that are either finance oriented or at least have valuable financial lessons:

Predictably Irrational by Dan Ariely. Great for class examples of Behavioral Finance. And really fun read. I think it is better than Freakonomics (sorry Steve).

Gatekeepers: the Professions and Corporate Governance by John Coffee Jr. Almost perfect for my corporate governance recap that I do in my corporate finance classes.

Men of Fire: Ristening to this one. Yeah it is about the US Civil War, but it again shows how misaligned incentives and poor management can make a huge difference. Even in war, agency costs matter!

* We just got a Bloomberg machine. I'd be really interested to hear how some of you use it for class.

* And finally a request. If you are from the Buffalo area, we’d love to have your help in the first ever BonaResponds Buffalo Service Day. It is this Saturday! While BonaResponds has built its name on trips to the Gulf Coast, it is also very active locally and has contributed approximately a quarter of a million dollars of services since August 2006 (which is after our “big” trip) with virtually no University Funding. BonaResponds is open to everyone and a whole lot of fun in addition to doing much good. So if you are local come on out and volunteer! (if you are not local but want to help you can always donate or better yet meet us for our next trip).
http://BonaResponds.org

American Stock Exchange and Delta Hedging

If you have ever taken a derivatives class (or even in some upper level corporate or investment classes) you probably are familiar with the "Greeks" and in particular Delta which is the change in value given a small change in the underlying asset price.

Interestingly, the American Stock Exchange now wants to allow Delta Hedging to be used more freely in offsetting option risks.

Self-Regulatory Organizations; American Stock Exchange, LLC; Notice of Filing and Immediate Effectiveness of Proposed Rule Change to Create a Delta Hedging Exemption From Equity Options Position Lim: "

"The exemptions for hedged positions generally require a one-to-one hedge (i.e., one stock option contract must be hedged by the number of shares covered by the options contract, typically 100 shares). In practice, however, many firms do not hedge their options positions in this way. Rather, these firms engage in what is known as 'delta hedging,' which varies the number of shares of the underlying security used to hedge an options position based upon the relative sensitivity of the value of the option contract to a change in the price of the underlying security. /7/ The Amex believes that delta hedging is widely accepted for net capital and risk management purposes."

JP Morgan and Bear to have a new price???

From the NY Times:

"The sweetened offer is intended to win over stockholders who vowed to fight the original fire-sale deal, struck only a week ago at the behest of the Federal Reserve and Treasury Department.Under the terms being discussed, JPMorgan would pay $10 a share in stock for Bear, up from the initial offer of $2...."

From CNN/Money:

" Under the revised terms, JPMorgan will buy 95 million new shares of Bear, giving it 39.5% of the troubled broker and a big leg up in getting shareholder approval to approve the takeover. Further, Bear Stearns' board members - including Chairman James Cayne, who was said to be shopping for a better deal - agreed to support the deal. The board controls about 5%, giving the bank almost 45% approval.

Why was the deal being redone? In part because os so called "mistakes". For more you will want to read the section by the "Deal Professor" that examines some of the errors that came about in the initial deal.

Bank of New York's Michael Woolfolk Discusses The Dollar - Features and Interviews - HardAssetsInvestor.com

Bank of New York's Michael Woolfolk Discusses The Dollar - Features and Interviews - HardAssetsInvestor.com:

"Michael Woolfolk, senior currency strategist for The Bank of New York Mellon, examines the forces pushing the dollar lower....

Woolfolk: I think that it is primarily an interest rate story, but we can’t be that simplistic about it. It’s also a growth rate story....We’re going to be seeing roughly about zero percent growth perhaps in the first half of this year. Europe will see something on the order of 1.5 percent growth. So even though Europe is slowing on a relative basis, they’re still growing faster than us.

We’re having difficulty attracting foreign investment into our stock and bond market currently, which also is undermining the dollar."

Have to admit a bias in this one. Many of the people I went to school with read the blog and if there is one thing I know, it is that they all have been wondering where is Michael J. Woolfolk. Well, Mark found this! A must watch. ;) (yes it is a video!)

Wall Street takes advantage of emergency Fed lending program - Mar. 20, 2008

Interesting story from CNN/Money

Wall Street takes advantage of emergency Fed lending program - Mar. 20, 2008:

"...Wall Street investment companies are taking advantage of the Federal Reserve's unprecedented offer to secure emergency loans, the central bank reported Thursday....Those large firms averaged $13.4 billion in daily borrowing over the past week from the new lending facility....This mechanism, similar to one available for commercial banks for years, got under way Monday and will continue for at least six months. It was the broadest use of the Fed's lending authority since the 1930s"

MBAs bearish on Bear job offers - Mar. 21, 2008

I know at least one of my students is a tad concerned ;)

MBAs bearish on Bear job offers - Mar. 21, 2008: "

Bear Stearns' meltdown and pending sale to JPMorgan Chase has left dozens of aspiring Masters of the Universe in the lurch. The recruiting season for investment banking positions - both full time and internships - ended months ago, back when Bear's stock traded for quite a bit more than the price of a venti mocha latte at Starbucks.

So what happens to those unlucky students who accepted positions at the now-defunct Bear Stearns? Will they get jobs at JPMorgan, or should they start learning how to make Frappuccinos?

Some career services directors aren't optimistic"

The same is true for those who work there. Everyone is in a holding pattern. Good luck to you all!

Can’t Grasp Credit Crisis? Join the Club - New York Times

Can’t Grasp Credit Crisis? Join the Club - New York Times:

"It has been going on for seven months now, and many people probably feel as if they should understand it. But they don’t, not really....I’m here to urge you not to feel sheepish. This may not be entirely comforting, but your confusion is shared by many people who are in the middle of the crisis.

“We’re exposing parts of the capital markets that most of us had never heard of,” Ethan Harris, a top Lehman Brothers economist, said last week. Robert Rubin, the former Treasury secretary and current Citigroup executive, has said that he hadn’t heard of “liquidity puts,”....

Liquidity puts are much like other forms of putable debt without all of the limitations as to when the debt is putable. (By the way the BEST explanation of liquidity puts, indeed much of the whole issue with off balance sheet debt in general is at Seeking Alpha from back in November)

Just one more thing on liquidity puts. SoundCapital.com has an example of their Liquidity Put Agreement online. Note this key point in their exposition of it:

"Thus, even if interest rates rise and the value of the securities fall, the issuer will always be able to put the securities back to the Provider at par, eliminating the need to mark the portfolio to market"

Which is why when the write-downs did occur they were for large amounts (I think, I will ask some accountants on this and the off-balance sheet treatment mentioned in the Seeking Alpha piece).

But I digress, back to the original NY Times article:

"As is often the case with innovations, though, there was soon too much of a good thing... The mortgages were then sliced into pieces and bundled into investments, often known as collateralized debt obligations, or C.D.O.’s....Once bundled, different types of mortgages could be sold to different groups of investors. Investors then goosed their returns through leverage, the oldest strategy around. They made $100 million bets with only $1 million of their own money and $99 million in debt. If the value of the investment rose to just $101 million, the investors would double their money"

The NY Times article good. Definitely recommend and especially if you have a final that might have essay questions before too long ;)

Why is Bear selling for more than the offer price?

Several people have asked why Bear is selling at so much over the JP Morgan offer price. I guess this is the best explanation I have seen.

Short version: Creditors want to assure the deal is approved, so they are buying shares in order to vote them.

Hedging the Bear Stearns Deal - Mergers, Acquisitions, Venture Capital, Hedge Funds -- DealBook - New York Times:

"The creditor buys Bear shares and a put at the price. Creditor then sells a call to pay for most (but probably not all) of the put. Creditor waits for the record date of the Bear shareholder vote so it can vote. It votes yes. Immediately thereafter the creditor sells its shares.

For a small sum (hedge) the creditor has now done its part to help the Bear deal go through despite the protests of Bear’s shareholders. And the creditor receives 100 cents on the dollar assuming JPMorgan makes good on the creditor’s debts.

Is this possible? It is not only possible, according to market reports, this is what is occurring and why Bear’s shares are trading at $6 a share."

SEC's Bear Stearns Probe Zeroes In on 'Put' Trades - WSJ.com

SEC's Bear Stearns Probe Zeroes In on 'Put' Trades - WSJ.com:

"The Securities and Exchange Commission is investigating the events leading up to the collapse of Bear Stearns Cos., specifically a surge in options contracts betting that the investment bank's share price would drop precipitously, according to people familiar with the matter....

The unusual trading in Bear's options began as early as March 7 and escalated through the following week....
Last week, the number of open put options leaped from 167,439 at the open of trading on Monday to 465,820 by the following Monday. That compares with open put contracts on Bear Stearns hovering around 155,000 the previous week, according to data from Schaeffer's Investment Research Inc., an options-research firm in Cincinnati.

"Betting on a 57% decrease in Bear Stearns stock in nine days is very unusual," said Todd Salamone, senior vice president of research at Schaeffer's Investment Research."

This is really not much to go on as many believed there could be trouble, but still I guess few (if anyone) expected this large of drop.

BTW there is also an investigation into the words of Bear executives prior to the collapse. From the NY Times:

"According to the Associated Press, the S.E.C.’s enforcement arm has sent a letter to JPMorgan Chase, which has offered to buy Bear Stearns, discussing “investigations and potential future inquiries into conduct and statements by Bear Stearns” before the takeover was announced."