Archive for the ‘Japanese Course’ Category
Japanese Yen – a Negative Beta Indicator
Japanese Yen – a Negative Beta Indicator
Sunday, October 26, 2008
By Adam Perl
The markets experienced another action-packed week as continuous worries about the economic situation sent the major indices plummeting across the globe. Even though the intensity began to pick up during the week due to various economic data and comments from ex-Fed chairman – Alan Greenspan, most of the volatility was felt towards the end of the week as the Asian markets yet again pushed the “sell-off” button, causing global indices to perish. The U.S market gapped down on Friday following the opening bell by over 5%. In addition to all the anxiety in the market, earnings of various leading companies fell short of their estimates, dropping like bricks. Gold, once classed as a safe haven during economic problems, continued its path down last week touching a low of $681 per ounce before retracing back part of its losses. To date, after extensive monetary actions the low yielding Dollar has become the new “safe-haven”. Even though interest rates of other economies are still yielding much higher interest than the U.S’s 1.5% fund rate, expectations of further rate cuts among deteriorating economies like the U.K is sending money back into the U.S Dollar. The Greenback continued to rise last week against most of its counterparts, excluding the Japanese Yen. The Dollar index bounced higher throughout the week and is now trading at 86.42 points. When analyzing the charts one can see that the lowest yielding currency pair, the Japanese Yen, yielding only 0.5% is rallying against the U.S Dollar. Why would investors prefer a 0.5% return when they can receive higher interest on other currencies?
A Walk down history Lane
After World War II most of Japan’s economy was demolished, millions of citizens were jobless and the government’s main aim was to rebuild the economy back up from scratch. For years to come, Japan’s economy based itself on manufacturing, services, shipping, machine tools and exporting motor vehicles which seemed to be the economies main source of income. The irony is, that those same countries that demolished Japan’s economy, such as the U.S, helped reestablish it by becoming their prime consumers through exports.
Even though Japan’s economy faced many obstacles along the way: other growing economies that based their incomes on those same goods and rising oil prices that had peaked twice during the 70′s and 80′s, japans economy managed to stay afloat because of cheap labor and competitive costs.
In 1979 Japan entered a new field, production of semiconductor chips along with technology. Not knowing that the outcomes of this new era would lead to catastrophic results for years to come, the economy entered a period of rapid growth which affected it in two ways:
1) Rapid growth led Japan to be the second leading economy market in the world after the U.S
2) Mass uncontrolled growth led the markets into a bubble, waiting to be burst. Prices were extremely high and the stock market at that time had money flowing into it making stocks well over priced.
In 1989, after examining the economy along with other factors, the Bank of Japan (BOJ) decided to take control of the situation by using monetary tightening in order to calm the economy down. This move by the BOJ triggered a mass selloff and led it to a wide spread recession, which has been lingering on the economy until today.
The situation had become so bad that in order to encourage consumer consumption and growth the BOJ dropped its monetary interest rates to near zero, hoping to pull the economy out of this dire situation.
Low interest rates gave companies the opportunity to take loans with hardly any interest; but instead of encouraging growth, it had the opposite effect of putting fear into the population, who’d rather save their money in case of worse times to come, forcing the BOJ to maintain a low interest rate policy.
Carry trades
While Japanese companies were struggling, foreign companies were galloping forward as their economies expanded at a rapid pace. As global economies and major indices raced forward forcing central banks to raise their interest rates (to control inflation), the difference in interest rates between Japan’s rate of 0.5% and other economies high rates presented investors with excellent investing opportunities. It is a well know fact that hedge funds and large firms yield on average 11% per year. If that is the case, carry trades (selling a low yielding currency and buying a high yielding currency) presented those investors with excellent returns. At the peak of economic growth, last year, the New-Zealand Dollar was yielding 7.5%. Selling the Japanese Yen currency, or taking a loan from Japan at 0.5% and investing it in the New-Zealand Dollar, yielded on average a 7% yearly return (only if the New-Zealand Dollar would gain value over the years – which it did). Investment firms choosing this type of investment had 63% of their 11% covered – “Easy Money”.
Where things went wrong
Over the last year central banks have been forced to reduce their interest rates to stimulate the economy, due to the ongoing dire situation. The extreme interest rate reductions ( the U.S reduced their interest rates from 4.25% to 1.5%) has forced investors to bank returns on interest rate differentials, closing their positions, sending money back to the Japanese Yen. As global economies and indices dropped, the Yen has regained its strength, gaining against most of its counterparts.
Taking a glance at the comparison chart below, one can see the negative correlation between the Japanese Yen and the S&P500.
*courtesy of stockcharts.com
Japanese Yen – A negative beta indicator.
Over the last couple of weeks, many analysts have been talking about a situation where the U.S indices might have found a bottom. Even though the S&P is currently trading in a bearish triangle, Friday’s session presented an inverted hammer on the SPY (see dojit’s school for further information) closing the session around support. Monday’s session will be thoroughly observed as a break of support will lead the indices and carry trades much lower. Support around current levels could revive sentiment leading the indices to a slight correction.
As this market has become a headline driven market, meaning that the news is influencing the market’s current direction, one can only turn to significant indicators when analyzing today’s markets. Once panic dies down, indices will begin to gain strength on expectation of economic growth. The Yen will lose its value as counterparts will regain their strength on interest rate increases. The Yen will yet again continuing its negative correlation or as I call it -the negative beta indicator.
* Beta- A statistical measurement that compares the volatility of a security compared to the overall market. A reading greater than 1 indicates that the security is more volatile than the market. A reading less than 1 indicates that the security is less volatile than the market. For example, EBAY’s beta is 1.34 meaning that if the market moves up, the stock will exceed slightly higher than the market itself, percentage wise.
Technical Analysis
*courtesy of stockcharts.com
USD/JPY- Monthly Chart
*courtesy of netdania.com
GBP/JPY-Monthly Chart
*courtesy of netdania.com
AUD/JPY-Monthly Chart
*courtesy of netdania.com
NZD/JPY-Monthly Chart
*courtesy of netdania.com
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Information reliability and liability: The contents are solely aimed for the use of “Experienced” investors in the financial markets who are fully aware of the inherent risk of trading. I, “Adam Perl”, do not accept any liability for any loss or damage whatsoever that may directly or indirectly result from any advice, opinion, information, representation or omission, whether negligent or otherwise, contained in our trading recommendations. I make no warranties or representations in relation to the Information (including, without limitation, in relation to its accuracy or otherwise) and do not warrant or represent that the services will be error free or uninterrupted. Copyright: This article is subject to and protected by the international copyright laws. Use of the information brought in this article is subject to making fair use only in accordance with these laws. It is not permitted to copy, change, distribute, or make commercial use of the information except with permission of the holders of the copyright. Risk Disclosure: The risk of losses involved in the transaction or speculations in the financial markets can be considerable. Please think carefully whether such trading suits you, taking into consideration all the relevant circumstances as well as your personal resources. Speculate only with funds that you can afford to lose.
About the Author
Dojit website was built in a unique way, taking into consideration the end-user’s usability. From weekly reports to a “school” created for the purpose of self-education, the website offers all traders, experienced and novices, different services, allowing them to improve their market knowledge while giving them broader perspectives about the financial markets.
Best way to learn Japanese Language?
What do you guys think is the best way to learn japanese language? I’m going to try Rosetta Stone but I wanna make sure if it really does work.
The best way to learn Japanese is through a variety of methods. You need to work on your grammar, listening, speaking, reading and writing. Its best to think of these as separate categories and focus on each specific category as these require different methods and techniques.
Start by learning the basics through grammar. The best books I found for this were:
Shin Nihongo no Kiso I & II – The Shin Nihongo no Kiso series is great for studying grammar and the stuff that you will find on the Japanese Proficiency Exam.
A Course in Modern Japanese by The University of Nagoya Press – This helped me with basic Japanese and improved my Japanese level through the use of conversational Japanese.
Important Things To Consider In Chosing An Online Japanese Learning Program
Should you be getting the problems of determining concerning how to learn Japanese, why not make use of the beneficial resource that’s already proper in front of you? I realize you got it right, indeed the computer what else? It’s most likely one of the most successful signifies of understanding an additional language these days. You could possibly go to your research with ease at home, with your personal surrounding, could possibly be really accommodating to one’s hectic schedule. And not exclusively that, however you’ll also reap the knowledge as much as what you could possibly get attending non-public lessons. Learning Japanese isn’t that hard that most people think, it’s a myth that Japanese is more complicated than others, it contains grammar and language syntax as any other language would, the people who says that are just to scared to bark on to a new challenge.
All of the major target is on you, and this is greatest the best way to discover Japanese. Choosing to consider private classes the common would worth about $40 per hour, however, totally geared up language learning computer software plan would only price up to $100, plainly displaying that personal lessons would price considerably. With the Rocket Japanese Program for example, you will save up to $700 a Month!
But whenever you study your classes privately from your very own property, you might be also not alone.You have a huge quantity of help. How would that be? How can that be feasible? Together with the support of on-line discussion boards manufactured around in only a mouse’s click away, you’ll find numerous diverse pupils such as you who’re ready to info or help you in individuals places you don’t seem to be to know.
There are also a lot of other individuals at your exact same learning stage with whom you’ll be able to get enjoyment from chatting with in Japanese as far as you have discovered, although you discover far more from your interactive expertise. Just in case you are astonished concerning how to research Japanese, interactive methods would be the finest. Bear in mind, this Software offers is fundamentally modified with outfitted multimedia resources such as video clip exhibits that talk about about tradition and just how to find out Japanese writing characters, and in addition audio references as a basis for appropriate pronunciation. Japanese Culture has a big impact on the Japanese Language so studying that is also a critical aspect in mastering the Language. Moreover, in addition, it includes exams and quizzes, finding out video games, vocabulary word, grammar and conjugation charts, and producing sheets which can be wonderful for useful functions. it really is positively distinct that learning Japanese might be attained absolutely by way of software program system and with the use with the internet.
The positive side from the world wide web could be which you can generally uncover loads of supplies free of charge of cost and working out how you can converse Japanese is nonetheless 1 subject matter you may locate plenty of zero cost material about. Nonetheless, do additionally you obtain the exact same large quality studying from no cost courses? Free of charge Japanese Lessons in opposition to Compensated Japanese Lessons. Evaluating Free Japanese Lessons from Compensated Japanese Lessons. If only you are persevered to become taught then discovering required supplies you can quite possibly use for powerful studying on-line is simply at hand. Since it is free, you can genuinely discover rubbish ones more than the net but yow will uncover very good one also.
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About the Author
My Name is Charles and recently i’ve been working on a Review for A Japanese Language Program called “Rocket Japanese” where i skip all the hype and go to uncover it. This is one part of my “Research”.
Visit my website at: www.rocketjapanese.net
It’s Time to Take Your Japanese Lessons
At a time when the world is gung ho about the two Asian economic giants China and India what it feels stupid convincing someone to take lessons in Japanese. Makes sense if somebody tries to persuade you to learn Mandarin, Hindi or even English. Besides in the wake of recent Tsunami when leading economists are predicting recession in Japan which means businesses moving out of the country and lesser outsiders feeling the urge to learn the local language the chances seems bleaker. In an age where nothing can match the growing popularity of languages from China and India there has to enough reason presented to convince someone to learn Japanese. And yes despite the growing popularity of its neighbors Japan still holds its forte and so does its national language – Japanese.
Of the many reasons open to learning Japanese the pride of place gets taken by its people’s business acumen. One of the largest world economies and home to some of the most influential business establishments on the surface of this earth, Japan technological advancements are simply unbeatable. To conduct successful businesses with your Japanese makes the learning of Japanese language a paramount interest for economic visitors. Just think about the immense business opportunities opening their doors to you in an alien land just because you happen to know their language.
According to a survey after the English and Chinese internet users it’s the Japanese that use the internet most often. Just imagine the number of economic, social, cultural, and business opportunities you can stumble upon just because of the simple fact that you Japanese. Besides, the Japanese innovative zeal knows no bound. For the umpteen numbers of technological and economical advancements that the Japanese owe to the humanity at large it makes every sense to at least learn Japanese counterpart of what in English is called Thank You.
Equally vibrant is the Japanese culture. Japanese have most ardently preserved their cultural roots with greatest effort. They thoroughly deserve commendation and admiration for their efforts in enriching the international cinema, TV, theatre, karaoke or their manga comic books. This reflects their sharp acumen and skills to preserve their cultural identity. Besides Japan is a land of tremendously exceptional cultural and historical past. If you ever want to understand that then it is needless to state that a thorough knowledge of Japanese is a must too.
You might disagree with whatever I am about to write but believe it or not your knowledge of Japanese might set you apart from the crowd. Just think of the entire world clamoring to learn to Spanish, Arabic, Mandarin, German, English and even the native language of Timbuktu and then we have one in several thousands taking pride in having learnt Japanese. Also Japanese make great tourists they are absolute globe trotters. It helps to be guide fluent in Japanese suddenly bouncing into one on a Caribbean beach.
Last but not the least with its highest literacy rate in the world Japan has some terrific universities to seek education from. People from across the world flock onto the Japanese shores to seek good quality education and nobody knows better than them just how vitally important and useful it is to come ready with your Japanese lessons.
About the Author
Check for more methods how to learn Japanese with Rocket Japanese review
Palm Springs San Diego Orange County California Food Poisoning Attorney Sebastian Gibson Discusses the New Country of Origin Labeling Law (cool}
Until now, consumers who suffered food poisoning and the investigators looking for the cause, had no idea from which country the food that was eaten came from. With the new COOL (Country of Origin Labeling) law taking effect after September 30, 2008, all that will change, with a few exceptions.
Now when you get food poisoning, whether it is from food you bought at a grocery in San Diego, California, Orange County, CA, Los Angeles, Santa Barbara, Anaheim, Buena Park, Palm Springs, Temecula, Indian Wells, La Quinta or a restaurant in Ventura, Carlsbad, Oceanside, San Clemente, San Juan Capistrano, Newport Beach, Huntington Beach, Irvine, Santa Ana, Costa Mesa, Yorba Linda, Fullerton, Ontario, Rancho Cucamonga, Riverside, San Bernardino, Temecula, or Palm Desert, when the Department of Health investigates what made you sick, they may be able to determine this more accurately and without causing major economic damage to agricultural interests not at fault.
After years of lobbying for delays by grocery lobbying groups who argued the law would be too costly to implement, and who lobbied for delays, COOL has at last taken effect.
Now investigators will have an easier time tracking down the country of source. As it has often been raw food, such as peppers from Mexico most recently, the effect of the law will immediately help investigators. Health conscious consumers may feel more loyalty to a retailer who doesn’t just comply grudgingly with the law but who touts their going an extra step or two to let their shoppers know exactly what came from where.
Other food poisoning outbreaks in recent years have involved spinach, and beef. Now with the milk scare from China, there are calls to extend the law to dairy products.
There are also exceptions in COOL for butchers, fish markets, restaurants, restaurants in hotels, school cafeterias, and small retailers. Additionally if spices, sauce or breading has been added, no labeling is required. Though not exactly food, the law also does not apply to pharmaceuticals, though there are calls to extend the law to them. Produce mixed in displays may simply be labeled as being “from two or more countries of origin.”
Lawmakers and consumer groups are angry that the USDA seems to be attempting to evade congressional intent by allowing steaks and other meat cuts to be labeled with multiple country of origin labels. Congress only intended that exception for ground beef or for animals raised in more than one country. It has been said that there is a chasm of difference between the statutory language that was passed by Congress and the rule allowing multiple of country origin labels drafted by the USDA.
There are other discrepancies with how the law will be applied. Fish caught off the coast of Alaska by a Chinese or Japanese owned ship may be labeled as a product of China or Japan. Beef raised in another country that spends 30 days in a feed lot in the U.S. can be labeled as coming from the U.S.
Retailers are given discretion how they label the food. Meat counters, for instance, may simply list all the countries where the meat is produced, or they can label each cut. Hamburger will still likely give the consumer pause as meat that is ground up may come from numerous countries.
Once compliance goes into effect, businesses may be fined $1,000 per violation. The law is expected to cost at least $2 billion to implement.
Visit our website at http://www.sebastiangibsonlaw.com if you have an agriculture or agricultural, food, wine, drink or regulatory law issue. We have the knowledge and resources to represent you as your <A HREF=”http://www.sebastiangibsonlaw.com”>California Agricultural Lawyer</a> and <A HREF=”http://www.sebastiangibsonlaw.com”>California Food and Drink Attorney </a> or your attorney in the areas surrounding cities such as any of the cities in the Coachella Valley including Palm Springs, Palm Desert, Cathedral City, Indian Wells, Yucca Valley, Joshua Tree, Rancho Mirage, Desert Hot Springs, Indio, Coachella, La Quinta, or cities in San Diego, and Orange County, such as La Jolla, Del Mar, Carlsbad, San Clemente, Newport Beach, Laguna Beach, Huntington Beach, Anaheim, Santa Ana, Buena Park, Rancho Cucamonga, Ontario, Riverside, Temecula or Fullerton.
About the Author
Sebastian Gibson graduated cum laude at UCLA in 1972 and received two law degrees in the U.S. and the U.K., graduating with an LL.B. magna cum laude from University College, Cardiff in Wales and a J.D. from the University of San Diego School of Law in Southern California.
Mr. Gibson’s practice focuses on the areas of personal injury and wrongful death, business law, corporations, real estate, international law, entertainment law, patents, copyrights and trademarks, and a wide variety of other legal areas.
Sebastian Gibson is admitted before the Superior Courts of California as well as several Federal District Courts. He is the senior partner at the Law Offices of R. Sebastian Gibson.
The Sebastian Gibson Law Firm serves all of San Diego, Orange County, Palm Springs and Palm Desert, the Coastal Cities from La Jolla and Del Mar to Laguna Beach, Newport Beach, Irvine, Santa Ana and Irvine and up to Ventura, Santa Barbara and San Luis Obispo.
Visit the Sebastian Gibson Law website at http://www.SebastianGibsonLaw.com . We have the knowledge and resources to represent you as your California Food Poisoning Lawyer and California Foodborne Disease Attorney .
How to search courses for learning Spanish
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Actually Spanish is the first language program developed and remains are the most popular. A team of talented voice artists,fathers for Spanish lessons Christchurch, inguists, language educators, software developers, web experts, and support staff facilitates the creation and implementation of the language programs.
The voice of fathers work in the voice artist’s work in Spanish lessons Christchurch in teams, creating the conversations their students will eventually hear as gradual and sequential lessons called conversational learning. Highest attention is paid to every detail, with a focus on effective standard teaching methodology, substantive learning practices, and forward-looking interactive learning software.
Spanish classes Auckland is only be beneficial if the language school has a full schedule of Spanish class to choose from. Some Spanish classes Melbourne schools offer only three to four classes in weak and other schools are offer up to 45 scheduled classes with all levels from beginners upwards. There are various spanish courses Auckland are available that are following Augusta, ballybunion, leopard creek, Kingston heath, st.Andrews old course, valderrama, nine bridges, cabo del sol, pebble beach. These are most popular golf courses in Melbourne, Ailsa at turn berry.
Learn Spanish Auckland is very easy for United States of America people. Learn Spanish Auckland classes are available in Mumbai also. Language skills are saves you at the time of going other countries. The classes for learn Spanish Auckland they realized the need after they were done with school. Between the work and family you really don’t see where you can fit in the time learn another language. Learn Spanish Auckland is rocket languages. Auckland is one of the most popular multi-cultural cities in entire the world, so it’s very understandable that non-English speaking people deem it to be an ideal place to grasp the English language. Over a quarter of the country’s population lives in Auckland and the people are Learn Spanish Auckland easily and quickly.
Talking about Spanish classes’ wellington, the community is known globally in entire the world for hosting equestrian and polo event. As the fact, it has become host to both the National Horse Show and the Winter Equestrian Festival, which is one of the reasons why it is highly regarded as one of the “Best Polo Destinations in the World”. Spanish classes’ wellington schools are offer only 3-4 classes within a week, while others offer up to 45 scheduled Spanish classes with all levels from beginners upwards. At the time of busy schedule classes you can also select a semi private class for Spanish or private Spanish lessons that are learn any level of Spanish.
About the Author
Shaily John is an author for learnspanishonline ( http://learnspanishonline.net.au ), one of the best online spanish language school in Melbourne, Australia. She has been writing articles about spanish classes auckland for many years.
“Anomaly – The True Architects of the Economic Crisis?”
Those of you who followed Nouriel Roubini during the Asian Currency crisis over a decade ago* should have already recognized the similarity between that crisis and this one. Roubini was recently interviewed and gave his opinion:
“The U.S. has been living in a situation of excesses for too long. Consumers were out spending more than their income and the country was spending more than its income, running up large current-account deficits. Now we have to tighten our belts and save more. The trouble is that higher savings in the medium term are positive, but in the short run a consumer cutback on consumption makes the economic contraction more severe. That’s the paradox of thrift. But we need to save more as a country, and we have to channel more resources to parts of the economy that are more productive. And when you have too many financial engineers and not as many computer engineers, you have a problem…
…I think this country needs more people who are going to be entrepreneurs, more people in manufacturing, more people going into sectors that are going to lead to long-run economic growth. When the best minds of the country are all going to Wall Street, there is a distortion in the allocation of human capital to some activities that become excessive and eventually inefficient.”
However, Nobel laureate Robert Merton of the Harvard Business School has a different perspective:
http://www.infidelrevolution.com/profiles/blogs/the-true-architects-of-the/edit#
“Moving forward, we need more financial engineers, not fewer risk and innovation, including derivatives, are not going away, and we need senior managements, boards, and regulators of financial institutions who understand them.”
Who are the Financial Engineers? And What the Hell Are They Talking About?
I received my Master of Science in Financial Engineering degree back in 2002 and still to this day no one knows what the hell that means. Ok, Financial Engineers are often “rocket scientists” (literally) that are hired by large banks and multinational corporations to build sophisticated mathematical models with the intention to predict the likelihood of risky events, to provide valuations for instruments that are traditionally hard to price, and to create synthetic securities for the hedging risk (and sometimes for speculating).
“As LBO specialist Ted Stolberg once told Inc. Magazine, ‘Financial engineering is a lot like building a bridge. You can build it anyway you like as long as it doesn’t collapse when heavy trucks run over it and you can add additional lanes when you want more traffic to go over it. And when it’s all done, it should be a thing of beauty, like the Golden Gate’” (Warsh, 1993, p. 296).
These “quants”, as they are lovingly called, are often lured from poor paying academic jobs by Wall Street to high paying jobs in London, New York, Chicago, or California. The corporate executives that hire these Quants often like to remind their investors that everything will be alright because of the brilliant minds they now have on the payroll.
Unfortunately, there are two large problems in financial engineering that have emerged in hindsight. First, finance is ultimately about human beings and their relationships to each other. Real finance bears little resemblance to the logical order of math and physics. Most models in finance begin with the basic assumption of “Homo Economus”, the assumption that man is a rational being. This has largely been proven to be a faulty assumption thanks to the recent research of cognitive neuroscience.
Second, the output from the financial models is misinterpreted by the decision makers in senior level management. As Alfred Korzybski said, “The map is not the territory”. Much too much decision making has been based upon these models, giving them far too much weight. Senior executives seem all to eager to confirm their successes and deny their failures, it is human nature after all.
Financial Models: Stock Market Rationality or Irrationality?
“It is more than a metaphor to describe the price system as a kind of machinery, or a system of telecommunications which enables individual producers to watch merely the movement of a few pointers, as an engineer might watch the hands of a few dials, in order to adjust their activities to changes of which they may never know more than is reflected in the price movement.”
- F.A. Hayek
The efficient market hypothesis is quite appealing conceptually and empirically, which accounts for its enduring popularity. In a nutshell, efficient stock markets are generally thought of as equilibrium markets in which security prices fully reflect all relevant information that is available about the “fundamental” value of the securities (Tangentially, Benjamin Graham, famous for co-authoring the fundamentalist treatise Security Analysis with David L. Dodd, was quoted as saying shortly before his death, “I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities… I doubt whether such extensive efforts will generate sufficiently superior selections to justify their costs… I’m on the side of the ‘efficient market’ school of thought…” [Malkiel, 1996, p. 191]).
Despite its popularity, efficient capital markets theory has weathered some very appropriate criticisms. Since a theory is a model of reality and not “reality” itself, anomalies arise where theory does not mirror reality and the theory of efficient capital markets is no exception. Ray Ball’s article The Theory of Stock Market Efficiency: Accomplishments and Limitations (Ball, 1994, p. 40) presents a mostly balanced perspective and illuminates some interesting anomalies:
1) A study by French and Roll suggests that prices overreact to new information which is then followed by a correction, allowing contrarian investors to take profits.
2) Excess volatility of prices due to the “extraordinary delusions and madness of crowds”.
3) Prices underreact to quarterly earnings reports, which in itself seems an anomaly in the tendency of prices to overreact to new information.
4) A recent study by Fama and French provides evidence that there is no relationship between historical betas and historical returns which has lead many to believe the equilibrium-based CAPM, developed greatly due to the enormous amount of empirical data on efficiency, has failed. (Not included in Ball’s article, but told in Malkiel’s A Random Walk Down Wall Street is the story of how Fama and French also determined that buying a stock that has performed poorly for the past two years will often give you above average returns during the next two years (Malkiel, p. 198), thereby allowing contrarians to take a profit once more.)
5) There are seasonal patterns to be found in the data on stock returns or small firms, such as the “January effect”, where stock prices are unusually higher during the first few days of January or the “weekend effect” where average stock returns negatively correlated from closing on Friday to closing on Monday.
Anomalies missing from Ball’s article include:
1. the evidence that firms with low price-earnings ratios outperform those with higher P/E ratios.
2. the evidence that stocks that sell with low book-value ratios tend to provide higher returns.
3. the evidence that stocks with high initial dividends tend to provide higher returns (Malkiel, pp. 204 -207).
Where Ball’s article differentiates itself from most other summaries of the trials and tribulations of the theory of efficient capital markets is in a section titled “Defects in ‘Efficiency’ as a Model of Stock Markets” (Ball, p. 41 – 46) where he discusses the general neglect within the theoretical and empirical research on stock market efficiency of the processing and acquisition costs of information. This neglect could be the reason for the anomalies, such as the “small firm effect”, the tendency of small cap stocks to provide higher returns. He also criticizes the assumption in the efficient markets hypothesis of investor “homogeneity” and suggests the need for a new research program.
Ball also considers the role of both transactions costs in the efficient markets theory literature “largely unresolved” and the effect of the actual market mechanism on transacted prices, also known as “market microstructure effects”. He defends efficient markets theory from Robert Shiller’s argument (that the historical variance of stock prices has been much more volatile than can be justified by historical variance in actual dividends) by challenging Shiller’s use of a constant market expected return in nominal terms. Since CAPM assumes a constant risk free rate of return and a constant market risk premium it is impossible to determine a “correct” amount of variance in the market index.
Ball also defends market efficiency from Shiller and other behavioralists in maintaining that the mean-reversion in stock returns does not necessarily imply market irrationality. CAPM does not claim to dismiss the trend for periods of relatively high returns to be followed by periods of relatively low returns. In fact, such cyclical patterns may be the result of rational responses by investors to political/economic conditions and corporations to changes in investor demand for stocks.
Ball then grants more space to Shiller and the behavioralists by ending his piece with the rhetorical question “Is ‘behavioral’ finance the answer?” He very quickly answers, “I don’t think so” (Ball, p. 47). I would rephrase the question so it reads “Does ‘behavioral’ finance yield useful answers?” and my answer would be “yes.” Whether or not investors behave rationally, that is, whether or not investors accurately maximize expected utility is an important assumption of the efficient market hypothesis and if it is not true, it may explain why the anomalies exist.
Work in prospect theory by Allias, Kahneman and Tversky provides important evidence that the standard assumption of expected utility maximization assumed by most financial economists may not furnish accurate representations of human behavior (prospect theory states that individuals are better represented as maximizing a weighted sum of “utilities,” determined by a function of true probabilities which gives zero weight to extremely low probabilities and a weight of one to extremely high probabilities). While such evidence is not damning, it is troubling to say the least (Shiller, 1997).
Interestingly enough, Ball’s article omits the common practice of financial economists to categorize the theory of the stock market efficiency into three types which, from least to most orthodox, are as follows:
1. The weak form states that the history of stock price movements contains no useful information enabling investors to consistently outperform a buy-and-hold portfolio management theory.
2. The semi-strong form maintains that no available published information will help security analysts select “undervalued” securities.
3. The strong Form holds that everything known or even knowable about a company is reflected in the price of the stock.
Statistical evidence lends credibility to the weak and semi-strong forms, and discounts the strong form revealing that corporate insiders have earned excess profits trading on inside information. In support of the weak and semi-strong forms, the results of Ball and Brown’s mid-1960’s study (Ball, p. 35) of how the stock market actually responds to announcements of annual earnings suggests that the market anticipates approximately 80% of the new information found in annual earnings before the earnings were actually announced. In other words, investors were mostly deprived of future opportunities to profit from the new information since stock prices had already processed the information released in the annual earnings reports.
It seems to me investors and “Quants” alike would do well to not to swallow any one approach whole, warts and all, but to carefully weigh the evidence of all the different approaches. In scientific experimentation, where Quants feel at home, there are no success and failures, only outcomes or results. All that emerge are data points that tell you if you hypothesis is correct or not. Unfortunately, in capital markets, if an “experiment” is leveraged enough, you can bankrupt entire countries, and now, perhaps even the world. In capital markets, the real risk of experimentation like this can result in people not eating.
What is Risk and Where Does Financial Engineering Come In?
Well, we can intuitively say there seems to be a positive relationship between risk and uncertainty. The more certain we can be of a particular outcome, the less risky it is. However, in a dynamic world such as ours where we can barely (and usually inaccurately) predict the weather five days from now, how can a financial manager, farmer, or any interested party expect to predict, say, the price of tea in China weeks, months, or even years from now?
This is where the beautiful asymmetric nature of a financial instrument called an “option” comes in:
“A call option is the right to buy a specified quantity of some underlying asset by paying a specified exercise price, on or before an expiration date.
A put option is the right to sell a specified quantity of some underlying asset for a specified exercise price, on or before an expiration date” (Figlewski and Silber, 1990, p. 4).
An investor’s potential loss is limited to the premium, while the potential profit is unlimited. So while it may be impossible to predict the future price of tea in China, it is possible to set a floor for the amount of loss allowed to occur without setting a ceiling on the profits reaped.
Options belong to a class of financial instruments called derivatives, aptly named because they derive their value from something else. Options, for example, derive their value from an underlying asset. Other derivatives include interest rate and exchange rate futures and swaps, whose values depend on interest and exchange rate levels (some parties exchange cash payment obligations because they may prefer someone else’s payment stream), commodity futures, whose value depend on commodity prices, and forward contracts, which are similar to future contracts except that the commodity under contract is actually delivered upon a specified future date. But how can we use these instruments to minimize our exposure to risk?
“Financial engineering is the use of financial instruments to restructure an existing financial profile into one having more desirable properties” (Galitz, 1995, p. 5). In other words, it is the province of the financial engineer to design “synthetic” securities to achieve desired risk-return results. You take combinations of option, futures, swaps, etc. and create new securities to mitigate unforeseen risks.
Assuming that the cash flows between the straight security and the synthetic portfolio are equivalent, then any difference in the present market values of the two is an arbitrage opportunity. An arbitrage is trade in which one buys something at one price and simultaneously sells essentially the same thing at a higher price, in order to make a riskless profit (In an efficient market such opportunities should be rare, and when the wily investor took advantage of it the very process should drive the price of what they are buying up and the price of what they are selling down).
A Simple Example of How Financial Engineering Actually Works
In his article, The Arithmetic of Financial Engineering (Smith, 1999, p. 534) Donald J. Smith uses simple arithmetic and algebra to illustrate the relationships of a variety of different security combinations (synthetic securities) used by financial engineers to create these unique risk-return trade-offs.
His basic explanatory formula looks like this;
A + B = C
where,
A + B comprise the synthetic portfolio
C is the straight security
+ sign denotes a long position, or a lending posture
- sign denotes a short position, or a borrowing posture
Using the arithmetic outlined above, Smith can illustrate the relational structure of such synthetic securities as;
Interest rate swaps
+ Interest Rate Swap = + Unrestricted Fixed Rate Note – Floating Rate Note
The coupon for most bonds is fixed ahead of time, hence the name fixed-income securities, but many issues have coupons that are reset on a regular basis and therefore float, these are called floating rate notes.
Collars
+ Collar = + Cap – Floor
“Caps” and “Floors” are option contracts that guarantee the maximum [cap] and minimum [floor] rate that can be reached. Caps and floors are essentially interest rate insurance contracts that insure against losses from the interest rates rising above or falling below determined levels.
Mini-Max Floater
+ Mini-Max Floating Rate Note = + Typical Floating Rate Note – Cap
Inverse Floaters
- Inverse Floater = – Two Fixed Rate Notes + Unrestricted Floating Rate Note – Cap
Inverse floaters appeal to those investors who are bullish on bond prices and expect interest rates to drop. This is the synthetic security that Robert Citron used wrongly and ended up bankrupting Orange County, California when the Federal Reserve sharply raised interest rates in 1994. This folly ended up costing Orange County $1.7 billion in 1994 dollars!
Participation Agreements
+ Participation Agreement = + Cap – Floor
This simple arithmetic formula wields great explanatory power for those who seek to an easy understanding of the complexities of financial engineering. However, the financial engineer must be cautious with the double edged sword of derivative instruments. When used to hedge, derivatives can be invaluable guards against risk, however if used to speculate, they can invite unnecessary risks. Also, hubris can be devastating as sometimes the payoffs can be too complex to fully understand. Unintended consequences can be a bitch (see credit default swaps)
The United States Government = The Paleo-Financial Engineers
“Blessed are the young, for they shall inherit the national debt”
-Herbert Hoover
Let’s look at one of the most complicated financial engineering schemes of all time, the relationship between the United States Treasury and the Federal Reserve system. The Federal Reserve is a privately owned corporation. In other words as the popular phrase goes, “The Federal Reserve is as ‘federal’ as Federal Express”. The largest stock holders of the Federal Reserve bank are the 17 largest banks on the planet.
As a matter of record, for the United States the last century has been one of deficits and debt. Simply put, a deficit occurs whenever you spend more than you have. Every time the government spends more than it has it must issue a debt instrument or I.O.U., usually a U.S. Treasury bond, to cover the expenses.
The Federal Reserve banking cartel buy these bonds (with paper currency literally created out of thin-air) on the promise that the government will pay the Federal Reserve back both the principal and a fixed rate of interest. In exchange for this interest payment, the Federal Reserve literally creates money (mostly electronically and completely out of thin air) through manipulated ledger accounts. What most people fail to recognize is that the main way Treasury generates the revenue to pay off it’s debt to the Federal Reserve is through taxation. Simply put, our income taxes goes directly to bankers.
A more sobering fact is this, to get an idea of how much the U.S. owes to bondholders (i.e., the Federal Reserve banking cartel) just take a look at the National Debt. It towers at over $11 trillion (remember a trillion is a thousand billion, and a billion is a thousand million, and million is a thousand thousand. With an estimated population of the United States of 305,367,770, that means that each United States citizen’s share of the outstanding public debt is nearly $40K at this writing. The tricky part is this, if the growth of the debt is constant and greater than the rate of growth of average real income, then what should we expect the government to do when tax revenues are no longer sufficient to pay the interest on the debt?
Then once the money (again, which was created out of thin-air) trickles down back into the economy as the government spends it, and finds its way back into the private banks. Once there, the real inflation begins through the magic of fractional reserve banking. This is all documented in the Federal Reserves’ own manual entitled “Modern Money Mechanics”. In a nutshell, since they only maintain a fraction of the actual reserves on-hand (while their ledgers falsely say they have the whole amount) the currency is inflated and the risk of bank runs are ever present.
There are only three basic courses of action the government can take; repudiate, hyperinflate, or liquidate. I favor the liquidation of governmental assets (non-essential governmental properties like the FDA, FCC, or the IRS) over repudiation or hyperinflation simply because liquidation of governmental assets is the surest way to end big government as we know it. Repudiation would shock the economy, interest rates would skyrocket, and bond prices would plummet; too much risk involved. Hyperinflation would only devalue the currency and impoverish everyone concerned.
In Conclusion
All this brings me back full circle to Nouriel Roubini’s quote again:
“The U.S. has been living in a situation of excesses for too long. Consumers were out spending more than their income and the country was spending more than its income, running up large current-account deficits. Now we have to tighten our belts and save more. The trouble is that higher savings in the medium term are positive, but in the short run a consumer cutback on consumption makes the economic contraction more severe. That’s the paradox of thrift. But we need to save more as a country, and we have to channel more resources to parts of the economy that are more productive. And when you have too many financial engineers and not as many computer engineers, you have a problem…
…I think this country needs more people who are going to be entrepreneurs, more people in manufacturing, more people going into sectors that are going to lead to long-run economic growth. When the best minds of the country are all going to Wall Street, there is a distortion in the allocation of human capital to some activities that become excessive and eventually inefficient.”
I wholeheartedly agree that the solution lies in entrepreneurship. However, the quote is bookended by the concept of “excess” and associates it with our economic crisis. This begs the question though, who are the true architects of this excess, the Financial Engineers alone or are the Federal Reserve and the U.S. Treasury complicit as well?
REFERENCES
Hayek, F. A. (September, 1948). The Use of Knowledge in Society. The American Economic Review, XXXV, No. 4.
Malkiel, B. G. (1996). A random walk down wall street. New York, N.Y.
Ball, R. (1994). The theory of stock market efficiency: accomplishments and limitations. In D. H. Chew, Jr. (Ed.), The new corporate finance; where theory meets practice (pp. 35 – 48). Boston, MA.
Shiller, R. J. (1997). Human Behavior and the Efficiency of the Financial System. [online]. Available: http://www.econ.yale.edu/~shiller/handbook.html.
Warsh, D. (January 17, 1988). After the Crash (financial engineering). economic principals. New York, N. Y.
Figlewski, S. and Silber, W. L. (1990). financial options: from theory to practice. New York, N. Y.
Galitz, L.C. (1995). financial engineering: tools and techniques to manage financial risk. Burr Ridge, Illinois.
Smith, D. J. (1999). The Arithmetic of Financial Engineering. In D. H. Chew, Jr. (Ed.), The new corporate finance; where theory meets practice (pp. 535 – 543). Boston, MA.
(June 20, 1999).
*The Lessons of the Yen (I wrote this back in 1998 for the Golden Gate University student newspaper, if you substitute “Japan” for “America” it could be true today)
As little as ten years ago it was thought that America’s unemployment and growth rates would never be more appealing than those of Japan’s. Such thinking has proven wrong, and the sting is being felt around the world.
What effect, if any, do problems in one part of the world have on the others? Well, the sinking Japanese economy, the latest of the Asian Tigers to be struck by the Asian currency crisis iceberg is cause for concern for some Golden Gate University students in San Francisco. International students receiving funds from Japan are the most immediately affected. Erina Ishikawa (MBA, entrepreneurship) and Dongil Yun (masters, computer information systems), have both felt the effects of an unfavorable exchange rate since the decline of the Yen. “When I came (to America) ten years ago, things were much cheaper for us in Japan, now the opposite is true,” said Yun.
Anticipating economic problems in Japan and noticing higher interest rates in the US, Misa Aoki (MA, Public Relations) changed her Yen savings to dollars over a year ago. While not impacted by the threat of waning purchasing power due to her foresight, she still worries about finding a job after graduating and returning to Japan. Such fears are not unfounded. The rising unemployment rate of 4.1% is the highest in Japan since World War II.
Fortunately, none of those interviewed knew of anyone who has had to drop out of school and return to Japan because of the crisis. They all said that they were concerned for the future of Japan’s economy, but that they ultimately do not think that the current crisis is that big of a deal. Jiro Ushio, chairman of the powerful Japan Association of Corporate Executives echoes the same sentiment, “[t]he realities of Japan’s economy are not as bad as the world thinks.” The president of the American Chamber of Commerce in Japan, Glenn S. Fukushima, said, “[f]undamentally it comes down to the fact that people in Japan generally don’t think that things are so bad that they need to have fundamental change.”
Even some in Japan feel that the US expects its own bubble economy to pop soon and is merely looking for a scapegoat. Obviously, there were problems enough for Secretary of the Treasury, Robert Rubin, to intervene to prop up the falling Yen in mid-June. His multi-billion dollar gamble paid off in the short run, reversing the Yen’s slide by 8% within one day.
Critics of Japan’s government maintain that the under guidance by the Ministry of Finance, Japanese banks made bad loans to weak companies instead of letting the market work. The bad loans account for more than $600 billion, an amount larger than the entire economy of China, the world’s most populated country. Surprisingly however, the Japanese people overwhelmingly re-elected the current government.
Prescriptions for recovery are everywhere, MIT’s Paul Krugman suggests that Japan’s central bank should inflate the money supply and lower interest rates to stimulate domestic demand, while others say that Japan’s April deregulatory “Big Bang” liberalization program will ultimately pay off in the long run. Whether the “big bang” or a more Schumpeterian “evolutionary” course is taken, with last week’s resignation of Prime Minister Hashimoto, the future is uncertain.
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