I found an interesting article on Anna's blog, entitled: "Bailout Tab". We all have heard on a weekly basis how the government has come up with some new bailout program with some interesting name and a cool sounding acronym. Her article caught my interest as I have never really thought of how much the government has spent in total on all the bailout programs, where they are getting all the money from and how they could ever repay all the money.
I found this interesting article in the New York Times that makes a perfect summary of all the money that has been spent and borrowed by the government and where it was allocated. Through April 1st, the government has made total commitments of $12.1 trillion and they have also spent a total of $2.5 trillion. As an investor, the government has made a commitment of $7.7 trillion and has spent $1.4 trillion. Secondly, government as a lender has committed $2.3 trillion and spent $680 billion. Lastly, government as an insurer committed to $2.1 trillion and spent $340 billion. For further details please see the article.
In Anna's blog she asks the question: "But where do they get this money?". The first answer is obviously the taxpayers money. But could our taxes possibly be enough to cover all the bailout expenses and keep the country running at the same time? No, so thus the government creates new money, as Anna also stated in her blog and this results in raising the countrie's already huge deficit. According to deficitsdomatter.org, the US national deficit is currently over $11 trillion and it is constantly increasing. Check out the link it is cool to see how fast the national deficit is increasing every second.
This brings me to another question; how will they ever be able to repay all of this deficit? Anna makes a valid point as she says that the government should not rely on people to repay their loans, as it was these exact same people that defaulted on their initial loans and caused part of the crisis. I agree with her on this point and I believe that the government should have some regulations in place where they can help in guiding the banks to select the appropriate people to lend to. This will in turn lead to the banks receiving some of their bailout funds if the banks become profitable again. When it comes to the remainder of the deficit that needs to be repaid, I do not have any solutions or thoughts, and that is why I am glad that I am not the president. Any thoughts are welcome.
Monday, April 20, 2009
Sunday, April 19, 2009
Banking Nationalization VS. "Good bank, Bad bank"
Banking Nationalization is becoming a very big possibility in the US, through the government bailing out the big banks and taking in large stakes of ownership in these banks. Nationalization refers to a government that acquires a majority interest or full interest in a bank. The government, being the largest shareholder, would make all the decisions such as replacing the management team and wiping out the existing shareholders. Then, once the bank has fully recovered, the healthy bank is sold back to private investors and the bank could continue as a healthy, private bank. Bank nationalization had been practiced by several countries and the best known example of this is when Sweden nationalized their banks in the 90's and successfully recovered their banking system. Even though banking nationalization has been proved to work by countries such as Sweden, the US is a firm non-believer in banking nationalization. This was shown when US top economic advisers, recommended that Japan should not have nationalized their banking system during the Japanese economic depression in the 90's. The US is now however facing similar challenges to Japan and they are currently doing the exact opposite as they advocated almost two decades ago.
As many US economists and politicians oppose the proposed solution of a nationalized banking system, someone needs to come up with an appropriate alternative. On proposed solution is the "Good bank, Bad bank" strategy. This kind of plan would split an institution (bank) into two parts: First is the "Good bank", which will receives all the good assets and some of the firms remaining capital. This well then be a healthy institution and continue to be a productive private company. The "Bad bank", will receive all the bad assets and the remaining capital of the firm. Even though there will not be enough capital to cover these bad assets, new capital would likely come from taxpayers money.
Now you would think that whether we as the taxpayer pay for a nationalized banking system, or whether we are paying to adopt this "good bank, bad bank approach. Why would it matter which strategy we choose. Common sense tells us that we should go with the nationalized banking approach, since at has been proven to work in the case of Sweden. But, Alan Blinder who is a economics professor at Princeton and also the former vice chairman of the Federal Reserve thinks otherwise. He states in a NY Times article that there are several reasons why a national banking system would not work. Firstly, Blinder describes a "domino effect" where he says that if the government takes control over a few banks, the rest of the banks would soon not be able to compete with the government owned banks and would soon default, thus causing a domino effect. Secondly, the US government would have a near impossible task to be able to manage thousands of banks that make up the world's largest economy. The swedes were successful, since they only had a handful of banks to manage. The third and most important factor, is that of a political stance. Since bank nationalization could almost be considered as a taboo subject in the minds of many Americans, politicians will have plenty of obstacles to overcome the American disbelief in nationalization.
So looking at all the obstacles that lie ahead of initializing a national banking system, I would prefer to see a different strategy put in place, such as the "good bank, bad bank" strategy. Bank nationalization may have worked successfully in other countries, but I believe that in the democratic system that we live, no policy will survive that most Americans do not believe in and also at this scale would the US government really have the man power and skills to pull off such a daunting task?
http://www.nytimes.com/2009/01/26/business/economy/26banks.html
http://www.nytimes.com/2009/01/16/business/16banking.html
As many US economists and politicians oppose the proposed solution of a nationalized banking system, someone needs to come up with an appropriate alternative. On proposed solution is the "Good bank, Bad bank" strategy. This kind of plan would split an institution (bank) into two parts: First is the "Good bank", which will receives all the good assets and some of the firms remaining capital. This well then be a healthy institution and continue to be a productive private company. The "Bad bank", will receive all the bad assets and the remaining capital of the firm. Even though there will not be enough capital to cover these bad assets, new capital would likely come from taxpayers money.
Now you would think that whether we as the taxpayer pay for a nationalized banking system, or whether we are paying to adopt this "good bank, bad bank approach. Why would it matter which strategy we choose. Common sense tells us that we should go with the nationalized banking approach, since at has been proven to work in the case of Sweden. But, Alan Blinder who is a economics professor at Princeton and also the former vice chairman of the Federal Reserve thinks otherwise. He states in a NY Times article that there are several reasons why a national banking system would not work. Firstly, Blinder describes a "domino effect" where he says that if the government takes control over a few banks, the rest of the banks would soon not be able to compete with the government owned banks and would soon default, thus causing a domino effect. Secondly, the US government would have a near impossible task to be able to manage thousands of banks that make up the world's largest economy. The swedes were successful, since they only had a handful of banks to manage. The third and most important factor, is that of a political stance. Since bank nationalization could almost be considered as a taboo subject in the minds of many Americans, politicians will have plenty of obstacles to overcome the American disbelief in nationalization.
So looking at all the obstacles that lie ahead of initializing a national banking system, I would prefer to see a different strategy put in place, such as the "good bank, bad bank" strategy. Bank nationalization may have worked successfully in other countries, but I believe that in the democratic system that we live, no policy will survive that most Americans do not believe in and also at this scale would the US government really have the man power and skills to pull off such a daunting task?
http://www.nytimes.com/2009/01/26/business/economy/26banks.html
http://www.nytimes.com/2009/01/16/business/16banking.html
Tuesday, April 14, 2009
Response to Universal Currencey
In this post I am writing in response to Unique's post on Universal Currency. I agree completely with Unique's negative point of view of adopting a universal currency system. I have found several further evidence that dates back over a century that outlines some of the essential problems of using a universal currency system.
From a New York Times article published on January 28, 1858, the editor of the NY Times wrote an article suggesting the "ignorance" and foolishness of economists to try and adopt a universal currency system. The editor suggests that gold and silver had been used for centuries for "a half civilized and Barbaric" world and that no advancement had been made to currency valuable enough to replace gold and silver. Even when all the countries in the world have their own currencies now, I still believe that we are still ultimately "a half civilized and barbaric" world. Just look at all the investors buying gold as soon as the value of the dollar dropped. Look at the U.S. and their huge stockpile of gold at Fort Knox. According to the World Gold Council, in September 2008, the US still had 8,133.5 tonnes of gold reserve. When the state of one's currency is in doubt, we as the human race tend to resort back to our ancestor's currency in the form of gold and silver.
The next valid and the most crucial point the the editor of the NY Times make, is that you would have to find someone powerful enough to force your currency or the newly proposed currency on all the nations of the world. The editor proposes this person to be of equal fame as "Alexander or Julius Caesar". For the proposed currency to take affect, the world would need a world leader who would be able to convince the rest of the world that it would be in their best interest to partake in this option, which could be very unlikely.
So for now, in my opinion, a universal currency sounds like an ideal, yet unpractical idea. Through much research and many negotiations, I believe that it can be achieved and this is proven by the most of the countries in Europe taking part in the Euro, but I do not see it being a success in the near future.
From a New York Times article published on January 28, 1858, the editor of the NY Times wrote an article suggesting the "ignorance" and foolishness of economists to try and adopt a universal currency system. The editor suggests that gold and silver had been used for centuries for "a half civilized and Barbaric" world and that no advancement had been made to currency valuable enough to replace gold and silver. Even when all the countries in the world have their own currencies now, I still believe that we are still ultimately "a half civilized and barbaric" world. Just look at all the investors buying gold as soon as the value of the dollar dropped. Look at the U.S. and their huge stockpile of gold at Fort Knox. According to the World Gold Council, in September 2008, the US still had 8,133.5 tonnes of gold reserve. When the state of one's currency is in doubt, we as the human race tend to resort back to our ancestor's currency in the form of gold and silver.
The next valid and the most crucial point the the editor of the NY Times make, is that you would have to find someone powerful enough to force your currency or the newly proposed currency on all the nations of the world. The editor proposes this person to be of equal fame as "Alexander or Julius Caesar". For the proposed currency to take affect, the world would need a world leader who would be able to convince the rest of the world that it would be in their best interest to partake in this option, which could be very unlikely.
So for now, in my opinion, a universal currency sounds like an ideal, yet unpractical idea. Through much research and many negotiations, I believe that it can be achieved and this is proven by the most of the countries in Europe taking part in the Euro, but I do not see it being a success in the near future.
A small sign of stabilizaion on Wall street
Goldman Sachs is the first of the big banks that are attempting to pay back federal money allocated by the Troubled Asset Relief Program (TARP). Goldman announced profits of $1.66 billion or $3.39 a share for the first quarter. They also announced record revenues $6.56 billion largely due to the lack of competition from Bear Stearns and Lehman Brothers. This would be a breakthrough for the financial system as it is showing positive signs that one of the big banks are finally on a road to recovery and are attempting to pay back federal money.
Funny enough, Goldman is being scrutinized for their desire to pay back federal loans and some even say that this might not be good for the financial system as a whole. So much so, that Goldman needs to wait for approval from the treasury to be able to pay back the funds and they are subject to a stress test from federal examiners that determines their eligibility to pay back the funds. I feel that if the company managers feel comfortable enough to pay of debt, they should do that. This seems to me like the responsible decision to do with incoming revenues unlike AIG that used money to pay bonuses. This situation could be compared to you and I, that might want to pay off our home mortgages sooner by paying higher monthly payments, but the bank tells us that we cannot do it. As for the financial system as a whole, if Goldman decides to pay off their debt, they will surely be able to allocate more funds to other aspects such as bonuses and high stock dividends. This in turn will make Goldman the bank to work for on Wall street and this might also motivate other big banks to follow in Goldman's footsteps for financial success.
Goldman should also not be scrutinized for wanting to be independent of government funds. They have very legitimate reasons for doing so. By paying off these government loans, they receive independence from the government's rules and regulations that stipulate what Goldman should spend their loan money on.
Goldman should definitely be allowed to repay their TARP money. This could only be good for the economy. This kind of news could set an example for other banks to follow, put some confidence into employees minds to keep up a good and honest work ethic and lastly could establish some confidence in the capital market and make people invest again by buying new shares.
Goldman Using Share Sales to Return Bailout Money
Funny enough, Goldman is being scrutinized for their desire to pay back federal loans and some even say that this might not be good for the financial system as a whole. So much so, that Goldman needs to wait for approval from the treasury to be able to pay back the funds and they are subject to a stress test from federal examiners that determines their eligibility to pay back the funds. I feel that if the company managers feel comfortable enough to pay of debt, they should do that. This seems to me like the responsible decision to do with incoming revenues unlike AIG that used money to pay bonuses. This situation could be compared to you and I, that might want to pay off our home mortgages sooner by paying higher monthly payments, but the bank tells us that we cannot do it. As for the financial system as a whole, if Goldman decides to pay off their debt, they will surely be able to allocate more funds to other aspects such as bonuses and high stock dividends. This in turn will make Goldman the bank to work for on Wall street and this might also motivate other big banks to follow in Goldman's footsteps for financial success.
Goldman should also not be scrutinized for wanting to be independent of government funds. They have very legitimate reasons for doing so. By paying off these government loans, they receive independence from the government's rules and regulations that stipulate what Goldman should spend their loan money on.
Goldman should definitely be allowed to repay their TARP money. This could only be good for the economy. This kind of news could set an example for other banks to follow, put some confidence into employees minds to keep up a good and honest work ethic and lastly could establish some confidence in the capital market and make people invest again by buying new shares.
Goldman Using Share Sales to Return Bailout Money
Tuesday, April 7, 2009
Response to Internal Control
Mike Corby wrote an interesting summary regarding internal control in one of his posts. Even though I do not think that his article was incorrect by any means, I found it very interesting. I thought that I would extend his post and also relate it to my previous post, where I discussed credit rating agencies and their failure to properly rate the companies that partook in risky trading.
Internal control, as mentioned by Mike, is a well executed check and balance system throughout a company that uses audits to oversee operations. These internal audits ensure compliance of regulations by creating ways to lessen risks and loss of assets. Mike is spot on with this definition of internal control, but he failed to mention both aspects of internal control. According to Wikipedia there are two aspects to internal control. The first is from an accounting perspective, which is what Mike was referring to, and secondly is from an organizational perspective. The organizational perspective involves detecting and protecting the company from fraud and also safeguards the company's resources, both physical and non-physical.
When it comes to three credit ratings; Finch, Moody's and S&P failed to have some internal control system in place. They disregarded a check and balance system to make sure that they have the correct rating system and that old ratings were not used over and over even if they were not updated and correct. This was clearly shown by these agencies as they gave high ratings even to companies that partook in risky mortgage-backed securities. If a proper internal control system was in place, this disaster may have been averted and these credit agencies might still have a good reputation.
The SEC now requires corporations to include an internal control report during their annual report. The Sarbanes-Oxley Act, requires companies to have a statement of management's responsibility for establishing and maintaining an adequate internal control structure and procedures for financial reporting and also management's report of the effectiveness of the company's internal control system. Lastly, this act also requiers an auditor to substantiate the management's report mentioned above.
The SEC seems to be taking the right steps in regulating companies, but another section of this act states that all companies need to report these internal control statements except for registered investment companies. I feel this is a thoughtless move on the part of the SEC. Why would they regulate everyone else, but not investment companies? I feel that the SEC should regulate everyone and not favor a select few and tragedies like the Madoff corporation will not happen again. So should the SEC not favor the the three big credit rating agencies and allow more competition to enter the market and also strictly regulate them, thus also resulting another check and balance system.
http://www.nysscpa.org/cpajournal/2007/1007/essentials/p34.htm
Internal control, as mentioned by Mike, is a well executed check and balance system throughout a company that uses audits to oversee operations. These internal audits ensure compliance of regulations by creating ways to lessen risks and loss of assets. Mike is spot on with this definition of internal control, but he failed to mention both aspects of internal control. According to Wikipedia there are two aspects to internal control. The first is from an accounting perspective, which is what Mike was referring to, and secondly is from an organizational perspective. The organizational perspective involves detecting and protecting the company from fraud and also safeguards the company's resources, both physical and non-physical.
When it comes to three credit ratings; Finch, Moody's and S&P failed to have some internal control system in place. They disregarded a check and balance system to make sure that they have the correct rating system and that old ratings were not used over and over even if they were not updated and correct. This was clearly shown by these agencies as they gave high ratings even to companies that partook in risky mortgage-backed securities. If a proper internal control system was in place, this disaster may have been averted and these credit agencies might still have a good reputation.
The SEC now requires corporations to include an internal control report during their annual report. The Sarbanes-Oxley Act, requires companies to have a statement of management's responsibility for establishing and maintaining an adequate internal control structure and procedures for financial reporting and also management's report of the effectiveness of the company's internal control system. Lastly, this act also requiers an auditor to substantiate the management's report mentioned above.
The SEC seems to be taking the right steps in regulating companies, but another section of this act states that all companies need to report these internal control statements except for registered investment companies. I feel this is a thoughtless move on the part of the SEC. Why would they regulate everyone else, but not investment companies? I feel that the SEC should regulate everyone and not favor a select few and tragedies like the Madoff corporation will not happen again. So should the SEC not favor the the three big credit rating agencies and allow more competition to enter the market and also strictly regulate them, thus also resulting another check and balance system.
http://www.nysscpa.org/cpajournal/2007/1007/essentials/p34.htm
Monday, April 6, 2009
The SEC and the Credit Rating Agencies
In today's lecture, Prof. Grace mentioned how the big three credit ratings; Moody's, Standard and Poor's and Fitch, are in a monopoly and how it is virtually impossible for competition to enter the market. I found this very interesting and I decided to investigate why the SEC would want to prevent more companies from entering into this market.
Connecticut Attorney General, Richard Blumethal, questioned why the big three credit rating agencies were given over $400 billion of the bailout money and why six of their smaller competitors were shut down. This money was intended to restore credit markets and Blumenthal questioned why it was given to the credit rating agencies when they were some of the main contributors to the current economic crisis. They did this, as Prof. Grace said today, by not adjusting their credit ratings appropriately with portfolios that dealt with mortgage-backed securities.
The credit rating agency is a $5billion-a-year industry and Blumenthal describes it as an "Old boys club" of Wall street, a complete monopoly that needs to be broken up. In my opinion these three agencies need to be regulated and double checked. Obviously there is no check-and-balances system in place between the three main agencies and they have a "scratch my back, scratch your back" attitude. Mary Schapiro, the chairman of the SEC suggested to ask congress for more supervision and regulation for the Wall street credit rating agencies. Schapiro, was given this authority in 2006 and also wanted to reduce the industry's dependence in these credit rating agencies.
A good way to bring in a system of checks-and-balances is to create monopolistic economy by bringing in new competition (new credit rating agencies). Know, Prof. Grace also mentioned today that the SEC prevents competition from entering the market. This obviously contradicts my previous statement where I said that SEC wanted to reduce the dependency on these agencies and also to regulate them. I tried to research this statement by Prof. Grace, but I couldn't find anything about how the SEC denies new credit agencies to enter the market.
So please feel free to reply to this post, either supporting or negating my opinion.
Associated Press
Connecticut Attorney General, Richard Blumethal, questioned why the big three credit rating agencies were given over $400 billion of the bailout money and why six of their smaller competitors were shut down. This money was intended to restore credit markets and Blumenthal questioned why it was given to the credit rating agencies when they were some of the main contributors to the current economic crisis. They did this, as Prof. Grace said today, by not adjusting their credit ratings appropriately with portfolios that dealt with mortgage-backed securities.
The credit rating agency is a $5billion-a-year industry and Blumenthal describes it as an "Old boys club" of Wall street, a complete monopoly that needs to be broken up. In my opinion these three agencies need to be regulated and double checked. Obviously there is no check-and-balances system in place between the three main agencies and they have a "scratch my back, scratch your back" attitude. Mary Schapiro, the chairman of the SEC suggested to ask congress for more supervision and regulation for the Wall street credit rating agencies. Schapiro, was given this authority in 2006 and also wanted to reduce the industry's dependence in these credit rating agencies.
A good way to bring in a system of checks-and-balances is to create monopolistic economy by bringing in new competition (new credit rating agencies). Know, Prof. Grace also mentioned today that the SEC prevents competition from entering the market. This obviously contradicts my previous statement where I said that SEC wanted to reduce the dependency on these agencies and also to regulate them. I tried to research this statement by Prof. Grace, but I couldn't find anything about how the SEC denies new credit agencies to enter the market.
So please feel free to reply to this post, either supporting or negating my opinion.
Associated Press
Monday, March 30, 2009
The New Exit Strategy
Foreclosures are becoming a daily story with friends and their family's losing their homes and all the equity that they have built up for years and years. After investigating short selling I came across an interesting article that suggests that short selling is a better option to take than foreclosing your house.
As we discussed in our lecture today, "in a short sale, the lender allows the property to be sold for less than the total amount due on the loan. In some cases, the lender forgives the remaining debt." So you are probably thinking why this is such a good idea? You are still losing a lot of your equity.
There are several advantages to doing a short sell as opposed to a foreclosure. The first and probably the most important, a short sell is much less detrimental to your credit record than compared to a foreclosure. Short selling also takes much less time and is much less expensive than a foreclosure.
Now you are probably thinking if short selling is so much more advantageous, why is everyone not doing it instead of foreclosures? Well, there are also several negative aspects to a short sell. The first obstacle that you as the homeowner would have to overcome is finding a real estate agent that will work for much less commission than in normal circumstances. Secondly, you would have to convince a lender to short sell a property, which could be very difficult. Also, once you have convinced the lender to engage in a short sell, the amount that the lender forgives is also taxable by the government.
Even though short selling is the clear choice over foreclosures, it is till the best idea to try and work out late payments with your lender and avoid putting yourself in the situation where you would have to choose between a foreclosure or a short sale on your home.
http://www.tucsoncitizen.com/daily/local/42927.php
http://real-estate.lawyers.com/residential-real-estate/Selling-Your-Home-For-Less-Than-You-Owe.html
As we discussed in our lecture today, "in a short sale, the lender allows the property to be sold for less than the total amount due on the loan. In some cases, the lender forgives the remaining debt." So you are probably thinking why this is such a good idea? You are still losing a lot of your equity.
There are several advantages to doing a short sell as opposed to a foreclosure. The first and probably the most important, a short sell is much less detrimental to your credit record than compared to a foreclosure. Short selling also takes much less time and is much less expensive than a foreclosure.
Now you are probably thinking if short selling is so much more advantageous, why is everyone not doing it instead of foreclosures? Well, there are also several negative aspects to a short sell. The first obstacle that you as the homeowner would have to overcome is finding a real estate agent that will work for much less commission than in normal circumstances. Secondly, you would have to convince a lender to short sell a property, which could be very difficult. Also, once you have convinced the lender to engage in a short sell, the amount that the lender forgives is also taxable by the government.
Even though short selling is the clear choice over foreclosures, it is till the best idea to try and work out late payments with your lender and avoid putting yourself in the situation where you would have to choose between a foreclosure or a short sale on your home.
http://www.tucsoncitizen.com/daily/local/42927.php
http://real-estate.lawyers.com/residential-real-estate/Selling-Your-Home-For-Less-Than-You-Owe.html
Response to a respite in technological advancement
I ma writing in response to Anna's post entitled: "Will we experience a respite in technological advancement?" Anna states that due to the economy, people have started buying less cell phones, and this will lead a halt or slow down in technological development.
As I am sitting in my lecture writing this (not RMI lecture), I look to my right and my left and every person is either working on their laptop or on their new blackberry or iPhone (or both). As I look around me, I see complicated technological devices and I cannot help to disagree with Anna that technology is still advancing, if not faster than ever. Anna argues that people have started giving up luxury goods due to the recession and I completely agree with her. We all know what is happening to the auto industry, and how people are giving up buying new luxury cars during these times. However, I do not believe that cell phones could be considered as a luxury good. I believe that cell phones have become a necessity! If you do not have a device that is capable of keeping you informed in our fast-paced lifestyles, you are really putting yourself at a disadvantage and ultimately keeps you from your potential income.
Anna brings in a valid point that people are not buying these "luxury" phones since all the big companies are reporting big losses in sales. This could be true since these cell phone contract prices are all based on a time before the current crisis, and people can no longer afford these contracts. This does not mean that technology development will decrease. New powerful cell phones are still being released every other month. Just look at my previous post where I discussed the release of the new Palm Pre and the new Blackberry models that are constantly being released. http://na.blackberry.com/eng/newsroom/news/press/release.jsp?id=1823
Even though there are plenty of cell phone companies in the market, there is still a huge monopoly when it comes to cell phones. These contracts allow potential customers only to buy a particular phone with a particular service provider. This enables service providers to charge monopoly prices, since they are the only company to provide that particular model of cell phone. For example the apple iPhone sells at a very reasonable price, but the iPhone is locked in an exclusivity contract with AT&T, which allows AT&T to charge ridiculous prices for the iPhone 2 year contract. According to a news article on CNN, AT&T is now starting to sell the iPhone at a higher price, but then allows the customer to have the option not to sign the very expensive two year contracts.
AT&T has the right idea. Technology is still developing at an alarming pace and new cell phones are still going to be released very regularly. Thus, service providers need to adjust their strategies and also reduce some of the contract prices in order to attract more customers.
As I am sitting in my lecture writing this (not RMI lecture), I look to my right and my left and every person is either working on their laptop or on their new blackberry or iPhone (or both). As I look around me, I see complicated technological devices and I cannot help to disagree with Anna that technology is still advancing, if not faster than ever. Anna argues that people have started giving up luxury goods due to the recession and I completely agree with her. We all know what is happening to the auto industry, and how people are giving up buying new luxury cars during these times. However, I do not believe that cell phones could be considered as a luxury good. I believe that cell phones have become a necessity! If you do not have a device that is capable of keeping you informed in our fast-paced lifestyles, you are really putting yourself at a disadvantage and ultimately keeps you from your potential income.
Anna brings in a valid point that people are not buying these "luxury" phones since all the big companies are reporting big losses in sales. This could be true since these cell phone contract prices are all based on a time before the current crisis, and people can no longer afford these contracts. This does not mean that technology development will decrease. New powerful cell phones are still being released every other month. Just look at my previous post where I discussed the release of the new Palm Pre and the new Blackberry models that are constantly being released. http://na.blackberry.com/eng/newsroom/news/press/release.jsp?id=1823
Even though there are plenty of cell phone companies in the market, there is still a huge monopoly when it comes to cell phones. These contracts allow potential customers only to buy a particular phone with a particular service provider. This enables service providers to charge monopoly prices, since they are the only company to provide that particular model of cell phone. For example the apple iPhone sells at a very reasonable price, but the iPhone is locked in an exclusivity contract with AT&T, which allows AT&T to charge ridiculous prices for the iPhone 2 year contract. According to a news article on CNN, AT&T is now starting to sell the iPhone at a higher price, but then allows the customer to have the option not to sign the very expensive two year contracts.
AT&T has the right idea. Technology is still developing at an alarming pace and new cell phones are still going to be released very regularly. Thus, service providers need to adjust their strategies and also reduce some of the contract prices in order to attract more customers.
Tuesday, March 24, 2009
Blockbuster needs to be innovative
This post is in response to Jon's post where he explains that Blockbuster might soon close their doors due to some stiff competition from online DVD rental stores and also from smaller niche market DVD stores. I have always thought that Blockbuster had done really well since I see store on almost every other corner, I can think of three different Blockbuster locations within 5 miles from my house. So I decided to investigate this a little further and found that some parts of what Jon had said was true, but I found that Blockbuster is being cautious to protect themselves and that they were not going bankrupt.
From an article on CNNMoney.com, Blockbuster's spokesperson Karen Raskopf, said that they had hired a law firm called Kirkland & Ellis. Now this law firm is known to specialize in restructuring and bankruptcy and when Blockbuster made this announcement, their stocks fell 77% on the NYSE on Tuesday. Karen stated that Blockbuster simply hired Kirkland & Ellis to help with their ongoing finance and raising-capital initiative. From the NY Times, Karen added that they were not intending to file for Bankruptcy and they had also spoken to some investment banks regarding the restructuring of their credit line.
Jon makes a valid point when he says that Blockbuster has been struggling to keep up with online rivals such as NetFlix. This is where I see that Blockbuster needs to more innovative. Blockbuster had just signed a deal with CinemaNow that allows Blockbuster to stream movies over the internet. This is a step in the right direction, but Blockbuster had done this just to keep up with NetFlix who already had a similar service in place. Blockbuster now also face even more competition such as the big cable and satellite companies that allow you to order your movies on demand. In my opinion, Blockbuster should cut some of their expenses such as labor costs and property costs, which their competitors do not have. Blockbuster employs a staggering 8000 people worldwide compared to a mere 1200 employees working at NetFlix. I feel that it is time for Blockbuster to adjust their image and realize that in store rentals are a thing of the past.
Secondly, from another article in the NY Times, Blockbuster stated that their fourth quarter revenue fell by 12% and this was due to a decline in movie rentals, a smaller store base and negative foreign currency exchange rates. Even though it is hard to simply increase movie rental sales in the curent economy, Blockbuster could certainly take steps to hedge against their foreign currency risks. The way I see it Blockbuster needs to keep the cost of their risks to a minimum, or at least consistent and they can certainly do this through hedging contracts.
In conclusion, I feel that Blockbuster can certainly make it out of their current economic downturn through being a well managed and an innovative company. Home movies are still in high demand as it is one of the cheapest ways that people entertain themselves. In a time where money is tight, people will most definitely substitute more expensive dinners and going to the movies by staying at home and watching a rental from Blockbuster. They just need to make sure that they bring us the next best thing in home entertainment before NetFlix does.
From an article on CNNMoney.com, Blockbuster's spokesperson Karen Raskopf, said that they had hired a law firm called Kirkland & Ellis. Now this law firm is known to specialize in restructuring and bankruptcy and when Blockbuster made this announcement, their stocks fell 77% on the NYSE on Tuesday. Karen stated that Blockbuster simply hired Kirkland & Ellis to help with their ongoing finance and raising-capital initiative. From the NY Times, Karen added that they were not intending to file for Bankruptcy and they had also spoken to some investment banks regarding the restructuring of their credit line.
Jon makes a valid point when he says that Blockbuster has been struggling to keep up with online rivals such as NetFlix. This is where I see that Blockbuster needs to more innovative. Blockbuster had just signed a deal with CinemaNow that allows Blockbuster to stream movies over the internet. This is a step in the right direction, but Blockbuster had done this just to keep up with NetFlix who already had a similar service in place. Blockbuster now also face even more competition such as the big cable and satellite companies that allow you to order your movies on demand. In my opinion, Blockbuster should cut some of their expenses such as labor costs and property costs, which their competitors do not have. Blockbuster employs a staggering 8000 people worldwide compared to a mere 1200 employees working at NetFlix. I feel that it is time for Blockbuster to adjust their image and realize that in store rentals are a thing of the past.
Secondly, from another article in the NY Times, Blockbuster stated that their fourth quarter revenue fell by 12% and this was due to a decline in movie rentals, a smaller store base and negative foreign currency exchange rates. Even though it is hard to simply increase movie rental sales in the curent economy, Blockbuster could certainly take steps to hedge against their foreign currency risks. The way I see it Blockbuster needs to keep the cost of their risks to a minimum, or at least consistent and they can certainly do this through hedging contracts.
In conclusion, I feel that Blockbuster can certainly make it out of their current economic downturn through being a well managed and an innovative company. Home movies are still in high demand as it is one of the cheapest ways that people entertain themselves. In a time where money is tight, people will most definitely substitute more expensive dinners and going to the movies by staying at home and watching a rental from Blockbuster. They just need to make sure that they bring us the next best thing in home entertainment before NetFlix does.
Monday, March 23, 2009
JP Morgan's New Jets On HOLD
As I have now read over 10 or so blogs about the AIG bonuses and I thought that I would throw in my two cents as well. Even though there are numerous arguments that I have read now concerning both sides of the story, whether it was contractual agreements that forced bonuses to be payed out or whether it was filthy, greedy wall-street executives that are trying to milk every last cent of the taxpayers' money. Everyone is outraged! Even to that point where employees of AIG are being threatened and the CEO of AIG, Liddy is refusing to give out the names of the employees (watch the details).
I feel that what this big mess basically comes down to proper management and social/moral responsibility. I found an interesting article in the New York Times, titled: "JPMorgan to repay TARP money before buying jets". JPMorgan had planned on buying two new Gulfstream 650 airplanes and renovating their hangar to house these new planes at a cost of $138 million. In light of recent events JPMorgan had decided to put these purchases on hold and to concentrate on repaying $25 billion that they had received from TIPS (Troubled Asset Relief Program). Similarly CitiGroup had also put their plane orders on hold. Even though the CEO of JPMorgan considers these expenses as "the cost of doing business" projects like renovating a plane hangar with "quarry tile" are still very fancy, luxurious and unnecessary expenses.
At least JPMorgan had done (which I would consider) as the right thing to do by deferring these unneccesarry expenses, both from a management stand point and a moral stand point. Anyone could easily compare this situation to their personal finances; you can spend your paycheck on your bills and credit card debt or you can just ignore your important expenses and go on big shopping spree and blow your entire paycheck.
In conclusion, AIG should have done the same. Re-write employee contracts and sort out bad management and concentrate and getting the company back on its feet, rather than spending money that is not theirs on lavish bonuses.
I feel that what this big mess basically comes down to proper management and social/moral responsibility. I found an interesting article in the New York Times, titled: "JPMorgan to repay TARP money before buying jets". JPMorgan had planned on buying two new Gulfstream 650 airplanes and renovating their hangar to house these new planes at a cost of $138 million. In light of recent events JPMorgan had decided to put these purchases on hold and to concentrate on repaying $25 billion that they had received from TIPS (Troubled Asset Relief Program). Similarly CitiGroup had also put their plane orders on hold. Even though the CEO of JPMorgan considers these expenses as "the cost of doing business" projects like renovating a plane hangar with "quarry tile" are still very fancy, luxurious and unnecessary expenses.
At least JPMorgan had done (which I would consider) as the right thing to do by deferring these unneccesarry expenses, both from a management stand point and a moral stand point. Anyone could easily compare this situation to their personal finances; you can spend your paycheck on your bills and credit card debt or you can just ignore your important expenses and go on big shopping spree and blow your entire paycheck.
In conclusion, AIG should have done the same. Re-write employee contracts and sort out bad management and concentrate and getting the company back on its feet, rather than spending money that is not theirs on lavish bonuses.
Monday, March 16, 2009
Palm Pre
Since I am a bit of a gadget geek, Jon's post on the new Palm Pre caught my interest. Jon basically explained that the new Palm will not be able pull the company out of the whole that they have been in over the last decade, without using some contracts to hedge against their risks.
I agree with Jon that the new phone will not be able to rescue the company by itself, but I found a few articles that would suggest that Palm could revive their current economic status through proper risk management decisions.
Palm was the blackberry about a decade ago and there are still plenty of loyal Palm followers out there. Thus this is the first point; in several lectures we have discussed the importance of a company's reputation to its sales and customer loyalty. An example of this is the iPhone. The success of the release of the iPhone relied heavily on the previous success of iPods and the reliability of Apple's handheld devices. Everyone knows that palm devices were cutting edge and reliable when they first came out and everyone had to have one. Thus I feel the new Palm Pre will be a success as it is riding on that reputation that Palm had created over a decade ago.
The next important factor is proper management. The crucial factor with the Pre is the timing of the release of the phone. McNamee, who is a major investor stated in an interview that people always want to buy the coolest new thing. That was the case with the iPhone. Now, two years later after the release of the iPhone, people are going to want to buy the latest gadget after their cell phone contracts have expired. Thus the Pre is going to be released at the optimum time for it to have the greatest chance of succeeding.
Lastly, I found another article on unwiredview.com that does not take a risk management view on this situation, but more from a perspective of economics. The basic law of supply and demand states that if the supply of a product is limited, demand for that product will go up, and thus the price of the product will rise. Palm is planning to limit their supply to only 200 000 units of the Pre. This limitation will increase demand for the Pre, but even though the prices are fixed with signing cell phone contracts, this increase in demand might be a strong enough incentive for people to switch from their curent cell phone contracts and pay the high cancellation fees.
So hopefully through proper risk management decisions and a bit of good luck we can see the Pre make Palm great again and save them from their 6 straight quarter lossess of over $650 million.
I agree with Jon that the new phone will not be able to rescue the company by itself, but I found a few articles that would suggest that Palm could revive their current economic status through proper risk management decisions.
Palm was the blackberry about a decade ago and there are still plenty of loyal Palm followers out there. Thus this is the first point; in several lectures we have discussed the importance of a company's reputation to its sales and customer loyalty. An example of this is the iPhone. The success of the release of the iPhone relied heavily on the previous success of iPods and the reliability of Apple's handheld devices. Everyone knows that palm devices were cutting edge and reliable when they first came out and everyone had to have one. Thus I feel the new Palm Pre will be a success as it is riding on that reputation that Palm had created over a decade ago.
The next important factor is proper management. The crucial factor with the Pre is the timing of the release of the phone. McNamee, who is a major investor stated in an interview that people always want to buy the coolest new thing. That was the case with the iPhone. Now, two years later after the release of the iPhone, people are going to want to buy the latest gadget after their cell phone contracts have expired. Thus the Pre is going to be released at the optimum time for it to have the greatest chance of succeeding.
Lastly, I found another article on unwiredview.com that does not take a risk management view on this situation, but more from a perspective of economics. The basic law of supply and demand states that if the supply of a product is limited, demand for that product will go up, and thus the price of the product will rise. Palm is planning to limit their supply to only 200 000 units of the Pre. This limitation will increase demand for the Pre, but even though the prices are fixed with signing cell phone contracts, this increase in demand might be a strong enough incentive for people to switch from their curent cell phone contracts and pay the high cancellation fees.
So hopefully through proper risk management decisions and a bit of good luck we can see the Pre make Palm great again and save them from their 6 straight quarter lossess of over $650 million.
Ski Resort Risk Management
I went skiing over spring break and when I was on the Ski lift, I kept looking up at the thin cable holding over a hundred people, so I started thinking about what could go wrong and what risk management techniques ski resorts have in place. I found an interesting article written by a lawyer and he discusses several risk management steps that a ski resort can take with ski lift operations so that they can have a better chance of winning cases if they get sued.
The simplest step that a ski resort can do is post up clear signs that warns skiers of the potential injuries or death that can occur when they go skiing. Ski resorts should also make guests sign clear waiver that also states the risk that is involved in skiing. This is the most effective and important factor that can protect ski resorts in legal cases. Additional signs that provide instructions to skiers around the ski lift is also necessary. Other signs on the ski slope, like "slow" signs will also reduce the risks of accidents.
Another important risk management technique is the proper training of the ski lift operators. If ski lift operators can give proper instructions to skiers, they can reduce incidents caused by a lack of employee training. In addition ski resorts should also place visible fences on the edges of the trails and also pads on the ski lift towers.
Lastly, ski resorts should keep good records of all accidents that take place. This includes records like photography, witness accounts and employees that worked at the time of the accident. If a ski resort is being investigated in a legal case, it has the best chance of defending itself if they have all the evidence of the risk management techniques that they have in place.
www.halleland.com/pdf/RiskMgmt_SkiLift.pdf
The simplest step that a ski resort can do is post up clear signs that warns skiers of the potential injuries or death that can occur when they go skiing. Ski resorts should also make guests sign clear waiver that also states the risk that is involved in skiing. This is the most effective and important factor that can protect ski resorts in legal cases. Additional signs that provide instructions to skiers around the ski lift is also necessary. Other signs on the ski slope, like "slow" signs will also reduce the risks of accidents.
Another important risk management technique is the proper training of the ski lift operators. If ski lift operators can give proper instructions to skiers, they can reduce incidents caused by a lack of employee training. In addition ski resorts should also place visible fences on the edges of the trails and also pads on the ski lift towers.
Lastly, ski resorts should keep good records of all accidents that take place. This includes records like photography, witness accounts and employees that worked at the time of the accident. If a ski resort is being investigated in a legal case, it has the best chance of defending itself if they have all the evidence of the risk management techniques that they have in place.
www.halleland.com/pdf/RiskMgmt_SkiLift.pdf
Monday, February 23, 2009
Homework From Slides
New expected revenue = 106, Cost of capital = 0.05, 99% confidence level CaR (z=2.326). Should the pharmaceutical company invest in the new drug?
Calculate CaR with 99% confidence:
Calculate CaR with 99% confidence:
- 2.326*20=46.52 (new)
- 2.326*25=58.15 (current)
- 2.326*35= 81.41 for combined(calculated by finding the variance of the cash flows, taking the square root and then multiplying by Z=2.326)
- New drug=106/(1.05)-100=0.9524
- 106/1.05-100-.11*(change in CaR from old to new) = 106/1.05-100-.11*(81.41-58.15)=-1.6062
9 Commandments of Risk Mangement
I, let's just say stumbled upon an interesting article explaining the 9 rules of risk management developed by the RiskMetrics group. I was excited at first as the author of the article suggested that these simple rules are the only guidelines a risk manager needs to make confident risk management decisions. Before I started reading the 9 rules I was excited to find out that I would know everything that there is to know regarding risk management in a matter of minutes...
Oh, but I was wrong! I started reading the 9 rules and it reminded me of the 10 commandments of the bible. Short sentences that tells us what to do even though we all know it already. For example, the first rule says:"There is no return without risk", the 8th rule says:"Use common sense". The entire list of rules are common sense and also all the material we covered in the first five minutes of our first lecture. There is no way that this article is all that I would personally need to be a successful risk manager. Sorry, try again RiskMetrics.
Oh, but I was wrong! I started reading the 9 rules and it reminded me of the 10 commandments of the bible. Short sentences that tells us what to do even though we all know it already. For example, the first rule says:"There is no return without risk", the 8th rule says:"Use common sense". The entire list of rules are common sense and also all the material we covered in the first five minutes of our first lecture. There is no way that this article is all that I would personally need to be a successful risk manager. Sorry, try again RiskMetrics.
Supply Chain Risk Management Strategy
Many of us always look at ways to reduce the costs of risk in our firms or companies, but we never think about our suppliers. Come to think of it, you can make use of all the risk management strategies out on the market and reduce you risk cost to zero, however this could be essentially worthless if you have no supplier to supply you with products to sell and make some sort of profit. Many of us might think that it would be absolutely useless to implement some sort of supply chain risk management strategy, but think about it in this manner: What would happen if not your own office building burns down, but your supplier's office building burns down? Your supplier would not be able to supply you with your good thus you would not be able to sell it and run a profitable business. So supply chain management will ultimately affect you in one way or another. For example when China was hit by that huge earthquake last year, it affected many US companies that received their supplies from that part of China.
I found a video on youtube.com that discusses supply chain risk management. Supply chain risk management has become an increasing factor in many business strategies due to some of the changes involved in supply chains over the last few years. Supply chains are moving towards reducing inventory size which in turn reduces the buffer size that suppliers have in case something goes wrong. Also global sourcing is happening at a rapid pace, where we are no longer buying things from around the corner, but we are buying from all over the place, especially from outside the country. Companies also have a much larger supply base now and many different suppliers all of which require better and more efficient communicating skills. Lastly, a business' customers have greater demands for variability in products, so if you do not have the product that they want, they will go somewhere else to get it, thus you supply chain management is key.
This is where supply chain management kicks in. First and foremost companies need asses the risk associated with their supply chains. Tools to achieve this are described in detail in the video. Secondly the company needs to develop risk mitigation strategies for foreseeable risks, but these take time, effort and are expensive. The most important part of these strategies is a plan of how to respond as quickly as possible if an unlikely event was to occur and to minimize the cost of this event. This involves creating models to simulate what would happen in the case of an unlikely event happening.
I found a video on youtube.com that discusses supply chain risk management. Supply chain risk management has become an increasing factor in many business strategies due to some of the changes involved in supply chains over the last few years. Supply chains are moving towards reducing inventory size which in turn reduces the buffer size that suppliers have in case something goes wrong. Also global sourcing is happening at a rapid pace, where we are no longer buying things from around the corner, but we are buying from all over the place, especially from outside the country. Companies also have a much larger supply base now and many different suppliers all of which require better and more efficient communicating skills. Lastly, a business' customers have greater demands for variability in products, so if you do not have the product that they want, they will go somewhere else to get it, thus you supply chain management is key.
This is where supply chain management kicks in. First and foremost companies need asses the risk associated with their supply chains. Tools to achieve this are described in detail in the video. Secondly the company needs to develop risk mitigation strategies for foreseeable risks, but these take time, effort and are expensive. The most important part of these strategies is a plan of how to respond as quickly as possible if an unlikely event was to occur and to minimize the cost of this event. This involves creating models to simulate what would happen in the case of an unlikely event happening.
Monday, February 16, 2009
A Risk-Averse Generation
Many people are now asking what they should invest in or if they should invest at all during this economic recession? I found an interesting article in the New York Times, that comments on how the generation of investors in their 20's and 30's are becoming risk-averse or "shy investors" investing only in low risk, low return investments. People have always been taught to have a well-diversified portfolio and then you will have high, consistent returns, but due to the recent meltdown, many investors houses' equities and investment portfolios have gone down and their college degrees are not protecting them from unemployment. Also the possibility of unemployment and inconsistent cash flows makes risky investments less desirable. People are now considering less risky investments even though it means a lower return and a smaller retirement RV.
I think people should should still invest, but they should make wise decisions when doing so. Firstly, people should pay off high interest debt such as credit card debt and student loans, which in turn will free up some money for investments. Secondly, they should consider the reliability of the employment, such as a tenured professor has great job security and could invest more in equities. However, someone working in the stock market has less job security and should consider less risky investments. Whatever you decide to invest in, make sure you invest in something below your limit, something that you can easily afford.
Invest wisely...
I think people should should still invest, but they should make wise decisions when doing so. Firstly, people should pay off high interest debt such as credit card debt and student loans, which in turn will free up some money for investments. Secondly, they should consider the reliability of the employment, such as a tenured professor has great job security and could invest more in equities. However, someone working in the stock market has less job security and should consider less risky investments. Whatever you decide to invest in, make sure you invest in something below your limit, something that you can easily afford.
Invest wisely...
Should VaR be thrown in the trash can?
No it should not. Event though the VaR model is based on a normal distribution and can only predict losses 99% of the time, it does not take into account that 1% that could be a fat tail on the distribution model that represents huge losses. Some blame the financial meltdown on these risk management tools and they say that they should be abandoned. Just because the financial meltdown occurred in that 1% of unknown risk, it does not mean that we cannot use this in the 99% of the other (normal) financial times. The financial meltdown did not happen because these risk management tools failed, but more because of a lack of proper management and Wall Street greed. Value at Risk models are far from perfect and they need to be adjusted from only taking past statistics into account to predict future risk, but they cannot simply be discarded, they just need to be refined to consider that 1% fat tail.
http://www.nytimes.com/2009/01/18/magazine/18letters-t-.html?scp=3&sq=value%20at%20risk&st=cse
http://www.nytimes.com/2009/01/18/magazine/18letters-t-.html?scp=3&sq=value%20at%20risk&st=cse
Salmonella in your peanut butter
Since we have had so many discussions of how important reputations are to a company's success, I decided to investigate how a company like Peter Pan Peanut Butter could have used help from Government authorities that use proper risk management to handle situation like this.
The USDA, FDA and CDC started a risk assessment model in response to over 600 000 illnesses per year in the US from contaminated Salmonella eggs. From this risk assessment, they produced a farm-to-table model that could determine the effects of an intervention of an illness. This risk assessment process consists of 4 steps: The first step is to collect and organize all the information of the pathogen or nutrient. Secondly, determine the relationship between the pathogen and any harmful effects. Thirdly, is to determine how the pathogen may spread throughout the population. Lastly, is risk characterization which is just evaluating the risk involved.
Now the questions is, if Peter Pan makes use of these strategies; is it too late? Should Peter Pan rely on the government to fix their mishaps and make it public news or should they implement their own risk management program to prevent this mishap from happening from the start?
I believe that this farm should make use of their own risk management strategies for example, some farmers in the UK have taken out insurance contracts that covers their losses of flocks of birds that are slaughtered since they tested positive for Salmonella.
Nutrition, Food Safety, And Risk Assessment
The USDA, FDA and CDC started a risk assessment model in response to over 600 000 illnesses per year in the US from contaminated Salmonella eggs. From this risk assessment, they produced a farm-to-table model that could determine the effects of an intervention of an illness. This risk assessment process consists of 4 steps: The first step is to collect and organize all the information of the pathogen or nutrient. Secondly, determine the relationship between the pathogen and any harmful effects. Thirdly, is to determine how the pathogen may spread throughout the population. Lastly, is risk characterization which is just evaluating the risk involved.
Now the questions is, if Peter Pan makes use of these strategies; is it too late? Should Peter Pan rely on the government to fix their mishaps and make it public news or should they implement their own risk management program to prevent this mishap from happening from the start?
I believe that this farm should make use of their own risk management strategies for example, some farmers in the UK have taken out insurance contracts that covers their losses of flocks of birds that are slaughtered since they tested positive for Salmonella.
Nutrition, Food Safety, And Risk Assessment
Sunday, February 1, 2009
Wall Street lied to their computers
I found another article on the NY times that is in slight contrast to my last post. This article entitled, "How Wall Street lied to their computers" discusses a different opinion to that of the previous one entitled, "Risk Mismanagement". In this article, the writer states that the risk management models that were in place were actually functioning correctly and that they were giving top executives strong warning signs about the mortgage-backed loans, yet they still chose to be greedy and took on huge bets/risks even though they were advised against it. This is a big contrast to what the Risk Mismanagement article claimed that these risk models were faulty. I would also disagree with the Risk Mismanagement article as I showed in my previous post how Goldman Sachs top executives used their risk management models wisely to avoid the financial meltdown.
Wall Street executives supplied their risk models with over simplified data. This caused the risk models not to consider hard financial times and thus the warning signs were not as strong as it should have been with the correct data. The executives provided data to their risk models of the last few years when the market was reasonably stable, instead of providing them with up to date data so that they could show the proper results. Executives did this as they were required by regulators to monitor their risk positions and thus adjust their their bets or set aside more capital to cover the extra risk that is being taken on. By lying to their risk management models, these executives could bypass the regulators and their risk models and invest in the failing mortgage securities, even though all the warning signs were there not to invest.
Wall Street executives supplied their risk models with over simplified data. This caused the risk models not to consider hard financial times and thus the warning signs were not as strong as it should have been with the correct data. The executives provided data to their risk models of the last few years when the market was reasonably stable, instead of providing them with up to date data so that they could show the proper results. Executives did this as they were required by regulators to monitor their risk positions and thus adjust their their bets or set aside more capital to cover the extra risk that is being taken on. By lying to their risk management models, these executives could bypass the regulators and their risk models and invest in the failing mortgage securities, even though all the warning signs were there not to invest.
Saturday, January 31, 2009
Risk Management saved Goldman Sachs
Goldman Sachs had used proper risk management tools and good business sense to good use to avoid the financial crisis suffered by most of wall street such as Bear Stearns, Merrill Lynch and Lehman Brothers. According the the NY times article, managers at Goldman used risk management tools such as the VaR and the L&P to make the proper decisions to get rid of or hedge against mortgage-backed securities, thus saving them from the current financial crisis.
VaR is a Value at Risk model, developed by statistitions at JPMorgan and it is by far the most commonly used model to evaluate the boundaries of risk over a short duration in a normal market. VaR became so popular beacuase it could be used as a risk measure in any class of asset and it also takes into account many variables such as diversification, leverage and volatility. Since the big financial meltdown, Wall street started asking questions about the reliability of the VaR model and the fact that it did not take into account what would happen in the event of a financial meltdown. Several prominent risk managers stated that the VaR model is a useless measure and that it creates a false sense of security for the companies.
Goldman Sachs, however, used more than just the VaR model to evaluate the risk in their portfolio. CFO of Goldman Sachs, David Vinair says that they check their Profit and Loss (P&L) model on a daily basis to make sure that it is consistent with their risk models. In December 2006, Goldman's mortgage business had lost money for ten straight days and all the top managers sat down for a meeting with their risk managers as they looked over all their trading positions in the firm. During the meeting they looked over their VaR numbers and other risk management models and made the final decision to get rid of most of their mortgage-backed securities and hedged the rest of them.
Some argue that firms should have payed closer attention to their risk models and then maybe the meltdown could have been avoided and others argue again that it is the fault of models such as the VaR model that gave firms the false security and that these models were responsible for the entire meltdown. I feel that firms should not soley rely on one risk model, but have a few in place so that managers can be informed and ultimately make the correct decision as is in the case of Goldman Sachs.
VaR is a Value at Risk model, developed by statistitions at JPMorgan and it is by far the most commonly used model to evaluate the boundaries of risk over a short duration in a normal market. VaR became so popular beacuase it could be used as a risk measure in any class of asset and it also takes into account many variables such as diversification, leverage and volatility. Since the big financial meltdown, Wall street started asking questions about the reliability of the VaR model and the fact that it did not take into account what would happen in the event of a financial meltdown. Several prominent risk managers stated that the VaR model is a useless measure and that it creates a false sense of security for the companies.
Goldman Sachs, however, used more than just the VaR model to evaluate the risk in their portfolio. CFO of Goldman Sachs, David Vinair says that they check their Profit and Loss (P&L) model on a daily basis to make sure that it is consistent with their risk models. In December 2006, Goldman's mortgage business had lost money for ten straight days and all the top managers sat down for a meeting with their risk managers as they looked over all their trading positions in the firm. During the meeting they looked over their VaR numbers and other risk management models and made the final decision to get rid of most of their mortgage-backed securities and hedged the rest of them.
Some argue that firms should have payed closer attention to their risk models and then maybe the meltdown could have been avoided and others argue again that it is the fault of models such as the VaR model that gave firms the false security and that these models were responsible for the entire meltdown. I feel that firms should not soley rely on one risk model, but have a few in place so that managers can be informed and ultimately make the correct decision as is in the case of Goldman Sachs.
American Barrick
Since the case that we did on American Barrick was several years old, I did some research to find out whether their risk management policies have changed in the last couple of years. I found a few interesting articles in the NY times and I saw that they have changed quite dramatically. According to an article in the NY times, Barrick had suffered severe first quarter losses due to the company exiting hedge funds to take advandtage of the strong gold spot prices. Barrick was charged $557 million when they exited their hedge funds. By doing this, Barrick earnings were $398 million compared to the previous year of $263 million. Barrick said that they have completely eliminated their hedge book.
Barrick has always been very firm with their risk management plocies, but I agree with the recent changes that they have made. I looked at the gold price index over the last decade on goldprice.org and since January, 2001 where gold was trading at $260 an ounce, and it has been steadily increasing since then. Over the last 3 years gold prices have shot up from $450 an ounce in the beginning of 2006 up to $926 an ounce where it is today. The managers at Barrick had taken full advantage of this opportunity. If you take a look at Barrick's stock price chart on NY times, you will notice that its curve is very similar to that of the gold price chart.
I believe that Barrick should continue doing this until the market recovers and people stop buying gold as a fear of the weakeing dollar. Once the market recover, they should start hedging again to reduce the risk of gold price volatility.
Barrick has always been very firm with their risk management plocies, but I agree with the recent changes that they have made. I looked at the gold price index over the last decade on goldprice.org and since January, 2001 where gold was trading at $260 an ounce, and it has been steadily increasing since then. Over the last 3 years gold prices have shot up from $450 an ounce in the beginning of 2006 up to $926 an ounce where it is today. The managers at Barrick had taken full advantage of this opportunity. If you take a look at Barrick's stock price chart on NY times, you will notice that its curve is very similar to that of the gold price chart.
I believe that Barrick should continue doing this until the market recovers and people stop buying gold as a fear of the weakeing dollar. Once the market recover, they should start hedging again to reduce the risk of gold price volatility.
Monday, January 26, 2009
Forwards, Futures, Swaps and Options
I would like to continue with my last post about Derivatives and go into a little further detail about the main types of Derivatives and also explain how they relate to Risk Management.
A forward contract is a contractual agreement between two different parties. One of these parties agrees to buy a certain asset at a predetermined price and the other party agrees to deliver this asset at the same predetermined price. Both parties are required to honor this contract and there are no exceptions to this. Terms of the contract can be personalized since it is negotiated directly between two parties, however there is also a higher risk that one of the firms may default on their payments. I found a good example on Global Financial Management where a wheat farmer uses a forward contract to guarantee that he can sell 5000 bushels of wheat in 5 months time at 550 cents per bushel. This farmer is using proper risk management techniques from the start to guarantee that in the case of the market price for wheat drops dramatically for any reason, he will not be affected by it. This can however not work out since the farmer might have a terrible crop this season, and he will not be able to produce 5000 bushels of wheat to the buyer, thus defaulting on his contract.
A future contract is essentially the same as a forward contract, except it is exchanged in a formal, regulated exchange instead of directly between two parties. There are a few differences between the two, such as that future contracts guarantee against default, they are standardized and they are settled on a daily basis.
A swap contract is once again an agreement between two parties that to swap payments on regular future dates. Swaps are over the counter (OTC) derivatives that are just like forward contracts that have a risk that one side could default on their commitments. Swaps are generally used to hedge against risks created by volatile interest rates, currency exchange rates, commodity prices and share prices. Usually companies that borrow from banks with variable interest rates may reduce the cost of risk by entering into a swap to fix their cost of funding.
There are two types of options; call options and put options. A call option gives the owner the right to buy a certain underlying asset at a date and a fixed date, where as a put option gives the owner the right to sell the underlying asset at a certain date and a fixed price. Options are also an OTC derivative and is usually traded between a specialized dealer or in an organized exchange market, thus a premium needs to be paid by the buyer of the option as it provides so much flexibility.
A forward contract is a contractual agreement between two different parties. One of these parties agrees to buy a certain asset at a predetermined price and the other party agrees to deliver this asset at the same predetermined price. Both parties are required to honor this contract and there are no exceptions to this. Terms of the contract can be personalized since it is negotiated directly between two parties, however there is also a higher risk that one of the firms may default on their payments. I found a good example on Global Financial Management where a wheat farmer uses a forward contract to guarantee that he can sell 5000 bushels of wheat in 5 months time at 550 cents per bushel. This farmer is using proper risk management techniques from the start to guarantee that in the case of the market price for wheat drops dramatically for any reason, he will not be affected by it. This can however not work out since the farmer might have a terrible crop this season, and he will not be able to produce 5000 bushels of wheat to the buyer, thus defaulting on his contract.
A future contract is essentially the same as a forward contract, except it is exchanged in a formal, regulated exchange instead of directly between two parties. There are a few differences between the two, such as that future contracts guarantee against default, they are standardized and they are settled on a daily basis.
A swap contract is once again an agreement between two parties that to swap payments on regular future dates. Swaps are over the counter (OTC) derivatives that are just like forward contracts that have a risk that one side could default on their commitments. Swaps are generally used to hedge against risks created by volatile interest rates, currency exchange rates, commodity prices and share prices. Usually companies that borrow from banks with variable interest rates may reduce the cost of risk by entering into a swap to fix their cost of funding.
There are two types of options; call options and put options. A call option gives the owner the right to buy a certain underlying asset at a date and a fixed date, where as a put option gives the owner the right to sell the underlying asset at a certain date and a fixed price. Options are also an OTC derivative and is usually traded between a specialized dealer or in an organized exchange market, thus a premium needs to be paid by the buyer of the option as it provides so much flexibility.
Sunday, January 25, 2009
ERM Improves Business Performance
Enterprise risk management (ERM) is the process of planning, organizing, leading, and controlling the activities of an organization in order to minimize the effects of risk on an organization's capital and earnings. Enterprise risk management expands the process to include not just risks associated with accidental losses, but also financial, strategic, operational, and other risks.- SearchCIO.com
According to a post by Steven Minsky, founder and CEO of LogicManager, Inc, he has developed the RIMS Risk Maturity Model, which could be used by risk managers to meet the requirements of their company's ERM programs. Steven had assessed data over the last 14 months using this model to assess the ERM programs of 564 companies.
This study had four major findings, but I would like to highlight the first one; 93% of companies with an ERM program, make better risk management decisions than those without it. This model proves that when ERM programs are implemented properly according to the ERM guidelines, it could lower costs of capital and also improves business performance.
According to a post by Steven Minsky, founder and CEO of LogicManager, Inc, he has developed the RIMS Risk Maturity Model, which could be used by risk managers to meet the requirements of their company's ERM programs. Steven had assessed data over the last 14 months using this model to assess the ERM programs of 564 companies.
This study had four major findings, but I would like to highlight the first one; 93% of companies with an ERM program, make better risk management decisions than those without it. This model proves that when ERM programs are implemented properly according to the ERM guidelines, it could lower costs of capital and also improves business performance.
Derivatives Explained
So I was slightly confused on the first day of class when we discussed all the different financial contracts especially when it came to derivatives, so I decided to read up on it and try to understand it:
The Wikipedia defines derivatives as: Derivatives are financial contracts, or financial instruments, whose values are derived from the value of something else (known as the underlying). The underlying on which a derivative is based can be an asset (e.g., commodities, equities (stocks), residential mortgages, commercial real estate, loans, bonds), an index (e.g., interest rates, exchange rates, stock market indices, consumer price index (CPI) — see inflation derivatives), or other items (e.g., weather conditions, or other derivatives).
There are three main types of derivatives, known as forwards or futures, options and swaps. Derivatives are used mainly in two ways, called hedging and speculation. During Hedging, these derivatives are used to reduce the risk of loss when the value of these underlying assets change. During Speculation, these derivatives may be used by investors to increase their profits if the value of the underlying assets change the way that they expected.
I found a good example on usafutures.com that shows a great example of how a soybean farmer uses future contracts to hedge against falling crop prices to reduce the risk of his economic loss.
According to the Washington Post, Pres. Obama sent out a proposal in June 2008 to reduce the speculation in the energy market. This proposal will attempt to increase federal oversight in these markets and also prohibit international trading in unregulated futures markets. As a result, soaring oil prices may be stabilized . It seems that if speculation is not regulated it can be used in a negative and unethical way. In contrast to this, several airline companies use hedging in oil prices to reduce their daily running costs.
Hope this helps, made things a little clearer for me...
The Wikipedia defines derivatives as: Derivatives are financial contracts, or financial instruments, whose values are derived from the value of something else (known as the underlying). The underlying on which a derivative is based can be an asset (e.g., commodities, equities (stocks), residential mortgages, commercial real estate, loans, bonds), an index (e.g., interest rates, exchange rates, stock market indices, consumer price index (CPI) — see inflation derivatives), or other items (e.g., weather conditions, or other derivatives).
There are three main types of derivatives, known as forwards or futures, options and swaps. Derivatives are used mainly in two ways, called hedging and speculation. During Hedging, these derivatives are used to reduce the risk of loss when the value of these underlying assets change. During Speculation, these derivatives may be used by investors to increase their profits if the value of the underlying assets change the way that they expected.
I found a good example on usafutures.com that shows a great example of how a soybean farmer uses future contracts to hedge against falling crop prices to reduce the risk of his economic loss.
According to the Washington Post, Pres. Obama sent out a proposal in June 2008 to reduce the speculation in the energy market. This proposal will attempt to increase federal oversight in these markets and also prohibit international trading in unregulated futures markets. As a result, soaring oil prices may be stabilized . It seems that if speculation is not regulated it can be used in a negative and unethical way. In contrast to this, several airline companies use hedging in oil prices to reduce their daily running costs.
Hope this helps, made things a little clearer for me...
Wednesday, January 14, 2009
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